Last updated on October 15th, 2021 at 12:00 pm
It is imperative for any financial professional to know the basics of effectively analyzing the financial statements of a company. This requires a thorough understanding of 3 important areas:
- The structure of the financial statements
- The characteristics, trends, and patterns of the economy of the industry which the firm belongs to
- Strategies of the company to differentiate itself from competitors.
A finance professional with financial analyst courses will be able to work his way through analyzing financial reports with effortless ease. However, the following six-step approach could help in developing an effective analysis of financial statements.
- Identify the economic traits of the industry
It is integral to undermine the value chain analysis of the industry- the chain of activities involved in creating, manufacturing and distribution of the products or services. Michael Porter’s Theory of Five Forces- Threat of New Entrants, Threat of substitutes, Bargaining power of Buyers, Bargaining power of suppliers, Competition could be used to analyze the economic climate of the industry.
- Identify and analyze the strategies of the company
It is important to look at the nature of the product/service being offered by the company. One should look at the uniqueness, exclusivity, level of profit margins, customer base, customer loyalty, and cost control measure. It is also important to look at the supply chain, logistics and geographic and industry diversification of the company.
- Measure and assess the quality of the firm’s financial statements
The financial statements of the company must be reviewed in accordance with the relevant accounting standards and the current economic climate of the country. Balance sheets must be assessed on the basis of valuation, classification, and recognition to get a proper evaluation. The balance sheet must represent the true and complete position of the company’s financial scenario. The income statement must be a complete representation of the company’s economic performance. The cash flow statements will reveal the impact of the firm’s liquidity position from the operation, investments and financial activities angle over a period of time. In a nutshell. The cash flow details where the funds came from, where they were spent and how the liquidity of the company was affected. With a financial analyst certification, an experienced finance professional will be able to make a successful evaluation of these factors.
- Analyze the profitability and risk situation.
This is where a financial professional with a Financial Analyst certification can add value. With respect to profitability, two questions need to ask:
- How profitable are the operations in relation to the assets
- How profitable are the operations in relation to the equity shareholders?
It is important to identify potential risks, measure and assess their impact on profitability with the help of financial statement ratios relating to assets, debts, liquidity, etc. These ratios must be compared to earlier periods and also to the industry trends.
- Forecast financial statements
It is challenging, however, it is important to forecast with reasonable assumptions about the future of the firm. This should include the indicative figures of cash flows and income to the company in the coming financial year.
- Valuation of the company
The last step involves the valuation of the company. Although there are several methods, the discounted cash flow methodology is the most commonly used technique. Investments must be valued based on their future cash flows at a discounted rate. Methods such as relative valuation or accounting based measures could also be used.
Once the analysis is complete and the financial statement made, there is one pertinent question to be answered- “Can these figures be trusted”. Several firms have faced accounting irregularities and it is up to a finance professional to understand these types of manipulation to perpetuate into the causes and find effective solutions. Financial Analysis courses train professionals who wish to specialize in analyzing financial reports to help companies make the right investments towards healthy growth. These courses will help Financial Controllers who are closely involved in the financial aspects of the organization.
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