 Analysis of financial statements is a study of relationships among the various financial factors in a business.  It is a process of identifying the financial strengths and weaknesses of the firm by properly establishing relationship between the item of the balance sheet and the profit and loss account  Through analysis an attempt is made to determine the meaning and significance of financial statement data so that the forecast can be made in respect of future earnings, profitability etc..

 There are four basic financial statements that provide information needed by financial analysts to evaluate a company. These are :- i. The Balance Sheet ii. The Income Statement / Profit and Loss Account iii. The Funds Flow statement iv. The Cash Flows Statement

 The sources of funds are primarily short term in nature, payable in demand.  Financial Leverage is very high. In other words, the equity base is low. This is risky and can lead to earning volatility.  The proportion of Fixed Asset is very low.  A high proportion of bank funds are invested in loans and advances and investments, all of which are subject to interest rate volatility.  When deposit rate changes, the consequences impact on the cost of funds could create problems with the pricing on portfolio assets

 (a) To know the earning capacity of the entity : Financial analysis helps in ascertaining whether sufficient profits are being earned on the capital invested in the business or not. Moreover, it also helps us to know whether the profit is increasing or decreasing.  (b) To know the solvency of the entity : Analysis of the financial statements discloses whether the business is in a position to pay its short-term and long term liabilities in time.

 (c) To know the financial strength : It also discloses the total position of the business regarding its goodwill, internal finance system etc.  (d) Comparative study with other firms : The comparative study of the profitability of various firms engaged in the same industry can be done to study the position of the firm in respect of sales,profitabilityetc  (e) Capability to pay interest and dividend: The analysis also helps to assess whether the entity will have sufficient profits to pay the interest in time and whether it has the capacity to pay the dividend in future at a higher ratio.

(1) Limitations of financial statements:-Financial statements have their own limitations and thus the analysis done on the basis of such statements will also suffer from inadequacies. Moreover, the financial statements record only those events that can be expressed in terms of money. Qualitative aspect like cordial management-labour relations, efficiency of management and more which may have a vital bearing on the firm's profitability are ignored.

(2) Affected by window dressing: Most of the firm resort to window dressing and try to cover their weak points so that they do not face problems with their bankers and shareholders etc. It is common practice by firms to overvalue their closing stock and hence the result obtained based on such analysis are misleading (3) Different accounting policies: Firms adopting different accounting policies may not have the result which may be comparable. For example, the method of valuing closing stock of two firms may differ and thus the comparison of such results will be wrong.

 These are broadly classified into three categories, namely:- i. Comparative Statement Analysis ii. Time series Analysis or Intra comparison. iii. Inter firm analysis or Cross-section analysis

 A simple method of tracing periodic changes in the financial performance of a company is to prepare comparative statement  Comparative financial statement will contain items for two periods  An investigation of the comparative financial statements helps to highlight the significant facts and point out the items which need further analysis

 This reflects the movement of various financial characteristics over a period. Under this technique, the financial characteristics of a firm are compared over a number of years so as to know the directions in which the firm is moving

 Under this technique of analysis, financial statements of one firm are compared with financial statements of one or more other similar firms for profitability, solvency, liquidity, credit worthiness etc Thus, under this technique we prepares the comparative financial characteristics of an enterprise with other comparable enterprises.