Understanding and interpreting financial statements Coursework

Understanding and interpreting financial statements - Coursework Example Understanding and interpreting financial statements Financial Statement Analysis involves the careful selection of data from the financial statements in order to assess and evaluate the firm’s historical financial performance. The study focuses on the performance of Morrison’s and Tesco companies for 2008 and 2009. The financial statement analysis is based on the financial statements of both Morrison’s and Tesco companies. The four groups are Turnover, Solvency, Profitability, and Liquidity. Reasons for using ratio analysis. The financial statement ratio analysis is conducted to compare the financial performance of Morrison’s and Tesco over time (2008 and 2009). Both companies are competitors in the United Kingdom Grocery Chain market segment. The financial statement analysis is used to aid management or any interested party to make more informed decisions. Ratio analysis is a better alternative when compared to using pure hindsight, gut feeling, or plain guesswork in terms of making decisions. According to Gibson (2008), financial statement analysis is useful in improving all decision making activities. Since, the financial statement ratios are taken from both company’s audited financial reports, the analysis is based on actual economic (buy and sell, etc.) conditions occurring in the United Kingdom during 2008 and 2009. Economic conditions include supply, demand, equilibrium, scarcity, opportunity cost, and government (tax and other legal interventions) conditions. (Baumol, 2009). Brief description and justification of the ratios The financial statement ratios used in the Morrison’s research are divided into four sections. Liquidity ratios provide information about the firm’s ability to pay its current obligations and continue operations; In terms of justification, the ratios will indicate whether the company has to find other sources of cash inflows to pay for the company’s maturing obligations. The leverage ratios measure the company’s use of deb t to finance assets and operations; in terms of justification, the ratios would help determine the feasibility of increasing, decreasing, or retaining the company’s current debt structure. The cost management ratios measure how well a company controls cash; in terms of justification, the ratios will be used as a basis for improving current cash management policies. The profitability ratios measure earnings in relation to some base, such as assets, sales, or capital. The profitability ratios will justify if the company passed (reach benchmark in generating profits) or failed (generated loss) in the prior accounting period. Financial statement analysis is profitable complement to other decision making tools (Besley, 2008). Critical evaluation of the Limitations of the Analysis with regards to both the available information and the generic limitations of Ratio Analysis There are limitations on the comparison of the financial statements of the two companies with regards to both t he available information and the generic limitations of ratio analysis. The preparation of financial statement ratios would be a failure. First, the financial statement data of both Morrison’s and Tesco may be erroneous Second, both companies may be using different accounting principles. To remedy the situation, the industry ratio trends can help to