Financial Statement Analysis

Financial Statement Analysis

What is 'Financial Statement Analysis'?

Reviewing and evaluating a company's financial statements such as the balance sheet or profit and loss statement is Known as Financial statement analysis. It helps the user of the financial statements in gaining an understanding of the financial health of the company and enabling more effective decision making. All the financial data are recorded and summarized in the financial statement. This record and information must be analyzed and evaluated through the process of financial statement analysis so that it becomes more useful to investors, shareholders, managers, and other interested parties.

DIGGING DOWN 'Financial Statement Analysis'

Financial statement analysis is an analytical process of determining the past, current and projected performance of a business entity. Several techniques are generally used as part of financial statement analysis. Some of them are  horizontal analysis that compares two or more years of financial data in both dollar and percentage form; Likewise, under vertical analysis, each category of accounts on the financial statement  is shown as a percentage of the total account; and ratio analysis, under which we calculate mathematical and statistical relationships between financial data.

Financial statement analysis helps to identify the trends. With the help, these statements financial experts are able to find out liquidity, profitability, company-wide efficiency and cash flow. Major financial statements are the balance sheet, income statement and cash flow statement. The balance sheet is a clear picture position in time of the entity's assets, liabilities and shareholders' equity. Balance sheets are used by an analyst to analyze trends in assets, equity, and debts. The income statement starts with sales and ends with net income. It also provides the information on gross profit, operating profit, and net profit.When each of these profits is divided by sales we get gross profit margin, operating profit margin, and net profit margin. Likewise, the cash flow statement provides the summary of the company's cash flows from operating activities, investing activities and financing activities.

Methods of Financial Statement Analysis

Generally, two important methods exist for analyzing financial statements. The horizontal and vertical analysis is the first one. Horizontal analysis is the comparison of various financial information over a series of reporting periods, while vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item.

Ratio analysis is the second method for analyzing financial statements. Ratios are used to calculate the mathematical relationship among the various financial data. The ratio calculated for one period can be compared to the same ratio calculated for a prior period, or that is based on an industry average, to see the performance of the company with respect to its expectations. Wide variances will flag potential problems that will attract the attention of the user of the financial statements.

Users of Financial Statement Analysis

The user of financial statement analysis are:

Creditors are that person who supplies the products and services in credit to support the various business functions. So they are interested in knowing the firm’s ability to pay back their dues, and so will focus on various cash flow measures.

Investors are that person who provides the funds for setting up and running the business, The investors evaluate and analyze the financial statements to learn about an entity's capability to continue issuing dividends or to generate cash flow.

Management is the persons who manage and run the day to day operations of the business entity. The financial statement analysis reflects their performances and flag their mistakes.

Regulatory authorities:  If a company is a Public limited company, its financial statements are examined by the Securities and Exchange Commission to evaluate and check whether its statements match to the various accounting standards and the rules of the SEC.