Last updated on April 6th, 2024 at 08:34 pm
Analysing the financial statements of a company to facilitate decision-making is called Financial statement analysis. It involves evaluating and analysing businesses, budgets, projects and various finance-related transactions that help them to regulate their performance. In general, experts use financial analysis to determine the stability, solvency, or profitability of an entity and if they are enough for a monetary investment.
It is an integral part of financial statement preparation and is extensively used by external stakeholders to evaluate the overall financial health and business value of an organisation. Financial analysis on the other hand is used to determine economic trends, build future business plans, set financial policies, and find out suitable companies and projects to invest in.
This article will give you detailed information about financial statement analysis, its types and how it differs from financial analysis as a whole.
Three Techniques Used in Financial Statement Analysis?
Financial statement analysis is an integral part of preparing the financial modelling spreadsheet that helps forecast business performance. Financial analysts generally use the following techniques to analyse the financial statements of a company.
- Horizontal analysis: This is carried out via the comparison of historical data and is used for detecting growth trends from various time periods.
- Vertical analysis: This is carried out via the comparison of items listed on a financial statement and their relation to each other. For example, an expense item can be expressed as the sales percentage of a company.
- Ratio analysis: This is the final and most important part of the analysis where the line-item data like P/E (Price-to-earnings) ratios, dividend yield or earnings per share.
Financial Statement Types
To efficiently manage operations and run business forecasts, companies make use of financial statements like balance sheets, income statements, and cash flow statements to ensure that their stakeholders get maximum transparency. The different types of financial statements have been elucidated below:-
- Balance Sheet: This is a document that reports the financial worth of a company with regard to book value. It is usually divided into three segments namely:-
- Company assets: Cash and accounts are short-term assets that can be received and are proof of how efficiently the company is operating.
- Company liabilities: A company’s arrangements for expenses and how much debt capital is being paid off fall under company liabilities.
- The shareholder equity of the company: Detailed information about earnings from net income periodically and equity capital investments fall under shareholder equity.
It is important for the balance sheet to balance the assets and liabilities keeping the shareholder equity equal. This figure serves as the company’s book value and is considered an integral performance metric.
- Income Statement: This helps segregate the revenue earned against the expenses spent by a company to run its business activities. All in all, it refers to the net profit and loss of a company. It is broken into three segments for business efficiency analysis:-
- Revenue
- Operating profit
- Net income is reached
Analysing income statement involves calculating gross profit, operating profit, and finally, net profit margin.
- Cash Flow Statement: This is more like an overview of the cash flows of a company starting from investing activities, financing activities and operating activities. Net income is added to the cash flow statement, which is further included for operating activities as a top-line item. Investing activities section in the cash flow statement includes cash flows from firm-wide investments where as the financing activities section includes cash flows from equity and debt financing. At the very bottom, one can find the outstanding cash that is available in the company.
- Free Cash Flow Statements/ Other Valuation Statements: Analysts are also known to use other valuation or free cash flow statements to determine company value. Free cash flow statements show the total present value by deducting the free cash flow estimated by a company to generate. It is highly valuable for private companies before they go public.
Financial Analysis: A Brief Introduction
Financial analysis, unlike statement analysis, is used to monitor economic trends, decide what financial policy to set, make long-term plans, and pinpoint projects and companies to invest in. It can be done by both investment finance and corporate finance companies.
It is carried out by a financial analyst who synthesises financial data and thoroughly examines the financial statements of a company namely:-
- Income statement
- Balance sheet
- Cash flow statement.
Financial data is commonly analyzed by calculating ratios extracted from the data in the statements and comparing them against the company’s historical performance or the data of other companies.
Financial Analysis vs. Financial Statement Analysis
Both Financial analysis and financial statement analysis are involved in evaluating and analysing the financial statements of a company to facilitate economic decision-making. However, both have their key differences that need to be interpreted clearly for proper understanding. The differences have been elucidated below:-
| Key parameters | Financial Analysis | Financial Statement Analysis |
| Definition | Financial analysis refers to assessing and analysing the financial statements of a company for enhancing economic decision-making. | Financial statement analysis refers to comprehending what is essentially indicated by the financial statements like balance sheet, cash flow, income and the like. |
| Purpose | Financial analysis helps a company understand how much the results of a current period have changed from the past. | Financial statements analysis is carried out to help companies make informed decisions to enhance future performance. |
| Time | Financial analysis is straightforward and takes less time. | Financial statement analysis involves extracting, reviewing and detecting connections within the information at hand, making it more time-consuming. |
Conclusion
Financial statement analysis is an integral part of the financial modelling of a company because it helps provide in-depth information about the KPIs of a company over time. Financial analysis on the other hand is a more holistic term used to signify the processes involved in the analysis of a company’s financial health over time.
If you are planning to pursue a career in this field, you must have a deep understanding of both as well as how different they are from each other. To kickstart your career as a financial analyst, you can consider signing up for the Financial Analysis Prodegree In Collaboration With KPMG offered by Imarticus Learning.
