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Financial Statement Analysis refers to the act of measuring, assessing and interpreting the financial condition of an individual or firm through reported financial statements. Usually prepared for commercial organizations by professionals with the intention of measuring the viability, stability and profitability of a business venture or any of its subsidiaries ventures, financial statement analysis is vital to effective decision making by top level management. The process of financial statement analysis consists of reformulation of reported financial statements, analysis and adjustments of measurement errors and financial ratio analysis based upon reformulated and adjusted financial statements. In actual practice, the first two steps are overlooked and the calculation of financial ratios is done on the basis of the numbers provided in the financial statements. Certain adjustments to ensure the accuracy of the financial ratios and by extension the interpretations derived from them. Financial statement analysis is the foundation for evaluating and pricing credit risk and for doing fundamental company valuation.
By taking into consideration the conclusions of financial statement analysis the top level financial management can get an accurate understanding of their financial situation and thus will be better equipped to make important business decisions like stop, starting or resuming different business operations, borrowing or lending money, making investment decisions or other operational decisions like purchase of machinery, dividend policy decisions etc. Financial analysts make use of financial ratios in order to reach an understanding of the past, present and possible future financial performance of a firm. However financial ratios on their own are unable to present an absolute picture of a firm’s financial situation and thus are assessed together. Financial statement analysis makes use of many different types of financial ratios. Some such financial ratios are gross margin, operating margin, return on equity, return on assets, cash flow return on investment, current ratio, asset turnover, interest coverage ratio, dividend yield etc.
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