Financial analysis: Auditing EDP systems

Financial Analysis

Financial analysis is a quantitative valuation tool that measures an organization’s profitability and capital growth. The method compresses numbers derived from accounting records such as the balance sheet and income statement. Ratio analysis brings together firm data and creates states for comparison. The procedure entails combining evaluated ratios versus previous periods and other industry entities (Khan & Jain, 2007). The rates outline trends over time for a certain company or to establish comparisons between multiple businesses. There are three basic sorts of ratios in this regard: liquidity, profitability, and solvency ratios. Ratios consist of valuable tools used to analyze financial statements for investors, managers, owners, and creditors to know the positions of an organization. According to Watne and Turney (2002), the positive impacts of the calculations include the simplification of business statements into figures that enable easier calculations. Books of accounts tend to be detailed thus calculating ratios remains an essential way of creating understanding. The comparison gets allowed despite the size of organizations and their numbers. Fundamentally, the users of financial statements find a variety of alternatives when making investment decisions contrast to relying on only one company information. A company is also able to calculate its performance over a given period. On the one hand, trend analysis measures the growth of an enterprise thus giving managers the ability to speculate and strategize their mandate. On the other side, crucial information gets displayed efficiently using calculated figures. Therefore, it becomes faster to identify matters that get required for decision making.

Limitations of Ratio Analysis

Despite the high impact of ratios, there exist various disadvantages that face users of financial information. Watne and Turney (2002) accepted that companies work under different conditions and in different industries thus they meet regulations and market shocks that cannot get the same evaluation. On this note, placing the relativity of organizations under one classification lowers their credibility and reliability. Thus, financial statements rely heavily on assumptions and estimates not fitting the accounting standards set in the global industry. Besides, the increased violations reduce the usefulness of the financial ratios. Therefore, past information remains relevant to users who prefer future records.

References

Khan, M. Y., & Jain, P. K. (2007). Financial management. New Delhi: Tata McGraw-Hill.

Watne, D. A., & Turney, P. B. B. (2002). Auditing EDP systems. Cape Town, South Africa: Prentice-Hall International.