Financial statement analysis is nothing but reviewing and evaluating a company’s financial statements. It plays a major role in understanding the financial health of a company, thereby facilitating effective decision making. Financial statement analysis has different users, i.e. internal and external users. Internal users are the people who analyze the financial statement in order to make right decisions associated with the company operations. External users may not necessarily belong to the company and they might have some sort of financial interest. These users may be customers, investors, government, creditors, etc. Thus, it is very important for any financial professional to thoroughly know about Financial Statement Analysis. Let’s look into what a financial statement consists of!
Following are the major components of Financial Statement Analysis –
Income statement: This reveals all the company’s earnings during a particular period for which analysis is prepared.
Balance Sheet: This reveals the summary of what the company is owes and is owed
Cash Flow statement: This explains the income and expense incurred by the company during the analysis period.
What are the major steps involved in an effective analysis of financial statements?
- Identifying the industry economic features
- Discovering firm’s strategies
- Measuring the quality of the company’s financial statements
- Evaluating company’s current profitability and risk
- Preparing forecasted financial statements
- Taking necessary steps
Techniques Used To Analyze Financial Statements
Some of the most common methods include –
This method of analyzing financial statement involves creating economic, company and industry analysis.
Common Size Financial Statement Analysis
This is a percentage method. This method also referred as vertical analysis is closely related to percentage change financial statement analysis. In this method calculations are made in relation to a base year. This analysis allows finance managers to view the income statement and balance sheet in a percentage format. This makes them very easy to interpret.
In this method, industry trends are used by experts to analyze financial statements of a company. It is also known as industry analysis and it involves comparing a company to other companies in the same industry to know how one company is performing financially.
In this method, an estimate is prepared of future financial income based on trends existing in the market. It is based on historical data from the company’s financial statements and predicted data from futuristic financial statements.
Undoubtedly, financial statement analysis is an excellent tool. But, there are many issues you need to be aware of that can interfere while comparing a company to other companies in the same industry. It includes operational information, comparability between periods and comparability between companies.