Accountancy Part BAnalysis of Financial Statements

Which of the following is correct about Financial Analysis?

Answer & explanation

Correct answer: option 1

The correct answer is Option (1) → It does not consider Price Level Changes

Financial analysis works on figures in the financial statements, recorded at historical cost; a change in the price level is not reflected in them.

Option (2) It considers both monetary and non-monetary aspects — Incorrect. Only monetary information is considered; non-monetary aspects such as the quality of management are ignored.

Option (3) It does not include Cash Flow Statement — Incorrect. The cash flow statement is one of the financial statements, and cash flow analysis is a tool of financial analysis.

Option (4) It can’t be used by the lenders — Incorrect. Lenders use it to judge the firm’s long-term solvency and its ability to repay.

NCERT (2026-27 edition):
Limitations of Financial Analysis – “Though financial analysis is quite helpful in determining financial strengths and weaknesses of a firm, it is based on the information available in financial statements. As such, the financial analysis also suffers from various limitations of financial statements. Hence, the analyst must be conscious of the impact of price level changes, window dressing of financial statements, changes in accounting policies of a firm, accounting concepts and conventions, personal judgement, etc. Some other limitations of financial analysis are: Financial analysis does not consider price level changes. Financial analysis may be misleading without the knowledge of the changes in accounting procedure followed by a firm. Financial analysis is just a study of reports of the company. Monetary information alone is considered in financial analysis while non-monetary aspects are ignored.”