Last Updated on 2 months ago by Imarticus Learning

The main goals of financial statement analysis are to comprehend and analyse the data in financial statements in order to assess the firm’s profitability and financial stability, and to predict its future possibilities. The goal of the analysis is determined by the individual conducting it and his subject.

To highlight the significance of such analysis, the following purposes or objectives of financial statements analysis may be stated:
1) To evaluate the firm’s earning potential or profitability.

2) To evaluate managerial effectiveness and operational efficiency.

3)  To evaluate the firm’s long- and short-term solvency condition.

4) To pinpoint the causes of the company’s changing

Financial Statement Types

Companies give transparency to their stakeholders by using the balance sheet income statement and cash flow statement. The three statements are related to one another. They produce various interpretations of a company’s operations and performance.
Below is a summary of these four financial statements.

Balance Sheet

The balance sheet reveals the assets of a company’s value (per GAAP). Either equity or debt (liabilities) can be used to finance assets. As a result, the fundamental accounting formula of assets (A) = liabilities (L) + shareholders’ equity is created (E). In general, assets are ranked according to how quickly they can be turned.
In general, liabilities are listed according to when they are due.
The reader will be able to identify a company’s ability to meet short- and long-term financial obligations by understanding the leverage and liquidity of the balance sheet via the use of certain ratios that will be covered in this book. Understanding the balance sheet can also help the reader get a sense of the company’s capacity to raise money through equity or debt in order to purchase new assets or settle existing debt.

Income Statement

The income statement displays the revenues and costs that a business incurs over a specific time period). Typically, these line items are prepared in accordance with GAAP. Transactions are recorded at the point of sale. Accrual accounting uses the matching principle. In essence, accrual accounting computes receipts rather than actual cash.

Despite the fact that the money isn’t collected for a few weeks or months after it was sold, accrual accounting still considers the transaction to have occurred at the time of sale. Alternative accounting techniques include the cash basis.
This less popular method only computes transactions (revenues and expenses) when money is actually exchanged.

The revenues (or sales) produced from the sale of goods and/or services during typical business operations make up the top line of the income statement. The direct costs associated with making those sales are usually listed on the next line. When we analyse profitability ratios later, the net figure of these two reveals the gross profits and gross margins.

These non-cash expenditures are made in order to spread out the price of large, long-term assets throughout the time that they are utilised. The bottom line displays a company’s net income (or loss) after all expenses, including taxes and other non-operating income, have been deducted. Once more, a company’s net income (or loss) is not always the amount of money it brought in through sales; rather, it is the difference between that amount and that period’s expense receipts.

Statement of Shareholder’s Equity:

The income statement and balance sheet are related by this statement. The equity component of the balance sheet can then be reconciled with distributions, dividends, or capital infusions.
After distributions and dividends, any remaining net income is reinvested in the company, which raises the retained earnings account in the equity column of the balance sheet. The statement of shareholders’ equity contains a complete list.

The statement of shareholders’ equity also includes information about other equity sales and purchases, like stock repurchases, and reconciles. Many privately held businesses lack a declaration of shareholders’ equity and instead use simple equity accounts.
The company’s net income is often equal to the variation in retained earnings from one period to the next. If the amount is smaller, the difference usually represents the amount of distributions or dividends that were taken; nevertheless, the correctness of this information should be confirmed with the corporation.

The current balance sheet and prior period balance sheet dates should coincide with the income statement date range for these computations.

Statement of Cash Flows

A statement of cash flows can inform a reader whether or not a corporation generated cash from these receipts. The income statement can indicate if a company made a profit based on receipts. Sales receipts cannot pay creditors on their own. Actual cash received is of utmost importance to many readers of financial statements.

The accrual method data from the income statement is used to create the statement of cash flows. It is then adjusted up or down based on the changes in the balance sheet accounts.
The accountant creates the statement of cash flows using the direct approach. It includes factors like money received from clients, interest, money given to suppliers, etc. that have an impact on cash flow.

The reader is given a complete picture of the sources of cash and the uses of that cash in the statement of cash flows.
In this manner, an analyst may quickly analyse a company’s cash flows and be able to examine operating cash flows independently of the other operations. In the end, this statement makes up the discrepancy between the cash on hand at the start of a balance sheet period and the cash on hand balance at the end of the period.

The Skills You Need for Success

There are several methods available to you if you want to learn how to analyse financial statements.
You might choose a self-taught path, reading through publicly accessible financial statements to become accustomed to how financial data is normally presented.

Conclusion

Take your career to the next level. Find out how improving your knowledge can make your organisation more productive.

Financial statement analysis takes a holistic approach to evaluating and assessing the financial well-being of an organisation.