Answer
Financial statement analysis can be undertaken in different ways. The purpose of which the financial statement analysis to be undertaken and the person doing financial statement analysis are two main deciding factors of types of financial statement analysis. Financial statement analysis may be categorised on the two main basis which are being presented here:-
- According to Material Used:- Financial analysis according to this type can be of two type:
- Internal Analysis: Executives and employees of the enterprise conduct internal analysis because they have access to the books of accounts and all other information related to business. Therefore, such analysis becomes more reliable and useful to management.
- External Analysis: – An external analysis is done by those who are outsiders for the business and do not have access to the detailed records of the company. Shareholders, prospective investors, creditors, bankers, governmental agencies, researchers are outsiders who conduct such analysis on the basis of published financial statements. Increased governmental control over companies and governmental regulations have directed companies to disclose more detailed informations in order to improve analysis.
2. According to Modus Operandi: This type of analysis can be classified in two categories:-
- Horizontal Analysis: – when financial statements for a number of years are reviewed and analysed, it is termed as ‘Horizontal Analysis’.Under this method, figures of two or more years regarding each items are shown with changes from the base year. Generally, the first year is assumed as base or standard year. Increase or decrease in each item as compared to base year is shown in percentage form. For example, creditors shown in the balance sheet have increased or decreased as compared to the year 2011, and 2012. Horizontal analysis is used in comparative balance sheet and profit and loss account and in trend analysis. Area of strength and weakness from considerable insight are given to the management by this analysis. It is also known as ‘Dynamic Analysis’.
- Vertical Analysis:- It is a study of quantitative relationship of the various items in the financial statements on a particular date. It is related to one date or one accounting period. Therefore, it is termed as ‘Static Analysis’. Common size balance sheet and profit andloss account are examples of vertical analysis. Totals of financial statements of a particular accounting period are taken as 100 and then all items related to that statement are converted into percentage. For example, each item of Balance sheet is stated as a percentage of the total of the Balance sheet.
