Financial statement analysis is defined as the process of identifying financial strengths and weaknesses of the firm by properly establishing relationship between the items of the balance sheet and the profit and loss account. It also refers to an assessment of the viability, solvency, liquidity, stability and profitability of a business, sub-business or project.1. Profitability - its ability to earn income and sustain growth in both short-term and long-term. 2. Solvency - its ability to pay its obligation to creditors and other third parties in the long-term;3. Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations;4. Stability- the firm's ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business.5. Viability – the firm’s ability to operate its business.

It is performed by professionals who prepare reports using ratios that make use of information taken from financial statements and other reports. These reports are usually presented to top management as one of their bases in making business decisions. Based on these reports, management may:

Continue or discontinue its main operation or part of its business i.e. judging efficiency;

Indicating the trends of achievements / failures. Assessing growth potential of the business Measuring the profitability. Make or purchase certain materials in the manufacture of its product, Acquire or

rent/lease certain machineries and equipment in the production of its goods i.e. Forecasting, budgeting and seceding future line of action;

Issue stocks or negotiate for a bank loan to increase its working capital i.e. Measuring short-term and long-term financial position;

Make decisions regarding investing or lending capital; Simplified, systematic and intelligible presentation of facts Judging the solvency of the business. Other decisions that allow management to make an informed selection on various

alternatives in the conduct of its business.

Methods:1. Trend Analysis or Dynamic Analysis – It is also termed as ‘Intra-firm

comparison’, wherein financial statement of the same enterprise for two or more years is compared. Trend analysis is also known as ‘Horizontal analysis’, because each accounting variable is placed horizontally. Trend analysis assists in decision making regarding future line of action.

2. Structural or Static Analysis – It analyses a single set of financial statement. Relationship between two variables of the same statement is studied. Establishing relationship between gross profit and sales or current assets and current liabilities

etc. are its examples. As this analysis pertains to one specific year r time period, is termed as static analysis.

3. Comparative Financial Statements – An efficient management should not be satisfied with the present performance but should try to discover the possible profit earning possibilities of the business. In order to achieve this objective, the management should compare its current performance with the performance of previous year and identify the plus and minus points of the business.

4. Common Size Statements – Comparison of financial statements can be made, if information of all the statements is uniform. This is why; common size income statements and position statements are prepared. Every item of income statement (or position statement) is expressed in terms of percentage of its important heading.