Financial statement analysis is an integral part of the world of finance. Amateurs may find it tricky and critical to deal with financial statements. It is extremely important for finance professionals to master the skill of financial statement analysis and financial modelling. The art of financial statement analysis is a mix of the right ideas, contents and tools.
One should be equipped with the idea of what reports to analyse, determine various parameters and select the right tool for analysing. This is a brief guide that can make one understand the concept of financial statement analysis and how it works. However, a financial analysis course can help keen individuals to develop and understand a deep and insightful idea about financial statement analysis.
What is Financial Statement Analysis?
Financial statement analysis is the process by which the internal and external stakeholders of the company are able to take financial decisions and evaluate the performance of the business. It is a strong base regarding the financial decisions of an organisation. It allows concerned individuals to assess the overall financial health of a business and to evaluate the value of the same.
Additionally, financial statement analysis is also used to monitor the management and catering of finance throughout the organisation. The analysis of financial statements helps stakeholders to understand what areas are yielding them profits and what are resulting in losses.
Objectives of Financial Statement Analysis
The major goal of financial statement analysis is to provide financial facts and data to the company for the decision-making process, assessing past and present performance and making predictions about the success or failure of the company. Here are the main objectives of financial statement analysis:
- Financial statement analysis is important to assess the current financial position of a company. Keeping a regular record of financial transactions helps the management to make better financial decisions.
- Another objective of financial statement analysis is to identify and eliminate any discrepancies. Recording the income, expenditure, purchases and sales on a regular basis helps stakeholders to identify loopholes, if any.
- To allow stakeholders to make better decisions in future is another goal of financial statement analysis. it provides facts and reliable information on the basis of which better financial decisions can be taken.
- Financial statements are also analysed to lower the possibility of fraud in an organisation. By regular recording of financial statements people in a company will be aware that the management knows all of it which ultimately lowers the fraud percentage.
Types of Financial Statements
There are a few types of financial statements to provide transparency about the financial situation of a company. However, all the types of financial statements are interior linked and show different areas of finance. The three different types of financial statements are enumerated as follows:
The balance sheet is a financial report that depicts the financial worth of a company on book value. It consists of three parameters namely organisational assets, liabilities and shareholders’ equity. The concept is to equalise the acids and liabilities of a company to balance the shareholders' equity.
Cash and cash equivalents are short-term acids that showcase the operational efficiency and liquidity power of a company. The list of liabilities presents the dead capital of a company and its other expenses. Shareholders' equity consists of investments in equity shares and related investments along with the income from net profit.
The income statement is a financial report that measures the revenue of an organisation on one side and looks at the list of expenses on the other. It is also known as a profit and loss statement that gives a result as to whether a company has earned profits or made losses in a given period of time. Prophet margin helps businesses to understand whether they are incurring higher or lower operational costs.
Firstly, the income statement provides the gross profit analysing the revenue and direct costs. Secondly, it evaluates the operating profit by subtracting indirect expenses from gross profit. Lastly, the net income is calculated by detecting various taxes and interest from the operating profit.
Cash flow statement
A cash flow statement is a financial report that provides the details of only the inflow and outflow of cash and cash equivalents. The net profit is taken over to prepare a cash flow statement about various financial, operating and investment activities that are related to cash.
Operation activities include the cash flow regarding the day-to-day activities of a company. Cashflow regarding investment activities includes all the inflow and outflow of cash concerning various investments. Financial activities include the list of cash flows related to equity and debt financing. The end report shows the amount of cash that remains with the company and will be carried forward to the next accounting year.
Advantages of Financial Statement Analysis
Financial statement analysis helps businesses to grow and lower the chances of losses. The following are the major advantages of financial statement analysis:
- It allows businesses to evaluate the earning capacity of a company and how it can increase its profitability.
- The use of financial statement analysis makes it easier for companies to assess the effectiveness and ineffectiveness of the management.
- Financial statement analysis also helps in evaluating the liquidity of an organisation. Liquidity means the ability of an organisation to pay back its current liabilities.
- It helps to identify the new trends in the financial world and also determine what are the steps required to implement any changes in the organisation regarding financial situations.
- Financial statements are documents that show the current financial position of a company. Hence, it is easier to attract new investors and funds by showing the analysis reports and proving the company's value.
Financial statement analysis and financial modelling are interlinked, contributing to assessing the financial result of an organisation. It is important for active business persons to be very particular about financial statement analysis that includes various calculations related to financial ratios, determining profit and loss, preparing comparative statements and so on.
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