TS Grewal Solution Class 12 Chapter 2 Financial Statement Analysis

Assessing the earning capacity of profitability of the business and assessing the managerial efficiency are two objectives of Financial Statement Analysis.

Question 14. One of the objectives of Financial Statement Analysis is to identify the reason for change in the financial position of the enterprise states two more objectives of this analysis.

One objective of financial Statement Analysis is to identify the reason for change in the financial position of the enterprise. Inter-firm comparison and forecasting and preparing budgets are two more objectives of this analysis.

Question 15. One of the objectives of Financial Statement Analysis is to Judge the ability of the firm to repay its debts and assessing the short term as well long term liquidity position of the firm state two more objectives of this analysis.

One of the objectives of ‘Financial Statement Analysis’ is to judge the ability of the firm to repay its debts and assessing the short-term as well as the long-term liquidity position of the firm. Inter-firm comparison and forecasting and preparing budgets are two more objectives of this analysis.

Question 16. What is meant by Solvency of Business?

Solvency of Business means the ability of the firm to pay the short-term and long-term liabilities in time with interest on long-term borrowings.

Question 17. How the Solvency of Business is assessed by Financial Statement Analysis?

The short-term and long-term solvency of a business is assessed by Financial Statement Analysis by using ratio analysis and comparative statements.

Question 18. How the earning capacity of a business is assessed by Financial Statement Analysis?

The earning capacity of a business can be assessed by financial analysis and ratio analysis technique.

Question 19. State any two limitations of Financial Statement Analysis?

The Following are two limitations of Financial Statement Analysis:

(a) Historical Analysis

(b) Ignores Price Level Changes

Question 20. How Window dressing become a limitation of Financial Statement Analysing?

Window dressing refers to the presentation of a better financial position than what it actually is by manipulating the books of account. On account of such a situation, financial analysis may give false information to the users.

Question 21. How does subjectivity become a limitation of Financial Statement Analysis?

Analysis of financial statements is based on the information given in the financial statements. Hence, this analysis suffers from all such limitations from which the financial statements suffer. Therefore, unless the basic data given in the financial statements.

Question 22. Name any two parties interest in Financial Statement Analysis?

The two parties interested in Financial Statement Analysis are:

(a) Suppliers or Creditors

(b) Bankers and Lenders

Question 23. State why Shareholders are intrusted in Financial Statement Analysis?

Shareholders or Owners or Investors invest their savings in the enterprise. Therefore, they are interested in profitability and safety of their investments. They would like to know whether the business is profitable, have growth potential and its progress is on expected lines. Growth potential of business helps in appreciation of their investment.

Question 24. State why creditors are intrusted in Financial Statement Analysis?

Creditors or Suppliers for goods are interested in Financial Statement Analysis to know the short-term solvency position of a firm, which is the ability to meet its short-term solvency of a firm, can be determined with the help of financial statements. On the basis of analysis, they decide whether they should allow credit to the enterprise or not.

Question 25. State the intrust of trade unions in Financial Statement Analysis?

Trade Unions or Employees are interested in the Analysis of Financial Statement in their better working conditions, security of their jobs and better wage payments.

Question 26. State the Management of trade unions in Financial Statement Analysis?

Management is interested in the Analysis of Financial Statements to ascertain overall as well as segment-wise efficiency of their business. It also helps the management in decision-making controlling and self-evaluation.

Question 27. How Question ualitative aspects are ignored in Financial Statement Analysis?

Qualitative aspects are ignored in Financial Statement Analysis because these are confined to monetary alone, the qualitative aspects like quality of management, quality if staff, public relations are ignored while carrying out the analysis of financial statements.

Question 28. How the Financial Statement Analysis is useful to Financial Manager?

Financial Statement Analysis is useful to Financial Manager for deciding about the rate of divided; identify the key profit drivers and business risk in order to assess the profit potential of the firm. 

Question 29. State the significance of Analysis of Financial Statements to the lenders?

The significance of Analysis of Financial Statements to the ‘Lenders’ or ‘Bankers’ is in serving loans granted to an enterprises, that is regular repayment of principal and interest.

Question 30. State the significance of Analysis of Financial Statements to the Creditors?

The significance of Analysis of Financial Statement to the ‘Creditors’ is that, they are interested to know the short-term solvency position of firm, the ability to meet its short term liabilities.

Question 31. State one advantage of Financial Statement Analysis?

One advantages of Financial Statement Analysis is to identify the key profit drivers.

Question 32. State any one limitations of Financial Statement Analysis?

One limitation of ‘Analysis of Financial Statements’ is ignorance to the quality aspects like quality of management, quality of staff, public relations, while carrying out the analysis.

Short Answer Type Questions:-

Question 1. What is meant by analysis of financial statements? State any two objectives of financial analysis.

Financial Statement Analysis means a systematic of analyzing the financial information in the financial statements to understand and make decisions regarding the operations of the enterprise."

The lists of two objectives of analyzing the Financial Statements are:

(a) lnter-firm Comparison:- becomes easy with the help of financial analysis. It helps in assessing their own performance as well as that of others, if mergers and acquisitions are to be considered."

(b) Forecasting and Preparing Budgets:- Past financial statement analysis helps in assessing developments in future, especially in the next year.

Question 2. What is meant by analysis of financial statements? State any two limitations of financial analysis.

Financial Statement Analysis means a systematic process of analysing the financial information in the financial statements to understand and make decisions regarding the operations of the enterprise. 

The following are three disadvantages of Analysis of Financial Statements: 

(a) Variation in Accounting Practices: For inter-firm comparison, it is necessary that accounting practices followed by the firms do not vary significantly. As there may be variations in accounting practices followed by different firms, a meaningful comparison of their financial statements is not possible. 

(b) Window Dressing refers to the presentation of a better financial position than what it actually is by manipulating the books of account. On account of such a situation, financial analysis may give false information to the users.

Question 3. Briefly explain the various financial statement analysis techniques.

The various Financial Statement Analysis techniques are explained below: 

Comparative Statements mean a comparative study of individual items or Components of financial statements. That is Balance Sheet and Statement of Profit and Loss of two or more years are placed side by side along with change in amounts in absolute and percentage terms to facilitate comparison. 

Common-Size Statements mean statements in which individual items of financial statements of two or more years are placed side by side and thereafter converted into percentage taking a common base normally taken is total of assets or equity and liabilities, in case of Common-size Balance Sheet and Revenue from Operations, in the case of Common-size Statement of Profit and Loss. In the Balance Sheet, the total of assets or equity and liabilities is taken as 100 and all the figures are expressed as percentage of total. Similarly, in the Statement of Profit and Loss, Revenue from Operations, that is, Net Sales is taken as 100 and all amounts are expressed as a percentage of Revenue from Operations, that is, Net Sales. 

Ratio Analysis: Ratio is an arithmetical expression of relationship between two related or interdependent components of financial statements of an accounting period, Ratio analysis is an important technique for analysing financial statements, that is, Balance Sheet and Statement of Profit and Loss.

Cash Flow Statement is a statement showing flow of Cash and cash Equivalents during the accounting period, classified under Operating Activities, Investing Activities and Financing Activities. It shown the sources from which cash is received or generated and the purposes for which it is utilities or used. It also shows the change in cash position form one period to another.

Question 4. State any three advantages and three limitations of Analysis of Financial Statements.

The following are three advantages of Analysis of Financial Statements:

(a) Assessing the Earning Capacity or Profitability: On the basis of financial analysis, the earning capacity of an enterprise can be assessed. In addition, the earning capacity of the enterprise, in coming years, may also be forecast. All the external users of financial statements, especially investors and potential investors, are interested in earning capacity and forecast.

(b) Inter-firm Comparison becomes easy with the help of financial analysis. It helps in assessing their own performance as well as that of others, if mergers and acquisitions are to be considered.

(c) Explainable and Understandable: Financial analysis helps the users of the financial statements to understand the complicated matter in a simplified manner. Financial data can be made more comprehensive by charts and diagrams, which can be easily explained and understood.

The following are three disadvantages of Analysis of Financial Statements:

(a) Variation in Accounting Practices: For inter-firm comparison, it is necessary that accounting practices followed by the firms do not vary significantly. As there may be variations in accounting practices followed by different firms, a meaningful comparison of their financial statements is not possible."

(b) Window Dressing refers to the presentation of a better financial position than what it actually is by manipulating the books of account. On account of such a situation, financial analysis may give false information to the users.

(c) Identifies Symptoms: Financial1analysis identifies symptoms of the problems but does not offer its diagnosis. The management has to look for the remedy to rectify the problems.

Question 5. List any three objectives of analysing the Financial Statements.

The list of three objectives of analysing the Financial Statements is:

(a) lnter-firm Comparison becomes easy with the help of financial analysis. It helps in assessing their own performance as well as that of others, if mergers and acquisitions are to be considered.

(b) Forecasting and Preparing Budgets:  Past financial statement analysis helps in assessing developments in future, especially in the next year.

(c) Explainable and Understandable: Financial analysis helps the users of the financial statements to understand the complicated matter in a simplified manner. Financial data can be made more comprehensive by charts and diagrams, which can be easily explained and understood.

Question 6. What is meant by analysis of financial statements? How is useful for Creditors, Management, Investors, Employees, Government and Customers.

Financial Statement Analysis means a systematic process of analysing the financial information in the financial statements to understand and make decisions regarding the operations of the enterprise. It is helpful for:

(a) Creditors: Creditors or Suppliers for goods are interested in Financial Statement Analysis to know the short-term solvency position of a firm, which is the ability to meet its short-term solvency of a firm, can be determined with the help of financial statements. On the basis of analysis, they decide whether they should allow credit to the enterprise or not.

(b) Management: Management is interested in the Analysis of Financial Statements to ascertain overall as well as segment-wise efficiency of the business. It also helps the management in decision-making, controlling and self-evaluation.

(c) Investors: Shareholders or Owners or Investors invest their savings in the enterprise. Therefore, they are interested in profitability and safety of their investments. They would like to know whether the business is profitable, has growth potential and its progress is on expected lines. Growth potential of business helps in appreciation of their investment.

(d) Employees: Trade Unions or Employees are interested in the Analysis of Financial Statements in their better working conditions, security of their jobs and better wage payments."

(e) Government: Government is interested to know the legality of the business and betterment of society. It is interested in ensuring proper assessment of tax liabilities of the enterprise as per the laws in force from time to time.

(f) Customers: Customers have an interest in information about the continuance of an enterprise, especially when they have a long-term involvement with, or are dependent on, the enterprise.

Question 7. What is meant by analysis of financial statements? What is importance of Shareholders and Employees?

Financial Statement Analysis means a systematic process of analysing the financial information in the financial statements to understand and make decisions regarding the operations of the enterprise.

The importance of Analysis of Financial Statements to shareholders and employees are given below:

(a) Shareholders: Shareholders  or  Owners  or  Investors  invest  their  savings  in  the  enterprise. Therefore, they are interested in profitability and safety of their investments. They would like to know whether the business is profitable, has growth potential and its progress is on expected lines. Growth potential of business helps in appreciation of their investment.

(b) Employees: Trade Unions or Employees are interested in the Analysis of Financial Statements in their better working conditions, security of their jobs and better wage payments.

Question 8. Briefly explain of the limitations of financial statement analysis?

The following are the brief explanation of the limitations of Financial Statement Analysis:

(a) Variation in Accounting Practices: For inter-firm comparison. it is necessary that accounting practices followed by the firms do not vary significantly. As there may be variations in accounting practices followed by different firms, a meaningful comparison of their financial statements is not possible.

(b) Window Dressing refers to the presentation of a better financial position than what it actually is by manipulating the books of account. On account of such a situation, financial analysis may give false information to the users.

(c) Identifies Symptoms: Financial analysis identifies symptoms of the problems but does not offer its diagnosis. The management has to look for the remedy to rectify the problems.

(d) Historical Analysis: Financial statement analysis is a historical analysis. It analyses what has happened till date. It does not reflect the future. Persons like shareholders, investors, etc., are more interested in knowing the likely position in future.

(e) Ignores Price Level Changes: Price level changes and purchasing power of money are inversely related. A change in the price level makes analysis of financial statements of different accounting years invalid because accounting records ignore change in value of money.

(f) Quality Aspect Ignored: Since the financial statements are confined to monetary matters alone. The qualitative aspects like quality of management, quality of staff, public relations are ignored, while carrying out the analysis of financial statements.

(g) Suffers from the Limitations of Financial Statements: Analysis of financial statements is based on the information given in the financial statements. Hence this analysis suffers from all such limitations from which the financial statements suffer. Therefore, unless the basic data given in the financial statements is reliable, the conclusions derived on the basis of the analysis of this data cannot be reliable.

(h) Not Free from Bias: In many situations, the accountant has to make a choice out of alterative available that is choice in the method of inventory valuation or choice in the method of depreciation. Since the subjectivity is inherent in personal judgment, the financial statements are, therefore, not free from bias.

Question 9. Difference between Intra-firm and Inter-firm analysis.

The following are the difference between Intra-firm and Inter-firm Analysis:

(a) lntra-firm Analysis: A comparison of financial variables of an enterprise over a period of time is known as Intra-firm Comparison. It is also called Time Series Analysis or Trend analysis. It analyses the performance of a business over a number of years and shows trend of financial factors.

(b) lnter-finn Analysis: A comparison of two or more enterprises or firms is known as Inter-firm Analysis. It analyses and compares financial variables of two or more enterprises or firms to determine their competitive position. When a single set of statements of two firms is compared, it is known as Cross­ sectional Analysis.

Question 10. Discuss the advantages of Financial statement analysis.

The advantages of Financial Statement Analysis are: 

(a) Assessing the Earning Capacity or Profitability: On the basis of financial analysis, the earning capacity of an enterprise can be assessed. In addition, the earning capacity of the enterprise.in coming years may also be forecast. All the external users of financial statements, especially investors and potential investors, are interested in earning capacity and forecast.

(b) Inter-firm Comparison: becomes easy with the help of financial analysis. It helps in assessing their own performance as well as that of others, if mergers and acquisitions are to be considered.

(c) Explainable and Understandable: Financial analysis helps the users of the financial statements to understand the complicated matter in a simplified manner. Financial data can be made more comprehensive by charts and diagrams, which can be easily explained and understood.

(d) Assessing Managerial Efficiency: The financial statement analysis helps to identify the area where the managers have been efficient and the area where they have been inefficient. Any favorable or unfavorable variation can be identified and reasons thereof can be ascertained to pinpoint managerial efficiency or inefficiency.

(e) Assessing the Short-term and Long-term Solvency of the Enterprise: long-term and short-term solvency of an enterprise can be assessed on the basis of financial statement analysis. Creditors or suppliers are interested to know the short-term solvency or liquidity of the enterprise. Debenture holders and lenders are interested to know the long-term solvency of the enterprise to assess the ability of the company to repay the principal amount and interest thereon.

(f) Forecasting and Preparing Budgets: Past financial statement analysis helps in assessing developments in future, especially in the next year. An analysis thus helps in forecasting and preparing the budget.

Question 11. What is meant by financial statement analysis? How is important from the point of view of creditors and management?

Financial Statement Analysis means a systematic process of analysing the financial information in the financial statements to understand and make decisions regarding the operations of the enterprise.

It is important from the viewpoint of creditors and management as given below:

(a) Creditors: Creditors or Suppliers for goods are interested in Financial Statement Analysis to know the short-term solvency position of a firm, which is the ability to meet its short-term solvency of a firm can be determined with the help of financial statements. On the basis of analysis, they decide whether they should allow credit to the enterprise or not.

(b) Management: Management is interested in the Analysis of Financial Statements to ascertain overall as well as segment-wise efficiency of the business. It also helps the management in decision-making, controlling and self-evaluation.

Question 12. Explain the importance of financial analysis?

The importances of Financial Analysis are:

(a) Assessing the Earning capacity or Profitability: On the basis of financial analysis, the earning capacity of an enterprise can be assessed. In addition, the earning capacity of the enterprise, in coming years, may also be forecast. All the external users of financial statements, especially investors and potential investors, are interested in earning capacity and forecast.

(b) lnter-firm Comparison becomes easy with the help of financial analysis. It helps in assessing their own performance as well as that of others, if mergers and acquisitions are to be considered.

(c) Explainable and Understandable: Financial analysis helps the users of the financial statements to understand the complicated matter in a simplified manner. Financial data can be made more comprehensive by charts and diagrams, which can be easily explained and understood.

(d) Assessing Managerial Efficiency: The financial statement analysis helps to identify the area where the managers have been efficient and the area where they have been inefficient. Any favorable or unfavorable variation can be identified and reasons thereof can be ascertained to pinpoint managerial efficiency or inefficiency.

(e) Assessing the Short-term and Long-term Solvency of the Enterprise: long-term and short-term solvency of an enterprise can be assessed on the basis of financial statement analysis. Creditors or suppliers are interested to know the short-term solvency or liquidity of the enterprise. Debenture holders and lenders are interested to know the long-term solvency of the enterprise to assess the ability of the company to repay the principal amount and interest thereon.

(f) Forecasting and Preparing Budgets: Past financial statement analysis helps in assessing developments in future, especially in the next year. An analysis thus helps in forecasting and preparing the budget.

Question 13. What is meant by financial statement analysis and what is the interest of Management and shareholders in such analysis.   

Financial Statement Analysis means a systematic process of analysing the financial information in the financial statements to understand and make decisions regarding the operations of the enterprise.

It is important from the viewpoint of creditors and management as given below:

Shareholders:- Shareholders or Owners or Investors invest their savings in the enterprise. Therefore, they are interested in profitability and safety of their investments. They would like to know whether the business is profitable, have growth potential and its progress is on expected lines. Growth potential of business helps in appreciation of their investment.

Management:- Management is interested in the Analysis of Financial Statements to ascertain overall as well as segment-wise efficiency of the business. It also helps the management in decision­ making, controlling and self-evaluation.

Question 14. What is meant by financial statement analysis? How it is useful to investors and employees.

Financial Statement Analysis means a systematic process of analysing the financial information in the financial statements to understand and make decisions regarding the operations of the enterprise.

It is useful to investors and employees as given below:

(a) Investors: Shareholders or Owners or Investors invest their savings in the enterprise. Therefore, they are interested in profitability and safety of their investments. They would like to know whether the business is profitable, has growth potential and its progress is on expected lines. Growth potential of business helps in appreciation of their investment.

(b) Employees: Trade Unions or Employees are interested in the Analysis of Financial Statements in their better working conditions, security of their jobs and better wage payments.

Question 15. How financial statement analysis is useful to Potential investors and Tax Authorities.

Analysis of Financial Statements is useful to potential investors and Tax Authorities as given below:

(a) Potential Investors:- Shareholders or Owners or Investors invest their savings in the enterprise. Therefore, they are interested in profitability and safety of their investments. They would like to know whether the business is profitable, have growth potential and its progress is on expected lines. Growth potential of business helps in appreciation of their investment.

(b)Tax Authorities:- Tax Authorities are interested in ensuring proper assessment of tax liabilities of the enterprise as per the laws in force from time to time.

Question 16. How financial statement analysis is important to Government Authorities.

Government Authorities are interested to know the legality of the business and betterment of society. It is interested in ensuring proper assessment of tax liabilities of the enterprise as per the laws in force. Government ensures timely collection of tax.

Question 17. Why is financial statement analysis important to Creditors?

Creditors or Suppliers for goods are interested in Financial Statement Analysis to know the short-term solvency position of a firm, which is the ability to meet its short-term solvency of a firm, can be determined with the help of financial statements. On the basis of analysis, they decide whether they should allow credit to the enterprise or not