Definition of Management Accounting

Management accounting is an accounting branch that is used by managers for making decision to
benefit the management. It is a method of accounting through which accountants create statements,
reports, and documents related to business performance. This accounting branch is used for the
organization’s internal purposes to help accomplish business goals.
Managerial accounting, also called management accounting, is a method of accounting that
creates statements, reports, and documents that help management in making better decisions
related to their business’ performance. Managerial accounting is primarily used for internal
purposes & it provides quantitative as well as qualitative information. It considers relevant
information even if it cannot be measured in terms of money.
Management accounting professionals provide expertise in financial reporting so that they can
formulate strategies relevant to business goals. Through management accounting, accountants
can deliver accurate information related to business operation metrics.
Features of Management Accounting
 It involves inference of the cause and effects of the numerical results derived via financial
accounting.
 Management accounting is used for setting objectives, making plans to achieve these
objectives, and performance comparison.
 It does not follow the money measurement concept.
 Management accounting is used for forecasting.

Importance of managerial accounting

1. Provides data: It serves as a vital source of data for planning. The historical data captured by
managerial accounting shows the growth of the business, which is useful in forecasting.
2. Analyzes data: The accounting data is presented in a meaningful way by calculating ratios
and projecting trends. This information is then analysed for planning and decision-making. For
example, you can categories purchase of different items period-wise, supplier-wise and territory
wise.
3. Aids meaningful discussions: Management accounting can be used as a means of
communicating a course of action throughout the organization. In the initial stages, it depicts the
organizational feasibility and consistency of various segments of a plan. Later, it tells about the
progress of the plans and the roles of different parties to implement it.

1|Page Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

4. Helps in achieving goals: It helps convert organizational strategies and objectives into
feasible business goals. These goals can be achieved by imposing budget control and standard
costing, which are integral parts of management accounting.
5. Uses qualitative information: Management accounting does not restrict itself to quantitative
information for decision-making. It takes into account qualitative information which cannot be
measured in terms of money. Industry cycles, strength of research and development are some of
the examples qualitative information that a business can collect using special surveys.

Techniques used in Managerial Accounting

Following are the techniques that are used by management accounting professionals:
1. Marginal analysis
It is the examination of the benefits of activity in comparison with the additional cost that is
incurred by the same activity. Companies apply this technique in decision-making with the aim
of maximizing potential profits. It helps in identifying the benefits of business activities and
financial decisions.
Experts use marginal analysis when there are only limited funds available while there are
multiple potential investments. In such cases, experts analyze associated costs and benefits to
determine the more profitable investment.
2. Trend analysis
In accounting, trend analysis helps examine financial statements for inaccuracies to assess
whether certain heads need to be adjusted. It is one of the most useful management tools for
forecasting. Trend analysis results are useful in identifying unusual patterns and resolving
underlying issues. It uses historical data to understand market sentiments. This helps the
management in making better business decisions.
3. Capital Budgeting
Capital budgeting is the process used by management to identify projects that yield maximum
returns on investment over a period. Through this process, management can evaluate the
profitable investment projects with the highest ROI. This technique uses IRR, NPV, and PB to
decide on a profitable project.
Organizations can plan long-term goals since this process provides an estimate of expected
future cash flows. The estimation of cash flows helps management strategize business plans to
become profitable. Implementation of this technique also helps in risk mitigation.

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4. Constraint analysis
This involves the analysis of bottlenecks within the financial system that prevents the
organization from optimum performance. Through this analysis, the organization focuses on
maximizing the utilization of bottlenecks since these control the profitability of the business.
Here issues caused by principle bottlenecks are also analyzed, and their impact on profit, cash
flow, and revenue is calculated.
5. Inventory valuation and product costing
It is the accounting process of assigning value to a company’s inventory. Since inventory
represents most of the company’s assets, its valuation can be crucial in maximizing profitability.
Through proper inventory valuation, financial experts can get an accurate understanding of the
gross profitability of a company.
6. Standard Costing
Standard Costing is substituting expected cost with actual cost in accounting records. This is an
alternative to a cost layering system where historical cost information is maintained for inventory
items in stock. This involves the creation of estimated costs for different activities within the
company. This technique is used to closely approximate costs when identifying the actual cost is
time-consuming.

LIMITATIONS OR DISADVANTAGES OF MANAGEMENT ACCOUNTING

1. BASED ON FINANCIAL AND COST RECORDS

Both financial and cost accounting information are used in the management accounting system.
The accuracy and validity of management account is largely based on the accuracy if financial
and cost records maintained. These records determine the Strength and weakness of management
accounting.

2. PERSONAL BIAS

The analysis and interpretation of financial statements are fully depending upon the capability of
the analyst and interpreter. Hence, personal prejudices and bias of an individual can affect the
objectivity and effectiveness of the conclusions and recommendations.

3. LACK OF KNOWLEDGE AND UNDERSTANDING OF THE RELATED SUBJECTS

Financial accounting, cost accounting, statistics, economics, psychology and sociology are the
related subjects of management accounting. The organization can derive more benefits of

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management accounting if the management accountant has thorough knowledge over related
subjects. If not so, the success of management accounting system is questionable.

4. PROVIDES ONLY DATA

Under management accounting system, many alternatives are developed to solve a problem and
submitted before the management. Out of the many alternatives available, the management can
select any one of alternatives or even discard all of them. Hence, management accounting can
only provide data and not prescribe any course of action.

5. PREFERENCE TO INTUITIVE DECISION MAKING

Scientific decisions can be taken with the help of using management accounting techniques. But,
majority of the management accountant and top level executives prefer their past experience and
intuition in making business decisions. The reason is that an intuitive decision making is very
simple and easy.

6. MANAGEMENT ACCOUNTING IS ONLY A TOOL

The management accountant is using the management accounting system as a tool to give advice
and facilitate the management for decision making. The actual decisions, their implementation
and follow up action are the prerogative of the management.

7. CONTINUITY AND PARTICIPATION

The decisions are taken by the management. Their implementation is vested in the hands of
management accountant. The continuous efforts of management accountant and full participation
of all levels of management are necessary for successful operation of management accounting
system.

8. BROAD BASED SCOPE

The scope of management accounting is very wide since it considers both monetary and non-
monetary transactions of the business organization. The limited knowledge and experience of the
management accountant can lead to prepare the data unreliable and undependable.

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Managerial accounting in different industries

Let’s explore how management accounting applies to different industries.

1. Manufacturing

Management accounting plays a crucial role in cost control and production optimization. Cost
accounting techniques help identify the costs associated with producing each product. It allows
managers to make pricing decisions and optimize production processes. Additionally, just-in-
time (JIT) and lean accounting principles are commonly employed to minimize waste and reduce
inventory costs.

2. Service

In the service industry, the focus is on providing intangible services rather than physical
products. Management accounting techniques apply differently here. Activity-based costing
(ABC) is particularly valuable, as it helps allocate indirect costs to specific service activities. It
provides a more accurate view of the actual costs of providing services. Budgeting and
forecasting are also vital for managing service demand and resource allocation.

3. Healthcare

Management accounting assists in cost management and resource allocation in the healthcare
sector. Healthcare providers use cost accounting to determine the expenses associated with
patient care and medical procedures. Using relevant costing allows managers to evaluate the
costs and benefits of adopting new medical technologies.

5|Page Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

4. Retail

Management accounting techniques are employed in retail for inventory valuation and pricing
strategies. Retailers often use cost-volume-profit (CVP) analysis to determine the breakeven
point for different products. They can make decisions related to sales promotions and product
assortment.

5. Hospitality

The hospitality industry relies on management accounting for cost control and revenue
management. Managers use variance analysis to assess the performance of different departments,
like food and beverage and entertainment.

6. Technology

In the fast-paced technology sector, management accounting helps assess the financial feasibility
of research and development projects and capital investments. Capital budgeting techniques, like
Net Present Value (NPV), assist managers in evaluating the potential returns and risks associated
with innovative ventures.

7. Non-profit sector

Even in the non-profit sector, management accounting is essential for financial planning and
fundraising. Non-profit organizations use cost accounting techniques to allocate program
expenses and determine the cost per beneficiary.

Advantages of managerial accounting

Let’s explore some key benefits that make management accounting an invaluable asset.

1. Informed decision-making

Management accounting provides you with timely and relevant financial information. The data-
driven approach helps you make informed decisions based on accurate assessments of costs and
revenues. You can chart a course that aligns with the organization’s goals with a comprehensive
understanding of the financial implications of various choices.

2. Performance evaluation and control

Management accounting facilitates performance evaluation by comparing actual results against

budgets and forecasts. Variances between planned and actual performance provide insights into
areas that require attention. The continuous monitoring and control mechanism allows managers

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to take corrective actions promptly. It ensures your organization stays on track toward its
objectives.

3. Cost optimization

Cost analysis is a fundamental aspect of management accounting that helps you understand cost
behavior and identify cost-saving opportunities. Distinguishing between fixed and variable costs
enables you to focus on reducing avoidable expenses and enhancing operational efficiency.

4. Resource allocation

Efficient resource allocation is critical to a company’s success. Management accounting helps

determine the most productive allocation of resources, be it finances or materials. The
optimization ensures resource assignment for initiatives that generate the highest returns.

5. Strategic planning

Management accounting provides a solid foundation for strategic planning. Forecasting future
financial performance and analyzing market trends helps develop well-informed long-term plans
that capitalize on opportunities and mitigate potential risks—the forward-looking approach
positions your organization for sustained growth and success.

6. Flexibility and adaptability

Management accounting techniques can meet the specific needs of different businesses and
industries. Whether it’s cost accounting, activity-based costing, or variance analysis, you can
choose the most relevant tools for your decision-making processes.

7. Continuous improvement

Management accounting fosters a culture of continuous improvement. Regularly reviewing

performance metrics and making data-driven adjustments helps optimize processes and reduce
inefficiencies.

8. Effective communication

Clear and concise financial reports generated through management accounting facilitate effective
communication among departments and management levels. These reports give stakeholders a
comprehensive overview of the organization’s financial health.

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Limitations of managerial accounting

Let’s explore some critical limitations of management accounting:

1. Subjectivity in cost allocation

The process of allocating indirect costs to specific products or activities can be subjective and
prone to bias. Different allocation methods may lead to varying results. It will affect the accuracy
of cost information used for decision-making.

2. Focus on financial information

Management accounting primarily relies on financial data, which may provide a partial picture of
all aspects of the business. Non-financial factors, like customer satisfaction, can impact the
organization’s performance. However, it may not be reflected in financial reports.

3. Short-term orientation

Management accounting emphasizes short-term goals and results. These may lead to decisions
that prioritize immediate gains over long-term sustainability. Strategic planning may not work if
focusing solely on meeting short-term targets.

4. Costly and time-consuming

Implementing and maintaining a robust accounting system can be costly and time-consuming.
Small businesses or organizations with limited resources may find investing in sophisticated
accounting techniques challenging.

5. Complexity in interpretation

Management accounting data can be complex and require skilled interpretation. Managers must
possess a strong understanding of accounting principles and be able to analyze financial reports
effectively to make well-informed decisions.

6. Assumptions and estimates

Management accounting involves making assumptions and estimates to fill gaps in data. These
assumptions may not always hold true. It can lead to potential inaccuracies in decision-making.

8|Page Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

7. No guarantee of future performance

While management accounting relies on historical data and forecasts, it cannot predict future
events with certainty. Market conditions and customer preferences can change rapidly to impact
the accuracy of projections.

8. Ethical concerns

There can be ethical challenges, like manipulating financial data to present a favorable image or
meet targets. Ethical lapses can undermine the integrity of financial information and erode trust
within the organization.

Difference Between Financial, Cost and Management Accounting

Financial Management
Parameter Cost Accounting
Accounting Accounting
Strict adherence to Adheres to cost No mandatory
Adherence accounting standards accounting standards adherence to external
(GAAP, IFRS). and principles. standards.
Historical and Detailed cost data Forward-looking,
Nature of
objective financial and reports for subjective reports and
Statements
statements. specific purposes. analyses.
Mandatory
Publishing No mandatory No requirement for
publication and
and Auditing publication; external publication or
external audit for
Status audit is not common. external auditing.
public companies.
Internal vs Primarily for external Primarily for internal Exclusively for
External stakeholders use, but can be internal stakeholders
Reporting (investors, creditors). shared externally. (management).
Standardized format Format tailored to Flexible format,
Format based on accounting organizational cost tailored to
standards. analysis needs. management needs.
Used for budgeting
Limited emphasis on Strong emphasis on
and controlling
Forecasting forecasting; focuses forecasting and
costs, not
on past transactions. planning.
forecasting.

9|Page Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

 Reporting as needed As needed, often
Periodic reporting
Reporting for cost control and more frequent and
(quarterly, annually).
valuation. timely.
Full disclosure to
Disclosure based on Limited disclosure, as
Disclosure meet regulatory and
company policy; information is for
Status stakeholder
primarily internal. internal use.
requirements.
Supports decision- Aids in cost control, Aids in strategic and
Decision
making by external pricing, and operational decision-
Making
stakeholders. operational efficiency. making internally.

Management Accountant
Management Accountant is an officer who is entrusted with Management Accounting function of
an organization. He plays a significant role in the decision making process of an organization.
The organizational position of Management Accountant varies from concern to concern
depending upon the pattern of management system. He may be an executive in some concern,
while a member of Board of Directors in case of some other concern. However, he occupies a
key position in the organization. than him.
Role of Management Accountant
Management Accountant, otherwise called Controller, is considered to be a part of the
management team since he has the responsibility for collecting vital information, both from
within and outside the company. The functions of management accountant are:
 To establish, coordinate and administer, as an integral part of management, an adequate
plan for the control of operations. Such a plan would provide, to the extent required in the
business cost standards, expense budgets, sales forecasts, profit planning, and programme
for capital investment and financing, together with necessary procedures to effectuate the
plan.
 To compare performance with operating plan and standards and to report and interpret
the results of operation to all levels of management, and to the owners of the business.
This function includes the formulation and administration of accounting policy and the
compilations of statistical records and special reposts as required.
 To consult withal segments of management responsible for policy or action conserving
any phase of the operations of business as it relates to the attainment of objective, and the
effectiveness of policies, organization strictures, procedures.
 To administer tax policies and procedures.
 To supervise and coordinate preparation of reports to Government agencies.
 The assured fiscal protection for the assets of the business through adequate internal;
control and proper insurance coverage.

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  To continuously appraise economic and social forces and government influences, and
interpret their effect upon business.
Duties and Responsibilities of Management Accountant
Following are the duties of Management Accountant or controller:
 The installation and interpretation of all accounting records of the corporative.
 The preparation and interpretation of the financial statements and reports of the
corporation.
 Continuous audit of all accounts and records of the corporation wherever located.
 The compilation of costs of distribution.
 The compilation of production costs.
 The taking and costing of all physical inventories.
 The preparation and filing of tax returns and to the supervision of all matters relating to
taxes.
 The preparation and interpretation of all statistical records and reports of the corporation.
 The preparation as budget director, in conjunction with other officers and department
heads, of an annual budget covering all activities of the corporation of submission to the
Board of Directors prior to the beginning of the fiscal year. The authority of the
Controller, with respect to the veto of commitments of expenditures not authorized by the
budget shall, from time to time, be fixed by the board of Directors.
 The ascertainment currently that the properties of the corporation are properly and
adequately insured.
 The initiation, preparation and issuance of standard practices relating to all accounting,
matters and procedures and the co-ordination of system throughout the corporation
including clerical and office methods, records, reports and procedures.
 The maintenance of adequate records of authorized appropriations and the determination
that all sums expended pursuant there into are properly accounted for.
 The ascertainment currently that financial transactions covered by minutes of the Board
of Directors and/ or the Executive committee are properly executed and recorded.
 The maintenance of adequate records of all contracts and leases.
 The approval for payment (and / or countersigning) of all cheque, promissory notes and
other negotiable instruments of the corporation which have been signed by the treasurer
or such other officers as shall have been authorized by the by-laws of the corporation or
from time to time designated by the Board of Directors.
 The examination of all warrants for the withdrawal of securities from the vaults of the
corporation and the determination that such withdrawals are made in conformity with the
by-laws and /or regulations established from time by the Board of Directors.
 The preparation or approval of the regulations or standard practices, required to assure
compliance with orders of regulations issued by duly constituted governmental agencies.

11 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

Status:
The management accountant, often referred to as controller, is the manager of accounting
information used in planning, control and decision-making areas. He is responsible for
collecting, processing and reporting information that will help manager’s/decision makers in
their planning, controlling and decision-making activities. He participates in all accounting
activities within the organization.

Qualities a Management Accountant

A management accountant is someone who is expected to be an all-rounder in terms of a lot of
aspects. The following are considered to be essential qualities of a management accountant:
1. Decision-making skills:
Every management accountant is involved in a lot of important decision-making
activities like planning the budget of an organization, forecasting the financial demand in
terms of crisis and so on. The decision taken by the accountant will have a direct effect
on the organization’s budgetary allocations.
2. Providing the right information:
Most of the management accountants are required to keep updated themselves about the
financial happening of an organization as well as the financial status of the country. This
is why management accountants are involved in presenting the facts in terms of audits,
cause and effect analysis and so on.
3. Achieving the objectives:
In most of the organizations, the management accountants are supposed to be heading a
team and they will have to ensure that their team meets the objectives on time and
progresses towards the overall growth of the company. Here the management accountants
will have to take multiple roles to negotiate, to mentor and to lead the team.
4. Improving the efficiency of the processes:
Management accountants are mostly behind facts and numbers. So when this is the case,
they have to make sure the performance is effective and there are cost-effective measures
taken. If there is an error in terms of cost-cutting, then the entire budget of the
organization is in stake. They can suggest business process improvement which will
result in the efficiency of the processes.
5. Strong knowledge of technology:
There are no organizations that use traditional forms of accounting or conventional
methods when it comes to calculation of budget and so on. There is a lot of software and
tools that have been evolved to make the work of a management accountant easier and
there are a lot of cloud-based financial information systems where there is a lot of data
available for references and research.
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 6. Forecast of the future:
Forecasting, budget forecasting are two primary tasks a management accountant is
involved in. In any terms of contingencies, the organization should be able to function
without many losses. So for these cases, budget forecasting is carried out with respect to
the dynamic business environment, employee count, global economic changes and so on.

Financial Statement Analysis

Financial statement analysis is the process of analyzing a company’s financial statements for
decision-making purposes. External stakeholders use it to understand the overall health of an
organization and to evaluate financial performance and business value. Internal constituents use
it as a monitoring tool for managing the finances.

KEY POINTS
 Financial statement analysis is used by internal and external stakeholders to evaluate
business performance and value.
 Financial accounting calls for all companies to create a balance sheet, income statement,
and cash flow statement, which form the basis for financial statement analysis.
 Horizontal, vertical, and ratio analysis are three techniques that analysts use when
analyzing financial statements.
How to Analyze Financial Statements
The financial statements of a company record important financial data on every aspect of a
business’s activities. As such, they can be evaluated on the basis of past, current, and projected
performance.
In general, financial statements are centered around generally accepted accounting principles
(GAAP). These principles require a company to create and maintain three main financial
statements: the balance sheet, the income statement, and the cash flow statement. Public
companies have stricter standards for financial statement reporting. Public companies must
follow GAAP, which requires accrual accounting.1 Private companies have greater flexibility in
their financial statement preparation and have the option to use either accrual or cash accounting

Types of Financial Statements

Companies use the balance sheet, income statement, and cash flow statement to manage the
operations of their business and to provide transparency to their stakeholders. All three

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statements are interconnected and create different views of a company’s activities and
performance.

Balance Sheet
The balance sheet is a report of a company’s financial worth in terms of book value. It is broken
into three parts to include a company’s assets, liabilities, and shareholder equity. Short-term
assets such as cash and accounts receivable can tell a lot about a company’s operational
efficiency; liabilities include the company’s expense arrangements and the debt capital it is
paying off; and shareholder equity includes details on equity capital investments and retained
earnings from periodic net income. The balance sheet must balance assets and liabilities to equal
shareholder equity. This figure is considered a company’s book value and serves as an important
performance metric that increases or decreases with the financial activities of a company.
Income Statement
The income statement breaks down the revenue that a company earns against the expenses
involved in its business to provide a bottom line, meaning the net profit or loss. The income
statement is broken into three parts that help to analyze business efficiency at three different
points. It begins with revenue and the direct costs associated with revenue to identify gross
profit. It then moves to operating profit, which subtracts indirect expenses like marketing costs,
general costs, and depreciation. Finally, after deducting interest and taxes, the net income is
reached.
Basic analysis of the income statement usually involves the calculation of gross profit margin,
operating profit margin, and net profit margin, which each divide profit by revenue. Profit
margin helps to show where company costs are low or high at different points of the operations.

Cash Flow Statement

The cash flow statement provides an overview of the company’s cash flows from operating
activities, investing activities, and financing activities. Net income is carried over to the cash
flow statement, where it is included as the top line item for operating activities. Like its title,
investing activities include cash flows involved with firm-wide investments. The financing
activities section includes cash flow from both debt and equity financing. The bottom line shows
how much cash a company has available.
Financial Performance
Financial statements are maintained by companies daily and used internally for business
management. In general, both internal and external stakeholders use the same corporate finance
methodologies for maintaining business activities and evaluating overall financial performance.

14 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

When doing comprehensive financial statement analysis, analysts typically use multiple years of
data to facilitate horizontal analysis. Each financial statement is also analyzed with vertical
analysis to understand how different categories of the statement are influencing results. Finally,
ratio analysis can be used to isolate some performance metrics in each statement and bring
together data points across statements collectively.

Below is a breakdown of some of the most common ratio metrics:

 Balance sheet: This includes asset turnover, quick ratio, receivables turnover, days to
sales, debt to assets, and debt to equity.
 Income statement: This includes gross profit margin, operating profit margin, net profit
margin, tax ratio efficiency, and interest coverage.
 Cash flow: This includes cash and earnings before interest, taxes, depreciation, and
amortization (EBITDA). These metrics may be shown on a per-share basis.
 Comprehensive: This includes return on assets (ROA) and return on equity (ROE), along
with DuPont analysis.

Advantages of financial statement analysis

The main point of financial statement analysis is to evaluate a company’s performance or value
through a company’s balance sheet, income statement, or statement of cash flows. By using a
number of techniques, such as horizontal, vertical, or ratio analysis, investors may develop a
more nuanced picture of a company’s financial profile.

Different types of financial statement analysis

Most often, analysts will use three main techniques for analyzing a company’s financial
statements.
 First, horizontal analysis involves comparing historical data. Usually, the purpose of
horizontal analysis is to detect growth trends across different time periods.
 Second, vertical analysis compares items on a financial statement in relation to each
other. For instance, an expense item could be expressed as a percentage of company
sales.

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  Finally, ratio analysis, a central part of fundamental equity analysis, compares line-item
data. Price-to-earnings (P/E) ratios, earnings per share, or dividend yield are examples of
ratio analysis.
What is an example of financial statement analysis?
An analyst may first look at a number of ratios on a company’s income statement to determine
how efficiently it generates profits and shareholder value. For instance, gross profit margin will
show the difference between revenues and the cost of goods sold. If the company has a higher
gross profit margin than its competitors, this may indicate a positive sign for the company. At the
same time, the analyst may observe that the gross profit margin has been increasing over nine
fiscal periods, applying a horizontal analysis to the company’s operating trends.
Objectives of Financial Statements:
1. To provide useful information to the management of an organisation for the purpose of
planning, controlling, analyzing, and decision making.
2. To provide information to prospective investors to attract them, so that they can take rational
decisions regarding their investment based on the reports.
3. To demonstrate a company’s creditworthiness to lenders and creditors, as financial reports
help them in evaluating the ability of a company in repaying their money.
4. To provide information to the shareholders and public at large about the various aspects of the
entity.
5. To disclose how an organisation is procuring and using various resources.
6. To facilitate the statutory audit.
7. To abide by different legal and governmental regulations.
8. To disclose information about the economic resources of an entity claims to these resources
(liability and owner’s equity), and to show how these resources and claims have undergone
changes over a period of time.
9. To supply details on the cash flows that a business is exposed to, including their timeliness
and volatility.
10. To determine the liquidity position of an organisation, which in turn can be used to evaluate
whether an organisation can continue as a going concern.

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Characteristics of Financial Statements:
1. Recorded Facts: The financial statements of a business concern are nothing but a compilation
of the recorded facts and figures pertaining to various transactions entered into by an
organisation. Recorded facts refer to the information extracted from the financial transactions of
an enterprise.
2. Accounting Conventions: These refer to certain guidelines and a kind of course of action to
be followed for the purpose of preparation of financial statements. Some of the conventions are
materiality, conservatism, consistency, and full disclosure. It is imperative that recording in
books of accounts should be done following these conventions in order to tackle any complicated
or unclear business transactions.
3. Accounting Concepts: These refer to the generally accepted assumptions or rules or
guidelines, which assist an accountant in the process of preparation of financial reports. They can
be termed as basic building blocks for the recording of transactions in the books of accounts,
which further makes the base for the preparation of financial statements. It is important that an
accountant follows these concepts so as to maintain objectivity and neutrality in the accounting
records and financial statements.

4. Accounting Standards: An accounting standard is a collection of procedures and guidelines

used to standardize bookkeeping and other accounting operations over time and across different
businesses. All aspects of an entity’s financial picture, including its assets, liabilities, income,
outlays, and shareholders’ equity are subject to accounting standards. It is very important for
accountants to comply with various accounting standards mentioned in the Company’s Act, 2013
for recording transactions in the books of accounts to ensure verifiability and consistency in
reporting practices.
5. Selection of Accounting Policies: Accounting policies pertain to the different methods or
techniques of dealing with certain items while recording them in the books of accounts. For
example, an organisation might follow either the straight-line method or the written-down value
method of depreciation. Another instance is the choice of the basis of accounting which could be:
cash or accrual or a hybrid of these. These policies get reflected in the financial statements and
inform the stakeholders about the policies being adopted by the organisation.
6. Estimates: While preparing financial statements a business concern might make certain
assumptions or postulates. One such major assumption is the going concern concept of
accounting. Here, the business is considered to be a going concern, meaning such an organisation
would continue its operations for an unforeseeable period of time and would not stop in the
nearby future. As a result of this, the span of recording and financial reporting is set to be one
year. Estimating the useful life of an asset to provide depreciation, is yet another example of
Estimates in accounting.

17 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

7. Source of Financial Information: Financial statements provide useful information to the
management of an organisation for the purpose of planning, controlling, analyzing, and decision-
making. They also facilitate prospective investors in making rational decisions about their
investments based on the reports.

PARTIES INTERESTED IN FINANCIAL STATEMENTS

There are many people using the financial statements. They are assessing the financial statements
in terms of profitability, liquidity and solvency. Some of the interested parties of financial
statements are given below.
1. Shareholders: In every public limited company, shareholders are the real owners of the
company. Hence, they want to know the way of utilizing their investments and ascertain the
profitability and financial strength of the company.
2. Debenture holders: Debenture holders are the lenders or creditors of the company. They want
to know the short term and long term solvency position of the company. Short term solvency is
find out to know whether interest is payable by a company and long term solvency is find out to
know whether principal amount is payable by a company.
3. Creditors: They are the suppliers of the raw materials and other necessary items on credit to
the company. They are interested to know the liquidity position of the company.

4. Commercial Banks and Financial Institutions: Both commercial banks and financial
institutions may lend both short term loan and long term loan. Hence, they are interested to know
the short term solvency, long term solvency and profitability of the company.
5. Prospective Investors: Prospective investors who are going to buy the shares of the company
in the very future. Hence, they are interested to know future prospects and financial strength of
the company.
6. Employees: The regular payment of wages and salaries are based on the financial position of
the company. Hence, they are interested to know financial position of the company.
7. Trade Unions: The interest of the employees is protected only by the trade union. The interest
of the employees can be protected if the financial position of the company is very strong. Hence,
they are interested to know the financial position of the company.
8. Loyal Customers or Regular Customers: Some customers are loyal to the company since
they are buying the products for a long period continuously. Hence, they are interested to verify
the financial strength of the company.

18 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

9. Tax Authorities: Tax payable is based on the amount of profits earned by the company.
Hence, the tax authorities are using the financial statements for calculating profits earned by the
company.
10. Government Departments: Department of company affairs and other government
departments are dealing with the industry in which the company is engaged are interested in the
financial information relating to the company.
11. Research Institutions and Researchers: Social research institutions and researchers are
using the financial statements. They analyze the financial statements to find out the role of each
industry in economic development of a nation.
12. Economists: The economists are using the financial statements information for assessing
economic conditions of workers.
13. Editorial Board of Financial and Economic Dailies and Periodicals: They need financial
data in respect of every type of business units and hence, they are interested m financial
statements.
14. Members of Parliament: Some public limited companies are started as Government
Companies. Such Government Company financial statements are placed before the members of
parliament. In such cases, Public Accounts Committee and Estimates Committee are interested in
the financial information.
15. Professional Societies: It includes Chambers of Commerce and Industry Indian Accounting
Association, Confederation of Indian Industry, Employers’ Associations and the like. These are
very much interested to know the financial status of the business concern since they are formed
to protect the respective types of business units.
16. SEBI and Stock Exchanges: These are interested to assess the financial position and level
of performance of listed companies with a view to protecting the interests of investors.
17. Managers or Management: The management or manager has started to show keen interest
in knowing the contents of financial statements which are used for internal management and
control. Financial statements help the management in its various functions of planning, control,
coordination and motivation.

19 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

 Types of Financial Analysis
The financial analysis examines and interprets data of various types according to their suitability.
The most common types of financial analysis are vertical analysis, horizontal analysis, leverage
analysis, growth rates, profitability analysis, liquidity analysis, efficiency analysis, cash flow,
rates of return, valuation analysis, scenario and sensitivity analysis, and variance analysis.

20 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

Important types of Financial Analysis (as per syllabus):-
 Horizontal Analysis
The horizontal analysis measures the financial statements line of items with the base year. It
compares the figures for a given period with the other period.

Pros – It helps to analyze the company’s growth from year on year or quarter on quarter with the
increase in operations of the company.
Cons – The company operates in the industrial cycle. Therefore, if the industry is downgrading
despite the company’s better performance owing to specified factors that impact the industry,
trend analysis will indicate the negative growth in the company.

21 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

  Vertical Analysis
The vertical analysis measures the line items of the income statement or balance sheet by taking
any line item of the financial statement as a base and disclosing the same in percentage form.
For example, the income statement discloses all the line items in percentage form by taking base
as net sales Similarly, the balance sheet on the asset side reveals all the line items in the
percentage form of total assets.

Pros – The vertical analysis helps compare the entities of different sizes as it presents the
financial statements
in final form.
Cons – It solely represents a single period’s data, so it avoids comparison across different time
phases.

22 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

  Trend Analysis
Trend analysis means identifying patterns from multiple periods and plotting those in a graphical
format to derive actionable information.

Conclusion
Financial analysis is a systematic examination of a company's financial statements, ratios, and
other relevant data to evaluate its financial performance, identify strengths and weaknesses, and
make informed decisions about investments, business operations, and financing activities.
Financial analysis plays a critical role in decision-making, helping investors, management, and
other stakeholders identify trends, assess a company's financial stability, and determine its
growth potential. Stakeholders benefitting from financial analysis include investors,
management, creditors, regulatory authorities, and employees.
Different types of financial analysis include horizontal analysis, vertical analysis, ratio analysis,
cash flow analysis, trend analysis, and benchmarking. Financial analysis is useful in various
contexts, such as business performance evaluation, investment decision making, credit analysis
and lending decisions, mergers and acquisitions, and financial planning and budgeting. However,
financial analysis has limitations, including quality of financial data, subjectivity in
interpretation, variations in accounting practices, short-term focus, and external factors and

23 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi

macroeconomic influences. Continuous learning and staying updated with industry trends are
crucial for effective financial analysis in a constantly evolving business environment.

24 | P a g e Mr. Gaurav Kumar Bisen, Assistant Professor, SMS Varanasi