Bases of comparison and limitation of analyzing financial statements

To: R. J. Falk

From:

Date: 5 April 2011

RE: Bases of comparison and limitation of analyzing financial statements

 

I am writing this memo to educate you on the different bases of comparison and limitations of analyzing the financial statement. Additionally, I am also writing this memo to educate you on the quality of earnings.

 

Financial statements are those books of accounts, which are generally prepared at the end of every year. Financial analysis is the assessment of the financial statements to check on the credibility of whether the business is profitable and stable. Both internal and external members of the company use financial analysis to forecast the future trends of the company (Brewer, Garrison & Noreen, 2010).

 

There are several bases of comparison, which are generally used by companies when analyzing financial statements and they are used in different methods. These methods include several calculations, which are later compared to produce the defined results. The main bases that are followed are one whether the financial statements, which are being compared, are compatible with each other. If they are not compatible, they will portray wrong financial figures, which will be misleading to the user of the documents. Therefore, it is very important to check the compatibility of the different documents.

The other basis, which is important to consider when performing financial analysis of this statement is by the need to check the main purpose of the analysis. Financial analysis is used as a forecast of future events, which are likely to occur. Therefore, when the financial analysis of the financial statements is being performed, it is very important for the financial analyst to take into consideration, whether the financial analysis are giving information in relation to the future (Brewer et al., 2010). If this is not followed, the information in which they portray it might be misleading to the user of the documents.

 

However, there are several limitations, which are generally involved in the calculation of this financial analysis. One of the major limitations of this is the use of averages. Averages are not the true figures, which represent the company financial statements therefore; these averages might give misleading information to the users. The second limitation is that different companies have different acting years. This means that it would be very difficult for the comparison of information of companies with different account years because the information would be misleading.

 

Financial analysis are usually prepared based on cost therefore, several assumptions like inflation and deflation are overlooked. This means that the information might give a wrong meaning. Additionally, different companies have different accounting methods of preparing accounting statements. This will be very difficult to compare the different financial statements. Lastly, the financial analysis do not provide a clear information on the decisions made by the different users therefore instead of giving answers, it leaves the user with even more question than before.

There are several factors, which affect the quality of earnings in a company. These are usually mostly based on the management side. The quality of the management, that is, in its managerial practices usually (Brewer et al., 2010). A good management leads to a good quality of earnings and a poor management leads to poor quality management of earnings.

 

I hope the above information will help in understanding what you wanted.

 

Best regards,

 

 

References

Brewer, P. C., Garrison, R. H., & Noreen, E. W. (2010). Managerial accounting. Boston: McGraw-Hill Create.