535 limitations of financial analysis financial

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5.3.5 LIMITATIONS OF FINANCIAL ANALYSIS Financial analysis is only a means Financial analysis is a means to an end and not the end itself. The analysis should be used as a starting point and the conclusion should be drawn not in isolation, but keeping in view the overall picture and prevailing economic and political situation Ignores price level changes Financial statements are normally prepared on the concept of historical costs. They do not reflect values in terms of current costs. Thus, the financial analysis based on such financial statements or accounting figures would not portray the effects of price level changes over the period. Financial statements are essentially interim reports The profit shown by profit and loss account and the financial position as depicted by the balance sheet is not exact.. Accounting concepts and conventions Financial statements are prepared on the basis of certain accounting concepts and conventions. On account of this reason the financial position as disclosed by these statements may not be realistic. For example, fixed assets in the balance sheet are shown on the basis of going concern concepts. This means that value placed on fixed assets may not be same which may be relaised on their sale. On account of convention of conservatism the income statement may not disclose true income of the business since probable losses are considered with probable incomes are ignores. Influence of personal judgements Many items are left to the personal judgement of the accountant. For example, the method of depreciation, mode of amortization of fixed assets, treatments of deferred revenue expenditure all depend on the personal judgement of the accountant. The soundness of such judgement will necessarily depend upon his competence and integrity. However, the convention of consistency acts as a controlling factor on making indiscreet personal judgements Disclose only monitory of facts Financial statement do not depict those facts which cannot be expressed in terms of money. For example, development of a team of loyal and efficient workers, enlightened management, the reputation and prestige of management with the public. Are matters which are of considerable importance of 4 th business, but hey are nowhere depicted by financial statements
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65 5.4 REVISION POINT Techniques of financial analysis: 1. Comparative financial statements 2. Common size financial statement 3. Trend percentages 4. Funds flow analysis 5. Cost volume profit analysis 6. Ratio analysis. 5.5 INTEXT QUESTION 1. Explain the meaning of the term `financial statements’. State their nature and limitations. 2. Explain the different types of financial analysis. 3. Explain the various tools of financial analysis. 4. Justify the need for analysis and interpretation of financial statements.
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