The term financial analysis includes both analysis and interpretation. Analysis means simplification of financial data by methodical classification given in the financial statements. Interpretation means explaining the meaning and significance of the data. These two are complimentary to each other; analysis is useless without interpretation, and interpretation without analysis is difficult or even impossible.

Financial Statement Analysis is the process of critical evaluation of the financial information to understand and make decisions regarding the operations of the firm. It is basically a study of relationship among various financial facts and figures given in the financial statements. It essentially involves regrouping information to establish relationships and throw light on the points of strengths and weaknesses of a business enterprise.

The importance of analysis lies in identifying the financial strengths and weaknesses of the firm by properly establishing relationships between items of the balance sheet and the statement of profit and loss. It helps in assessing the operational efficiency and financial soundness of a company. It reveals important facts concerning managerial performance and the efficiency of the firm.

It is a judgemental process which aims to estimate current and past financial positions and the results of the operation. The primary objective is determining the best possible estimates and predictions about the future conditions. This enables analysts to take decisions involving comparison with other firms (cross sectional analysis) and with the firm’s own performance over time (time series analysis).

Financial analysis is significant for different users like management, owners, trade creditors, lenders, investors, and labour unions. For example, labour unions analyse financial statements to assess whether the firm can presently afford a wage increase. Thus, it helps various parties make informed decisions regarding the financial health and future prospects of the enterprise.