Need For Financial Statement Analysis

Simply speaking, Financial Statement Analysis is the meaningful analysis and  interpretation of 'Financial Statements'.  Over the years, the financial reporting system has become complex to interpret with the number of 'Notes to accounts' and extensive disclosure requirements. They are constructed in accordance and in compliance with Generally Accepted Accounting Principles (GAAP), which are often difficult to understand. Thus, the necessity to learn how to 'read' and 'understand' them has led to employing of certain processes, tools and techniques. The techniques and skills adopted to understand the position and performance of an enterprise with a focus on the financial statements is termed as 'Fundamental Analysis' as against 'Technical Analysis' which focuses more on the stock market measures. The need for Financial Statement Analysis is as follows:

1. The Annual Report is a substantial document that contains huge volume of information in various formats. The Balance Sheet, The Profit and Loss Account, Cash Flow Statement and notes to accounts comprise Accounting information on onehand, and the narrative reports such as Director's Report, Chairman's Report & Auditor Reports on the other hand. A holistic view of all these statements is required to enable the users of financial statements to  understand and interpret them to make the right economic decisions.

2. Financial statements are further made complicated due to the presence of a number of alternative measurements of reporting events and transactions. These variations in accounting treatment among the various companies and also among countries could be smoothened to make a comparison and understanding more effective.

3. Economic events and accounting entries often do not correspond or coincide making the financial reporting system imperfect. This could be partly attributed to the presence of accounting rules and norms on the timing, recognition and measurement front. This results in the difference in the timings of economic events and their accounting recognition. This often leads to an unrealistic picture of the affairs of the company, which is taken care of while undertaking Financial Statement Analysis.

4. The financial statements are general purpose statements. Users of the financial statements are numerous with each having unique purpose and specific data requirements for making economic decisions. Hence, Financial Statement Analysis becomes necessary to meet the requirements of these varied users.

5. The Annual reports contain supplemental data which are of immense importance in interpreting the financial statement but which are not included in the Financial Statements. This necessitates some adjustments to make them comparable, consistent over time, and more representative of economic reality.

6. In India, financial statements ignore the substance and recognize the legal form of the transaction. This misleads the users of accounts, in turn, resulting in wrongful economic decisions.

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