Modern Approach to Financial Statement Analysis (2024)

The below mentioned article provides a close view on the modern approach to financial statement analysis. After reading this article you will learn about: 1. Introduction to Modern Approach of Financial Statement Analysis 2. Definition of Modern Approach of Financial Statement Analysis 3. Advantages 4. Limitations.

Introduction to Modern Approach of Financial Statement Analysis:

In order to overcome the difficulties which appear under traditional approach, the modern approach to the analysis of the financial statements are being introduced. It is modern to say that the modern approach to financial statement analysis is quite logical, more-reasonable, most practical from the standpoint of various financial analysis relating to liquidity, solvency, profitability and management efficiency of a firm.

The modern approach to financial statement analysis encompasses both financial and non-financial factors which are very relevant from the context of financing decisions. Both internal and external environments of the business are considered here. (Internal environment includes: organisation structure, employee morale etc. and External environment includes: bargaining power of both debtors and creditors, outside competitors, etc.).

These factors play a very significant role in the context of profitability of a firm and at the same time affect the future development also. Needless to say that modern approach to financial statement analysis gives due importance and considers all these factors.

Since the modern approach takes into consideration both the economic and non-economic financial and non-financial factors, measurement of financial analysis predicts better future earning capacity, cash flow and funds flow (or sources and application of funds) position etc.

At present, some business reporting models were developed by some scholars (viz. The Value Chain Score Card in 2001 by Lev; The Balanced Score Card in 1992 by Kaplan and Norton) which consider non-financial factors for which analysis of financial statement has gained considerable importance. Needless to say that these models supply information relating to both historical and future prospects.

Moreover, in recent years, a good number of advanced statistical methods are used for the purpose of analysing financial statements (viz. measure of dispersion, e.g. coefficient of variation, standard deviation, correlation and regression analysis, time series analysis etc.).

These statistical devices help to analyse the financial statements through various decisions models of future courses of action since they supply the required data for the purpose, e.g. Corporate Financial Analysis Model, Portfolio Security Analysis Model etc.

Definition of Modern Approach of Financial Statement Analysis:

The modern approach to financial statement analysis is the analysis of financial accounting data taken from financial statements by the use of modern statistical tools and the application of various techniques which have been employed by various decision-making models along with various non-financial elements.

Features/Characteristics of Modern Approach:

The features/characteristic of modern approach:

(a) Application of Tools:

Modern tools and techniques along with the various decision-making models are used for the purpose of analysis of financial statement. Usually the various statistical tools and decision-making models are used for the purpose.

(b) Depending on the Data:

Like Traditional approach, the Modern Approach also depends on the data contained in the financial statements, but the application is made by an advanced technique.

(c) Type of Analysis:

Although the analysis is made with the help of advanced statistical techniques, it has to rely on the data contained in the traditional financial statements, viz., Profit and Loss Account and Balance Sheet.

(d) Purpose of Use:

The purpose of analysis is to study the various financial positions relating to profitability, liquidity, capital structure, management efficiency etc. The report which is prepared after such analysis is, no doubt, a reliable or dependable one.

(e) Prediction of Future:

Future activities can be predicted with the help of various decision-making models and other statistical tools which are found to be quite dependable.

(f) Scope:

Since advanced techniques are used in modern approach, its scope is very wide and acceptable by the users of accounting information. Moreover, it can be applied for collecting various accounting informa­tion both for general and specific use.

(g) Changing Price-level:

Even the Modern Approach fails to recognise the effect of changing price level since it depends on the raw data contained in the financial statements which, again, do not consider the changes in price-level.

(h) Helpful for General/Specific Information:

The modern approach is, no doubt, found suitable for the purpose of analysis of both general and specific information relating to any financial information needed by an analyst.

Advantages of Modern Approach to Financial Statement Analysis:

The Modern Approach to Financial Statement Analysis has the following advantages:

(a) Since modern techniques and tools are applied, result of the analysis is found to be dependable and reliable one, i.e. suitable to the decision-makers as decision-making models are used for the purpose of analysis.

(b) Since the analysis is forward-looking, it helps the management to take correct decision i.e. possibility of making error is limited.

(c) This analysis overcome the limitations of traditional approach to the analysis of financial statement since modern statistical tools and techniques and various other decision-making models are used.

(d) It supplies both the general as well as specific information to the users of financial statements and not like traditional analysis of financial statement which supplies only general information.

(e) Since financial and non-financial factors are considered here, it presents a better picture of the analysis which is found to be very helpful to the users of financial statements.

(f) Possibility of receiving effective information is very high since it follows the highly sophisticated mathematical and statistical tools for the purpose of analysis.

(g) This analysis is very flexible as it encompasses both financial and other non-financial related matters and there is possibility of expansion.

Limitations of Modern Approach to Financial Statement Analysis:

The Modern Approach to Financial Statement Analysis even is not free from snags. Some of them are:

(a) Difficult to use:

The use or application of this approach is, no doubt, difficult and not usable for general public as it requires the highly sophisticated mathematical and statistical knowledge.

(b) Difficult to collect information:

It is not so easy to collect the required information for the purpose of analysis. Moreover, it is costly.

(c) Difficult to use the Decision-Making Models:

The Decision-Making Models are based on a theory which is very relative. Their practical applications are not so effective in all cases. Moreover, the financial performance of all the enterprise under all circ*mstances is not equal. In reality, it is difficult to use and establish.

(d) Difficult to apply properly:

Since its effectiveness depends on the behaviour, attitude, role of the decision-maker which vary from person to person, time to time, it is difficult to apply as common to all.

(e) Difficult to predict future properly:

Prediction of future on the basis of the application of various sophisticated tools and techniques and decision-making models is not found to be suitable as the future is based on assumptions which is again, vary from person to person.

Illustration:

The following traditional financial statements (i.e. Profit and Loss Account and Balance Sheet) from the year ended 31.3.2007 are presented by X Ltd. Convert the same as per Modern Approach: