Comparative Financial Statement Definition and Importance
Comparative Financial Statement Definition – When financial statements figures for two or more years are placed side-by-side to facilitate comparison, these are called ‘Comparative Financial Statements.’
Such statements not only show the absolute figures of various years but also provide for columns to indicate the increase or decrease in these figures from one year to another.
In addition, these statements may also show the change from one year to another in percentage form. Because of the utmost usefulness of the comparative statements, the Companies Act, 1956 provides that the Profit & Loss Account and Balance Sheet of a Company must show the figures of the previous year also with the figures of the current year.
Purpose or Importance of Comparative Statements
To discuss the comparative financial statement definition in in-depth, let’s try to understand the need of them.
- Make the Data Simpler and More Understandable: When data for a number of years are put side-by-side in a comparative ‘form it becomes easier to understand them and the conclusions regarding the profitability and financial position of the concern can be drawn very easily.
- To Indicate the Trend: This helps in indicating the trend of change by putting the figures of production, sales, expenses, profits etc. for number of year’s side-by-side.
- To Indicate the Strong Points and Weak Points of the Concern: It may also indicate the strong points and weak points of the firm. Management can then investigate and find out the reasons for the weak areas and can take corrective measures.
- To Compare the Firm’s Performance with the Average Performance of the Industry: Comparative financial statements help a business unit to compare its’ performance with the average performance of the industry.
- To Help in Forecasting: Comparative study of the changes in the key figures over a period helps the management in forecasting the profitability and financial soundness of the business.
Limitations of Comparative Financial Statements
- These statements do not present the change in various items in relation to total assets, total liabilities or net sales.
- These statements are not useful in comparing financial statements of two or more business because there is no common base.
Constructing Comparative Financial Statements
In practical life any financial statement can be prepared as comparative statement but such analysis is more popular in the case of balance sheet and income statements. Thus most important comparative statements are:
- Comparative Balance Sheet
- Comparative profit &Loss Account
a. Comparative Balance Sheet
It can be prepared on two or more different dates can be prepared to decrease or increase in various assets, liabilities and capital. Such a Comparative Sheet is very useful in studying the trends in a business enterprise.
Method of Preparing Comparative Balance Sheet:
This type of Balance Sheet consists of four columns. First column shows data of previous year whereas second column shows data of current year. The third column consists of Fourth column shows the percentage of increase or decrease in absolute data.
Illustration 1: From, the following Balance Sheets of Asha Chemicals Ltd. as on 31st December, 2007 and 31st December, 2008 prepare a Comparative Balance Sheet and comment upon the changes:
Comments: The analysis of the above financial statement gives the following conclusions:
- Total fixed assets have increased by Rs. 6, 00,000, i.e. 50% increase.
- Purchase of fixed assets was financed partly by the issue of shares for Rs. 5, 00,000 and partly by increase in loan.
- Share Capital has increased by Rs. 5, 00,000, i.e. 100% increase. It has strengthened the financial position of the company.
- Reserves have decreased by Rs. 1, 00,000 i.e. 33.33% decrease, which reflects loss in the business during the current year.
- Current liabilities have increased by Rs. 2, 00,000, i.e. 100% increase, but current assets have also increased by Rs. 4, 00,000, i.e., 80% increase. It has resulted in increase in the working capital of the firm by Rs. 2, 00,000.
- 12% loan has increased by Rs. 3, 00,000 (60%). Out of it Rs. 1, 00,000 has been used for purchase of fixed assets and the balance Rs. 2,00,000 has been used as working capital.
b. Comparative Profit &Loss account or Comparative Income Statement:
Profit and Loss account shows the net profit or net loss of a particular year. On the other hand, comparative profit and loss account for a number of years provides the following information.
- Rate of change in sales
- Change in Cost of Goods sold
- Rate of change in gross profit
- Change in operating profit.
- Rate of increase or decrease in net profit.
Method of Preparing Comparative Profit &Loss account
The layout of this financial statement also consists of four columns. First column shows data of previous year. Second column shows data of current year. Third column consists of the data which relates to increase or decrease in absolute terms. Fourth column shows the increase or decrease in various items in the form of percentages.