Chapter 2

CONCEPTual framework

2.1 FINANCIAL STATEMENT ANALYSIS

The role of Financial Statement Analysis is to use the information in a companys financial statements, along with other relevant information to make economic decisions. A financial statement organized according to accounting projects. Its purpose to convey an understanding of some financial aspects of a business firm. It shows a position at a movement in time as in the case of Balance Sheet, or reveals a series of activities, over a given period of time, as in the case of an income statement. The internal users of information need such analysis to evaluate the efficiency of the management. The external users like to rely upon such analysis to take decision regarding making investments and granting credit Financial Statement Analysis implies analysis and interpretation of the Financial Statement for facilitating the drawing of valid conclusions from the reported facts and figures. Analysts use Financial Statement data to evaluate a companys past performance and current financial position in order to form opinions about the companys ability to earn profits and generate cash flow in the future. It is basically a process of identifying the strengths and weakness of the concern by truly setting up the relationship between the items that are usually contain in the financial statement. At present, Financial Statement Analysis does not remain confined within the periphery of financial statement only. It also examines and covers the interval environment in which the firm operates and also the external environment surrounding the firm. The financial statement invariably fails to project all details needed for proper decision making. So, the users of information have to look beyond financial statements also. The efficiency level of the management, the nature of the product and its diversification, employees morale etc. can never be reported by financial statements. Due to paucity of time, in this project, for the purpose of analysis, we have considered only Balance Sheets or Position Statements and Profit and Loss Accounts or Income Statements of Reliance Industries Limited for last five years. Now for the financial performance analysis we need different financial ratios. Financial ratios quantify many aspects of a business and are an integral part of financial statement analysis. Ratio Analysis is such a significant technique for performance analysis.

2.2 RATIO ANALYSIS

2.2.1 Meaning and definition of ratio analysis:
Ratio analysis is a widely used tool of financial analysis. It is defined as the systematic use of ratio to interpret the financial statements so that the strength and weakness of a firm as well as its

historical performance and current financial condition can be determined. The term ratio refers to the numerical or quantitative relationship between two variables.

2.2.2 Importance of ratio analysis:

To workout the profitability To workout the solvency Helpful in analysis of financial statement Helpful in comparative analysis of the performance To simplify the accounting information To workout the operating efficiency To workout short-term financial position It is helpful in budgeting and forecasting

2.2.3 Limitations of Ratios Analysis:

Differences in definitions Limitations of accounting records Lack of proper standards No allowances for price level changes Changes in accounting procedures Quantitative factors are ignored Limited use of single ratio Background is over looked Limited use Personal bias