Q.(OR) What is meant by Analysis of Financial Statements? Discuss its objects and limitations. (2+4+4)
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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? …
Analysis of financial statements means breaking down and studying the figures of the Balance Sheet and Statement of Profit and Loss to judge the firm's profitability, solvency and efficiency; it has clear objects and also real limitations. Both are set out below. …
Financial-statement analysis studies the statements (via ratios, comparative/common-size, trend and cash-flow analysis) to judge profitability, solvency and efficiency; its objects are decision-useful but it is limited by historical data, price-level changes, differing policies and bias.
Meaning: Analysis of financial statements is the process of establishing relationships between the items of the Balance Sheet and the Statement of Profit and Loss and interpreting them, using tools such as ratio analysis, comparative statements, common-size statements, trend percentages and the cash flow statement.
Objects (purposes):
- To assess the profitability and earning capacity of the business.
- To judge its short-term liquidity and long-term solvency.
- To measure operational efficiency and use of resources.
- To compare performance over years (intra-firm) and with other firms (inter-firm).
- To help management, investors, lenders and other stakeholders make decisions.
Limitations:
- Based on historical cost data, which may be out of date.
- Ignores the effect of price-level (inflationary) changes. …
Showing the 12 most recent of 41 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.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 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). …
- CBSE 2025Set ANNUAL1 markMCQQ.Parties interested in financial statements are (A) Managers (B) Financial institutions (C) Creditors (D) All of these
›Reveal solutionSolution
Financial statements serve a wide range of users — internal (management) and external (financial institutions, creditors, investors) — each needing the information for their own decisions. Hence the answer is (D) All of these.
For the BSEB Inter / Bihar Class-12 Accountancy syllabus, the parties interested in financial statements include:
- Managers: to plan, control and take operating decisions.
- Financial institutions / banks: to assess creditworthiness before lending. …
- CBSE 2025Set ANNUAL1 markMCQQ.When financial statements of two or more organisations are analysed, it is called (A) Intra-firm analysis (B) Inter-firm analysis (C) Vertical analysis (D) None of these
›Reveal solutionSolution
Comparing the financial statements of two or more separate organisations is a comparison between firms, called inter-firm analysis. Hence the answer is (B) Inter-firm analysis.
For Bihar Class-12 (BSEB Inter) commerce candidates, financial analysis can be classified by the basis of comparison:
- Intra-firm analysis: comparing the figures of the same firm over different years (within one firm).
- Inter-firm analysis: comparing the figures of two or more different firms for the same period. …
- CBSE 2025Set ANNUAL1 markMCQQ.Financial analysis is useful for (A) Investors (B) Shareholders (C) Debenture holders (D) All of them
›Reveal solutionSolution
Financial analysis helps all stakeholders assess profitability, solvency and safety of their funds — investors, shareholders and debenture holders each use it. Hence the answer is (D) All of them.
For the BSEB Inter / Bihar Class-12 Accountancy syllabus, financial statement analysis serves many users:
- Investors: to decide whether to invest, judging earning capacity and growth.
- Shareholders: to evaluate profitability, dividend prospects and the safety of their investment. …
- CBSE 2025Set ANNUAL1 markMCQQ.Which of the following is not the method of financial statement analysis ? (A) Ratio Analysis (B) Comparative Analysis (C) Trend Analysis (D) Capitalisation Method
›Reveal solutionSolution
Ratio analysis, comparative statements and trend analysis are standard tools of financial statement analysis, whereas the capitalisation method is used to value goodwill or a business. Hence the answer is (D) Capitalisation Method.
For Bihar Class-12 (BSEB Inter) commerce candidates, the common methods/tools of financial statement analysis are:
- Comparative statements
- Common-size statements
- Trend analysis (trend percentages)
- Ratio analysis
- Cash flow statement …
- CBSE 2025Set ANNUAL1 markMCQQ.Which of the following is a tool of financial statement analysis? (A) Cash Book (B) Trial Balance (C) Trend Analysis (D) All of these.
›Reveal solutionSolution
Trend Analysis is the tool of financial statement analysis — option (C).
Tools of financial statement analysis are techniques used to study, compare and interpret financial data. The common tools are comparative statements, common-size statements, trend analysis, ratio analysis and cash flow statements. A Cash Book and a Trial Balance are part of the basic book-keeping/recording process, n …
- CBSE 2025Set ANNUAL1 markMCQQ.Which of the following is not an example of spreadsheet software? (A) Word Pro (B) MS-Excel (C) Lotus 1-2-3 (D) None of these.
›Reveal solutionSolution
Word Pro is not a spreadsheet package — option (A).
Spreadsheet software organises data in a grid of rows and columns and is used for calculations, charts and analysis. MS-Excel and Lotus 1-2-3 are well-known spreadsheet programs. Word Pro, however, is a word-processing application (part of the Lotus SmartSuite) used to …
- CBSE 2025Set ANNUAL1 markMCQQ.The next column to Z column in MS-Excel is (A) AA (B) AZ (C) AB (D) AC.
›Reveal solutionSolution
The column after Z in MS-Excel is AA — option (A).
In MS-Excel, columns are named alphabetically: A, B, C, ... up to Z (26 single-letter columns). After column Z, the labels continue with two letters starting from AA, then AB, AC, and so on up to AZ …
- CBSE 2025Set ANNUAL1 markMCQQ.The financial function used in calculation of payment of any loan is (A) SLN (B) PMT (C) COUNTIF (D) SUMIF
›Reveal solutionSolution
PMT is used to calculate loan payments — option (B).
MS-Excel's financial functions include several for different purposes:
- PMT calculates the periodic payment (instalment) for a loan based on constant payments and a constant interest rate.
- SLN calculates straight-line depreciation of an asset. …
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