This is the final and important step of Accounting where the statements prepared after summarizing accounts are analyzed for interpretation purposes. There are various styles and tools through which the analysis can be done for the statements. There are several theories developed for analyzing the financial data or numbers. Most common tool in analyzing data is Ratio analysis.
Ratio analysis is the systematic use of mathematical ratios to analyze and interpret the financial statements of the company to determine its Financial and operating performance. It involves comparison of ratios with previous year’s performance and also with the competitor’s ratios. The ratios are classified into four major categories which are Liquidity Ratio, Profitability ratios, Solvency or Leverage ratios and Turnover Ratio.
Once the analysis part is done then comes interpretation. It is a management part of accounting where the analyzed statements are used to interpret the performance of the firm. Interpretation is also done to planning purposes. Financial performance of the firm is very important and a major concern for the owners of the business. Policy making is also done on the basis of interpretation of the data. Investors always follow financial interpretations before investing in any companies. All the external and internal factors make analysis and Interpretation a more important function of accounting (watts, Ross, and Zimmerman, 1986).