Types of Financial Statement Analysis

A distinction may be drawn between various types of financial analysis either on the basis of material used for the same or according to the modus operandi or according to the objective of the analysis.

According to Nature of the Analyst

• External Analysis: It is made by those who do not have access to the detailed records of the company. This group, which has to depend almost entirely on published financial statements, includes investors, credit agencies and governmental agencies regulating a business in nominal way. The position of the external analyst has been improved in recent times owing to the governmental regulations requiring business undertaking to make available detailed information to the public through audited accounts.
• Internal Analysis: The internal analysis is accomplished by those who have access to the books of accounts and all other information related to business. While conducting this analysis, the analyst is a part of the enterprise he is analyzing. Analysis for managerial purposes is an internal type of analysis and is conducted by executives and employees of the enterprise as well as governmental and court agencies which may have regulatory and other jurisdiction over the business.

According to Modus Operandi of Analysis

• Horizontal Analysis: When financial statements for a number of years are reviewed and analyzed, the analysis is called ‘horizontal analyses. As it is based on data from year to year rather than on one date or period of time as a whole, this is also known as ‘dynamic analyses. This is very useful for long term trend analysis and planning.
• Vertical Analysis: It is frequently used for referring to ratios developed for one date or for one accounting period. Vertical analysis is also called ‘Static Analysis’. This is not very conducive to proper analysis of the firm’s financial position and its interpretation as it does not enable to study data in perspective. This can only be provided by a study conducted over a number of years so that comparisons can be affected. Therefore, vertical analysis is not very useful.

According to the Objective of the Analysis

On this basis the analysis can be long-term and short-term analysis:

• Long-term Analysis: This analysis is made in order to study the long-term financial stability, solvency and liquidity as well as profitability and earning capacity of a business. The objective of making such an analysts is to know whether in the long-term the concern will be able to earn a minimum amount which will be sufficient to maintain a reasonable rate of return on the investment so as to provide the funds required for modernization, growth and development of the business.
• Short-term Analysis: This analysis is made to determine the short-term solvency, stability, liquidity and earning capacity of the business. The objective is to know whether in the short-run a business enterprise will have adequate funds readily available to meet its short-term requirements and sufficient borrowing capacity to meet contingencies in the near future.