Types of Financial Statement Analysis and Its Limitations

Financial statement analysis can be classified along two independent dimensions — WHO performs the analysis, and WHAT method is used.

By who performs it

• Internal Analysis is carried out by persons who have direct access to the firm's detailed internal books, ledgers and records — typically the firm's own management, or its internal auditors. Because they can go behind the published figures, internal analysis can be far more detailed.
• External Analysis is carried out by outsiders who have no access to the internal records and must rely entirely on the PUBLISHED financial statements — banks, creditors, investors, credit-rating agencies, tax authorities.

By method

• Horizontal Analysis (Comparative Analysis) studies how the SAME item has changed across two or more accounting periods — it looks ACROSS years, expressing the change in each item as both an absolute rupee amount and a percentage. This is the method behind the Comparative Statement (Section 9.3).
• Vertical Analysis studies the relationship BETWEEN different items of the SAME period's statement, by expressing every item as a percentage of one common base figure — it looks WITHIN one year. This is the method behind the Common-Size Statement (Section 9.3).

Limitations of Analysis of Financial Statements

Even though ratio and statement analysis is one of the most powerful tools available to a reader of accounts, a careful student must equally know the technique's real limits:

1. Historical, not predictive — the figures analysed relate to the PAST; they do not automatically guarantee the same result will repeat in the future.
2. Ignores qualitative factors — analysis works only with figures expressible in money; it cannot directly capture staff morale, brand reputation, or management quality. …