Meaning of Analysis of Financial Statements

The process of critically evaluating the financial information contained in the financial statements to understand and make decisions about a firm’s operations is called Financial Statement Analysis. It is not merely reading the numbers — it is a study of the relationships among various financial facts and figures presented in the statements, and the interpretation of those relationships to gain insight into the firm’s profitability, operational efficiency, financial health, and future prospects.

The term ‘financial analysis’ includes both analysis and interpretation. Analysis means simplifying financial data through methodical classification. Interpretation means explaining the meaning and significance of that simplified data. These two are complementary: analysis without interpretation is useless, and interpretation without analysis is difficult or even impossible.

Financial statement analysis is a judgemental process. Its primary objective is to estimate the current and past financial positions and operating results of an enterprise, with the goal of making the best possible estimates and predictions about future conditions. It essentially involves regrouping and analysing the information provided by financial statements to establish relationships and highlight the strengths and weaknesses of a business enterprise.

This analysis is useful in decision-making that involves: …