Q.Explain briefly any four objectives of 'Analysis of Financial Statements'.
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Financial Statement Analysis – A First Look
Think of a doctor checking your health. They don't just look at your height or weight alone — they compare your current weight with last year's, check your pulse rate against normal ranges, and see if your fever is rising or falling. That's analysis: taking raw numbers and asking "what does this mean?"
Financial Statement Analysis is exactly that — but for a business. You already know the two main financial statements from Class 11: the Balance Sheet (a snapshot of what the business owns and owes on a particular date) and the Statement of Profit and Loss (the earnings story for the year). Analysis is what you do after those statements are prepared. You don't just read the numbers; you interpret them, compare them, and draw conclusions.
The Precise Meaning
As the NCERT Class 12 Accountancy textbook puts it:
Financial Statement Analysis is the process of reviewing, evaluating, and interpreting a business's financial statements to assess its performance, financial position, and future prospects.
In simpler words: you take the raw data from the Profit & Loss Account and Balance Sheet, and you turn it into useful insights — Is the company making enough profit? Can it pay its debts? Is it growing or shrinking?
Why Does It Matter?
Three big reasons:
- For owners and investors — to decide whether to invest more money or take some out.
- For lenders (banks) — to check if the business can repay loans.
- For managers — to spot problems early (e.g., rising costs, falling sales) and fix them.
Without analysis, a Balance Sheet is just a list of numbers. With analysis, it becomes a story.
The Tools of Analysis (What You Actually Do)
NCERT focuses on three main techniques:
1. Comparative Statements
You take the same statement (say, the Profit & Loss Account) for two consecutive years and put them side by side. Then you calculate the absolute change (increase or decrease in rupees) and the percentage change.
Format for a Comparative Statement of Profit & Loss:
| Particulars | Note No. | 2022–23 (₹) | 2023–24 (₹) | Absolute Change (₹) | Percentage Change (%) |
|---|---|---|---|---|---|
| Revenue from Operations | 5,00,000 | 6,00,000 | 1,00,000 | 20% | |
| Cost of Materials Consumed | 2,00,000 | 2,50,000 | 50,000 | 25% | |
| Gross Profit | 3,00,000 | 3,50,000 | 50,000 | 16.67% |
The percentage change is calculated as: (Absolute Change ÷ Previous Year Figure) × 100. Always use the earlier year as the base.
2. Common Size Statements
Here, you express every item as a percentage of a common base. For the Profit & Loss Account, the base is Revenue from Operations (100%). For the Balance Sheet, the base is Total Assets (or Total Liabilities).
Format for a Common Size Balance Sheet (partial):
| Particulars | Note No. | Amount (₹) | Percentage of Total |
|---|---|---|---|
| I. EQUITY AND LIABILITIES | |||
| Shareholders' Funds | 4,00,000 | 40% | |
| Non-Current Liabilities | 3,00,000 | 30% | |
| Current Liabilities | 3,00,000 | 30% | |
| Total | 10,00,000 | 100% |
This instantly tells you: 40% of the company's funding comes from owners, 60% from outsiders.
3. Ratio Analysis
This is the most powerful tool. A ratio is simply one number divided by another. NCERT classifies ratios into three groups:
- Liquidity Ratios — Can the business pay its short-term bills? (e.g., Current Ratio = Current Assets ÷ Current Liabilities)
- Solvency Ratios — Can it pay its long-term debts? (e.g., Debt-Equity Ratio = Long-term Debt ÷ Shareholders' Funds)
- Profitability Ratios — How much profit is it earning? (e.g., Gross Profit Ratio = Gross Profit ÷ Revenue from Operations × 100)
A ratio by itself means nothing. You must compare it — with the industry average, with the company's past ratios, or with a standard norm. For example, a Current Ratio of 2:1 is generally considered healthy, but a ratio of 1:1 might signal trouble.
Accounting Treatment — What Gets Debited and Credited? …
Part (b)Concept understanding — Balance Sheet Presentation
Balance Sheet Presentation – A First Look
Think of your own finances. You have some things you own – a phone, a bike, maybe some cash in your pocket. And you have some things you owe – maybe you borrowed money from a friend, or you have a pending fee payment. If you wrote down everything you own on one side and everything you owe (plus what's truly yours) on the other, you'd have a personal balance sheet.
That's exactly what a company does. The Balance Sheet is a snapshot of a business's financial position at a single point in time – usually the last day of the accounting year. It shows two sides that must always be equal:
Assets = Liabilities + Capital
This is the fundamental accounting equation. The Balance Sheet is not an account – it's a statement. It doesn't get debited or credited. It simply presents the balances of real accounts (assets) and personal accounts (liabilities) plus the capital account, after all transactions for the year have been recorded and the Profit & Loss Account has been closed.
Why Does It Matter?
The Balance Sheet answers three critical questions for anyone reading it – owners, banks, investors, tax authorities:
- What does the business own? (Assets – from cash to machinery to buildings)
- What does the business owe to outsiders? (Liabilities – loans, creditors, outstanding expenses)
- What is the owner's stake? (Capital – the net worth)
If the Balance Sheet doesn't balance, something is wrong in the books. That's why it's the final check after preparing the Trial Balance and the Profit & Loss Account.
The Format (as per NCERT Class 12)
The Companies Act, 2013 prescribes a specific format for the Balance Sheet. It is divided into two sides:
| Left Side (Liabilities + Capital) | Right Side (Assets) |
|---|---|
| 1. Shareholders' Funds | 1. Non-Current Assets |
- Share Capital | - Fixed Assets (Tangible & Intangible)
- Reserves & Surplus | - Non-Current Investments
- Money received against share warrants | - Long-term Loans & Advances 2. Share Application Money pending allotment | 2. Current Assets 3. Non-Current Liabilities | - Current Investments
- Long-term Borrowings | - Inventories
- Deferred Tax Liabilities (Net) | - Trade Receivables
- Other Long-term Liabilities | - Cash & Cash Equivalents
- Long-term Provisions | - Short-term Loans & Advances 4. Current Liabilities | - Other Current Assets
- Short-term Borrowings |
- Trade Payables |
- Other Current Liabilities |
- Short-term Provisions |
This is the vertical format (also called the "order of liquidity" format) used by companies. For sole proprietors and partnerships, a simpler horizontal format is common, but the principle is identical.
Accounting Treatment – What Gets Debited/Credited?
The Balance Sheet itself is never debited or credited. It is a statement of balances. However, the items that appear on it come from accounts that were debited or credited during the year.
Here's how the major items originate:
| Balance Sheet Item | Originates From | Debit/Credit Nature |
|---|---|---|
| Capital | Capital Account | Credit balance (owner's claim) |
| Reserves & Surplus | Profit & Loss Appropriation Account | Credit balance (undistributed profit) |
| Long-term Borrowings | Loan Account (e.g., Bank Loan) | Credit balance (liability) |
| Trade Payables | Creditors Account | Credit balance (amount owed) |
| Fixed Assets | Asset Account (e.g., Machinery A/c) | Debit balance (what the business owns) |
| Inventories | Stock Account | Debit balance (goods on hand) |
| Trade Receivables | Debtors Account | Debit balance (amounts due from customers) |
| Cash & Bank | Cash/Bank Account | Debit balance (positive cash) |
A common mistake: students think the Balance Sheet is "balanced" by making a journal entry. No – it balances because the accounting equation always holds. Every debit has a matching credit somewhere.
--- …
Part (a)
Four objectives of Analysis of Financial Statements
- To judge profitability / earning capacity — assess whether the business earns adequate returns and whether profits are stable or growing.
- To assess liquidity and solvency — check the ability to meet short-term obligations (current/quick ratio) and long-term debts (debt–equity ratio).
- To evaluate operational efficiency — study how effectively assets are used (inventory turnover, debtors turnover) and whether costs are controlled. …
Part (a): four objectives — profitability, liquidity & solvency, operational efficiency, and inter-firm / intra-firm comparison.
Part (b): eight items placed under their Schedule III major headings and sub-headings.
Part (a)
Analysis of financial statements converts the raw figures of the Balance Sheet and Statement of Profit & Loss into meaningful information. Four key objectives:
- Judging earning capacity (profitability). Ratios such as gross profit, net profit and return on capital employed reveal whether the firm earns sufficient and stable returns — an absolute profit figure can hide a falling margin.
- Assessing liquidity and solvency. Liquidity (current, quick ratio) shows the ability to pay short-term dues; solvency (debt–equity, interest coverage) shows the ability to pay long-term debts. A profitable firm can still fail if it cannot pay its immediate liabilities.
- Evaluating operational efficiency. Activity ratios (inventory turnover, debtors turnover, working-capital turnover) show how efficiently resources are used and where costs need control.
- Facilitating comparison. Trend and comparative analysis let stakeholders compare the firm with its own past (intra-firm) and with competitors / industry (inter-firm) to make informed decisions. …
Showing the 12 most recent of 104 on this concept.
- CBSE 2026Set MARCH1 markMCQQ.Which of the following analyses shows duration-based classification?(a) External analysis(b) Horizontal analysis(c) Short-term analysis(d) Vertical analysis
›Reveal solutionSolution
Duration-based classification of analysis is represented by short-term (and long-term) analysis, so the answer is (c).
Financial statement analysis is classified on different bases:
Basis of classification Types Material used Internal and external analysis Modus operandi / method Horizontal and vertical analysis Duration / time span Short-term and long-term analysis - CBSE 2026Set MARCH1 markQ.Loans which are repayable within __________ months, are called as short-term borrowings.
›Reveal solutionSolution
Loans repayable within 12 months are called short-term borrowings.
As per Schedule III of the Companies Act, 2013, a liability is classified as current if it is expected to be settled within twelve months from the reporting date. Borrowings meeting this condition are shown under Current Liabilities as short-term borrowings; borrowings repayable after twelve months are long-term (non-current) borrow …
- CBSE 2026Set MARCH1 markQ.Match the following :
A B a) Valuation of goodwill i) Acknowledgement of debt b) Debentures ii) Earnings per share c) Revenue from operations iii) Inflows and Outflows of cash d) Profitability Ratio iv) Average profit method e) Cash flow statement v) Sales vi) Financial position ›Reveal solutionSolution
Correct pairings: a-iv, b-i, c-v, d-ii, e-iii (option vi is a distractor).
Each term is matched to its meaning from the Karnataka 2nd PUC Accountancy syllabus:
…
- CBSE 2026Set MARCH1 markQ.State any one user of Financial Statement Analysis.
›Reveal solutionSolution
One user of financial statement analysis is the investor/shareholder (others include management, creditors, banks, employees and government).
Financial statement analysis serves several interested parties who need information to make economic decisions.
…
- CBSE 2026Set ANNUAL1 markMCQQ.According to Indian Companies Act, 2013, the term "Sundry-creditor" has been replaced by which term? A) Trade receivables B) Trade payables C) Trade debtors D) Bills payables
›Reveal solutionSolution
'Sundry Creditors' is now shown as 'Trade Payables' under the Companies Act, 2013 - option (B).
The revised Schedule III format modernised the balance-sheet terminology that RBSE / CBSE Class-12 Accountancy follows:
- Sundry Creditors -> Trade Payables (option B). …
- CBSE 2026Set ANNUAL1 markQ.Fill in the blank: Those Assets, which are realised within __________ months are called current assets. (12/24)
›Reveal solutionSolution
Assets realised within 12 months are classified as current assets.
As per Schedule III of the Companies Act, 2013, an asset is treated as current if it is expected to be realised within twelve months after the reporting date (or within the firm's normal operating cycle, or is held primarily for trading, or is cash/cash equivalent). Ass …
- CBSE 2026Set ANNUAL1 markMCQQ.Current liabilities include(a) Sundry creditors(b) Outstanding expenses(c) Bills payable(d) All of these
›Reveal solutionSolution
All the listed items are current liabilities - option (d).
Current liabilities are obligations payable within a short period (normally one year). Sundry creditors (trade payables), outstanding expenses (expenses incurred but not yet paid) and bills payable (short-term promis …
- CBSE 2026Set ANNUAL1 markMCQQ.The Balance Sheet of a company is prepared according to which schedule of the Indian Companies Act 2013?(a) Schedule I(b) Schedule II(c) Schedule III(d) Schedule V
›Reveal solutionSolution
Correct option: (c) Schedule III.
Section 129 of the Companies Act, 2013 requires every company to prepare its Balance Sheet in the vertical form prescribed in Schedule III of the Act. So th …
- CBSE 2026Set ANNUAL1 markMCQQ.Office Building under construction which may take 3 to 4 years for completion will be shown under _______ in the Balance Sheet of the Company.(a) Intangible assets under development(b) Capital work in Progress(c) Non-Current Assets(d) Work in Progress(a) Intangible assets under development(b) Capital work in Progress(c) Non-Current Assets(d) Work in Progress
›Reveal solutionSolution
Office Building under construction is shown under Capital Work in Progress (Option B).
'Capital Work in Progress' (CWIP) represents the cost incurred so far on fixed assets that are being constructed or installed but are not yet ready for their intended use. Since the office building here will take 3 to 4 more years to complete, it is not yet a usable (operational) fixed asset; it cannot be depreciated or classified as a completed Building. It is disclosed as a separate line under Non-current Assets → Fixed Assets → Capital Work in Progress, …
- CBSE 2026Set ANNUAL1 markMCQQ.Under which Sub-head will "Patents and Trademark" appear in the Balance Sheet of a Company as per Schedule III of Company's Act, 2013 ?(a) Intangible Assets(b) Tangible Assets(c) Other Current Assets(d) Other Non-current Assets
›Reveal solutionSolution
Patents and Trademarks are shown under the sub-head "Intangible Assets" (within Fixed Assets, under Non-Current Assets).
As per the Schedule III format of the Balance Sheet (Companies Act, 2013), the asset side is classified as follows:
II. Assets
1. Non-current Assets
(a) Fixed Assets
(i) Tangible Assets — Land, Building, Plant & Machinery, Furniture & Fixtures, Vehicles (assets with physical existence)
(ii) Intangible Assets — Goodwill, Patents, Trademarks, Copyrights, Computer Software (assets with NO physical existence but having a long-term, identifiable value to the business)
(iii) Capital Work-in-Progress
(iv) Intangible Assets under Development
…
- CBSE 2025Set 67/6/11 markMCQQ.There are two statements : Statement I : The balance in the Statement of Profit and Loss in the Balance Sheet of Samta Ltd. showed a deficit of ₹ 2,00,000 on 31.03.2023 and a surplus of ₹ 3,00,000 on 31.3.2024. ₹ 5,00,000 will be considered as profit earned during the year for preparing Cash Flow Statement. Statement II : On 31.03.2023 the goodwill account of Zeeta Ltd. showed a balance of ₹ 4,00,000 and on 31.03.2024 it showed a balance of ₹ 5,00,000. ₹ 1,00,000 will be considered as goodwill acquired during the year for the preparation of Cash Flow Statement. Choose the correct option from the following : (A) Both the Statements are true. (B) Both the Statements are false. (C) Statement I is true, Statement II is false. (D) Statement II is true, Statement I is false.
›Reveal solutionSolution
Both Statement I, which calculates the profit earned during the year for Cash Flow Statement purposes, and Statement II, which identifies goodwill acquired during the year, are correct based on standard accounting principles.
Let's break down each statement to understand the underlying accounting concepts and their treatment in the preparation of a Cash Flow Statement.
Concept and Treatment
Statement I: Profit and Loss Balance for Cash Flow Statement
The Statement of Profit and Loss (P&L) balance shown in the Balance Sheet represents the accumulated profits or losses of the company up to that date. When preparing a Cash Flow Statement (CFS) using the indirect method, we need to determine the profit earned during the current year to arrive at the Net Profit Before Tax and Extraordinary Items. This figure is crucial because it forms the starting point for adjusting non-cash items and non-operating items to calculate cash flow from operating activities.
If the P&L balance shifts from a deficit (an accumulated loss, which is a debit balance) to a surplus (an accumulated profit, which is a credit balance), the profit generated during the year must have been sufficient to first cover the entire opening deficit and then create the closing surplus. The sum of these two amounts represents the total profit available for appropriation during the year.
Statement II: Goodwill Account for Cash Flow Statement
Goodwill is an intangible asset. An increase in the balance of any asset account, including goodwill, generally indicates that the asset has been acquired during the accounting period. In the context of a Cash Flow Statement, the acquisition of an asset (whether tangible like machinery or intangible like goodwill) is classified as a cash outflow under Investing Activities. This is because cash is used to purchase long-term assets that are expected to generate future economic benefits for the business. Conversely, a decrease in goodwill could be due to its amortisation (a non-cash expense) or its sale (a cash inflow).
Working Notes
-
Working Note 1: Calculation of Profit Earned During the Year (Statement I)
- Opening Balance of Statement of Profit and Loss (as on 31.03.2023) = Deficit of ₹ 2,00,000 (This is a debit balance).
- Closing Balance of Statement of Profit and Loss (as on 31.03.2024) = Surplus of ₹ 3,00,000 (This is a credit balance).
To calculate the profit earned during the year, we need to determine the total change from the opening deficit to the closing surplus.
- Amount of profit required to cover the opening deficit = ₹ 2,00,000
- Amount of profit required to create the closing surplus = ₹ 3,00,000
- Total Profit Earned During the Year = ₹ 2,00,000 (to cover deficit) + ₹ 3,00,000 (to create surplus) = ₹ 5,00,000. …
-
- CBSE 2025Set MARCH1 markMCQQ.Which of the following analyses shows stakeholders-based classification?(a) External analysis(b) Horizontal analysis(c) Short term analysis(d) Vertical analysis
›Reveal solutionSolution
Based on the party doing the analysis (stakeholders), analysis is internal or external; the option here is external analysis. Correct option: (a).
In GSEB Class-12 Commerce Accountancy (Analysis of Financial Statements):
- On the basis of the person/party (stakeholders) analysing: Internal analysis (by management) and External analysis (by outsiders such as investors, banks, creditors). …
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