DK Goel Solutions Chapter 2 Financial Statements Analysis
Read below DK Goel Solutions for Class 12 Chapter 2 Financial Statements Analysis. These solutions have been designed based on the latest Class 12 DK Goel Accountancy book used by commerce stream students issued for the current year and the questions given in each chapter.
When the financial statements are prepared and is being distributed to various stakeholders then the process of analysis of these financial statements starts. the students should understand how the financial statements are analyzed and who is interested to analyse these statements. it is also important to understand what sort of results are available post-analysis of financial statements.
The chapter contains a lot of questions which can be very helpful for Class 12 commerce students of Accountancy and will also help build strong concepts which will be really helpful in your career. These solutions are free and will help you to prepare for Class 12 Accountancy. Just scroll down and read through the answers provided below
Financial Statements Analysis DK Goel Class 12 Accountancy Solutions
Short Answer Questions
Question 1. State who may be interested in the analysis of financial statement and why?
Studies from the viewpoint of multiple actors may be involved in the study of the analysis of financial statements as follows:—
1.) Importance for Management:- A company’s management is often concerned with the company’s solvency, viability and financial structure.
2.) Importance for Investors:- Creditors want to know the company’s viability, i.e. to know whether or not the company can have enough capital assets and resources to cover its debts.
3.) Importance for Government:- On the basis of review of financial statements, the government will determine which industry is advancing on the desired lines and which industry needs financial assistance.
4.) Importance for financial institutions:- All financial institutions that offer industry financing, such as banks, insurance agencies, trust units, etc.
5.) Importance for Customers:- Investors and company owners are involved in the company’s survival and also want to know the company’s earning potential and its prospectus for future growth and success.
Question 2. What is meant by ‘Financial Analysis’? What is the interest of shareholders and prospective investors in such analysis?
“Financial analysis consists of separating facts according to a certain definite plan, organizing them according to certain circumstances in groups and then presenting them in a convenient and easy to read and understand form.”
Interests of shareholders and prospective investors:- Corporate investors and shareholders are involved in the company’s survival and also want to know the company’s earning potential and its prospectus for sustainable development and success. Analysis of a company’s financial statement allows them a lot in judging the company’s potential to pay dividends at a better cost, as well as the security of their investments.
Question 3. How is analysis of financial statement important to Government Authorities?
On the basis of the financial statement review, the government will judge which industry is advancing on the desired lines and which industry needs financial assistance. In such sectors where the gross margins are poor relative to the cost of production, the government will make a decision to reduce the GST. On the opposite, if, relative to the cost of production, the profit margins are too high, the government will raise the GST or impose the price regulations.
Question 4. Why is analysis of financial statements important to Creditors?
There are two kinds of borrowers who are:-
(i) Short-term creditors
(ii) Long-term creditors
(i) Short-term creditors want to know the viability of the undertaking, i.e. whether or not the undertaking will have enough existing assets and cash to cover its debts. In determining this, the present ratio and the fast ratio measured on the basis of financial statements support us.
(ii) Long-term creditors want to know two things, namely: (1) whether the company will be able to pay interest reliably and (2) whether the company’s ratio will decide whether or not the company will be able to pay interest on a daily basis and whether the company will be able to pay its obligations on maturity on the basis of the debt-equity ratio.
Question 5. “Financial Analysis is affected by window-dressing and the personal ability and bias of the analyst.” Comment.
In the eve of the accounting deadline, some businesses resort to window-dressing their financial statements to cover up poor financial standing. They may not register, for example, the sales made at the end of the year or may overvalue their closing stock. The findings obtained from review of the financial statements would be deceptive in some situations.
Question 6. What is horizontal analysis of financial statements?
In this method of analysis, financial statements are checked and evaluated for a period of years. In this method of study, estimates for two or three years are used and these figures are put side-by-side to allow comparison. Such study shows the rise or decline not only in actual figures but also in percentage form in these products. It also includes drawing comparisons and maintaining relationships over a number of years between different products of an organization. Since such analysis is based on the year-to-year date rather than just one year, it is often referred to as ‘Dynamic Analysis’.
Question 7. What is vertical analysis of financial statements?
Financial results for a particular year or on a given date are checked and analysed with the aid of proper devices such as ratios in such a form of analysis. It includes an analysis of the comparative relationship of a particular cycle between related products in the balance sheet or benefit and loss statement. The products are expressed as a proportion of the sum in the financial statement and the total is taken as equal to 100. Statements containing such studies are referred to as ‘General Size Statements’.
Question 8. What is the important of analysis of financial statements?
It has been of general interest to review financial statements. For multiple causes, different parties have been involved in a company’s financial statements. Different people look at the same financial statement from different angles, i.e. financial statements are used differently, all of them making the same statement but with a different purpose. For example, a buyer would be interested in sustainability, while the liquidity would affect a short-term borrower, i.e. the willingness of the corporation to pay its current liabilities.
Question 9. State any two objectives of analysis of financial statements.
The object of financial analysis depends on the needs of the client who analyses these declarations. Such varying needs can be:
1.) To Measure the Earning Capacity of Profitability:- According to Robert Anthony, “The overall objective of a company is to obtain a satisfactory return on the funds invested in it, consistent with maintaining a sound financial position.”
2.) To calculate solvency:- By financial analyses, it can be determined if the company is in a position to repay its short-term and long-term obligations on time. The liquidity ratio (current ratio and accelerated ratio), for example, is determined to decide if the firm has adequate cash capital to satisfy its short-term obligations, and the debt equity ratio is calculated to determine whether the corporation has the capacity to repay long-term liabilities.
Question 10. State any two limitations of analysis of financial statements?
Some financial research drawbacks are as follows:—
1.) Financial Reporting Limitations:- The financial report is focused on financial statements. But there are certain limits of financial statements themselves; thus, the limitations of financial statements are often the limitations of their study. For example, (i) The details contained in financial statements is often inconsistent and inaccurate; (ii) Financial statements are based on principles and norms of accounting. As such, owing to the shortcomings of financial statements, the value of financial analysis is reduced.
2.) Influenced by Window-dressing:- Some businesses resort to window-dressing their financial statements on the verge of the accounting date to cover up poor financial condition. They may not register, for example, the sales made at the end of the year or may overvalue their closing stock. The findings obtained from review of the financial statements would be deceptive in some situations.
Question 11. One of the objectives of ‘Financial Statement Analysis’ is to identify the reasons for change in the financial position of the enterprise. State two more objectives of this analysis.
‘Financial Statements Review’ objectives:
- Assessing the company as a whole and its numerous departments’ earning power or viability in order to judge the company’s financial fitness.
- Assessing the efficacy of management by the application of financial ratios.
- Assessing the undertaking’s short-term and long-term solvency.
- Assessing their own success as opposed to other companies in the same industry.
Financial Statements analysis means a systematic and thorough examination of a firm’s financial statements to break down and understand the data contained in it. This helps the companies measure the financial strengths, including profitability, efficiency, and growth prospects of the business.
Here are some important types of financial statements analysis –
● Internal Analysis
● External Analysis
● Vertical Analysis
● Horizontal Analysis
● Short-term Analysis
● Long-term Analysis
The most common techniques used in financial analysis are as follows –
● Trend Analysis
● Common Size Financial Statements
● Comparative Financial Statements
● Fund Flow Statement
● Cash Flow Statement
● Ratio Analysis
Generally, companies frame their financial statements to meet their objectives and to get help in making better financial decisions in the future. However, if the companies fail to draw a conclusion or output from the financial statements, they are of no use. Therefore, financial statement analysis helps the companies to monitor, compare and interpret the financial records within the accounting period. This helps them to dig into the weaknesses and strengths of the business.
The comparative financial statements are a set of documents issued by an entity to compare the financial status of two or more accounting periods. This assists the companies in evaluating the financial progress in a specific period. These statements present the complete data about the company’s transactions most accurately, helping the companies quickly understand the profits or losses.
Here are the limitations of the financial statement analysis –
● The techniques of financial statement analysis fail to track any modifications in the accounting policy.
● It overlooks the qualitative aspects like public relations, quality of management, etc.
● Financial Statements are stagnant and do not depict the price change for any product or service. Therefore, they lack authenticity as they are created on the basis of accounting concepts.
● The financial statements are generally biased by the analyst, and personal ability influences them.
Also refer to TS Grewal Solutions for Class 12