All About Financial Statement Analysis

All About Financial Statement Analysis

A financial statement serves as an accounting record facilitating comprehension of a business's financial status and cash movements.

A financial statement serves as an accounting record facilitating comprehension of a business's financial status and cash movements. Various statement types fulfill distinct purposes. The examination of financial statements involves scrutinizing the correlation between financial data in Financial statements. The study of Financial Statements assesses an enterprise's present and historical financial positions, as well as operational outcomes. The very motive of Financial Statement Analysis is to make informed predictions about future conditions by consolidating and assessing information within financial statements, revealing strengths and weaknesses in a business.
Why Organizations need a Financial Statement Analysis
 

1. Performance Evaluation: A Financial Statement Analyst assesses the financial health and performance of the organization.
2. Decision Making: Financial Statement Analyst aids in making informed decisions related to investments, loans, and strategic planning.
3. Risk Assessment: Financial Statement Analysts identify and prevent potential financial risks and vulnerabilities in the business.
4. Investor Confidence: Financial Statement Analysts are responsible for building trust and confidence among investors by providing transparent financial information.
5. Resource Allocation: Financial Statement Analysts assist in allocating resources effectively based on financial strengths and weaknesses.
6. Forecasting: Financial Statement Analysts support in forecasting future financial conditions and trends of an organization.

Process of Financial Statements Analysis
There are three major steps for the analysis of financial statements

1. Restating Financial Statements: The process involves presenting the financial statements in a way that allows for improved analysis and precise interpretation of the company's performance. For instance:

1. Income Statement: The process separates recurring items from non-recurring items along with the separation of income into transitory and core.
2. Balance Sheet: The process entails dividing the balance sheet into operating assets/liabilities and financial assets/liabilities.
3. Cash flow statement: It entails excluding financial transactions from the operating cash flow.
    

2. Adjustment of errors: The process eliminates any unnecessary or irrelevant information from the input data, resulting in improved accuracy and reliability of the reported accounting figures.
3. Financial Ratio Analysis: The Financial Ratio Analysis is conducted through adjusted financial statements, and it includes calculating ratios to evaluate the company's performance.

Types of Financial Statement Analysis
There are different types of Financial Statements Analysis:

1. Income Statement Analysis: The income statement analysis can be done in two different ways:

1. Vertical Analysis: The Financial Analyst looks up and down the financial statement to investigate the comparison of line items to the revenue as a percentage. Below listed are the grounds that are taken into consideration during vertical analysis:
   Tax
   Interest 
   Net earnings 
   Earnings Before Tax (EBT) 
   Gross profit Depreciation 
   Cost of Goods Sold (COGS) 
   Selling General & Administrative (SG&A) 
2. Horizontal Analysis: During horizontal analysis, we look at the year-over-year change in the income statement. The horizontal Analysis can be done with a simple formula that involves dividing the value in Period P by the value in the previous period (P - 1), subtracting 1 from the result, and converting it into a percentage to determine the percent change.

2. Cash Flow Statement Analysis: The study of Cash flow statements can help one understand the inflow and outflow of cash flow analysis. There is the investigation of these three components including cash used in investigating, operations, and financing will indicate the use of cash during evaluation time.
3. Pyramid of Ratio Analysis: Financial Statement Analysis uses a Pyramid of ratios to showcase the profitability, efficiency, and upliftment drivers for any business.
The analysis is conducted by considering the following insights:

1. Dupont analysis
2. Return on equity ratio (ROE)
3. Rates of return and profitability analysis
4. Profitability, efficiency, and leverage ratios
    

4. Balance Sheet Analysis: By analyzing the balance sheet, analysts can assess the operational effectiveness of the business. This involves comparing elements from the income statement with the company's capital assets listed on the balance sheet. By utilizing various financial ratios derived from the balance sheet, one can evaluate the company's ability to generate revenue and efficiently sell its inventory.
Advantages of Financial Statement Analysis

1. Facilitates operational decision-making in businesses.
2. Assesses firm profitability and operational efficiency.
3. Aids in evaluating the financial health of the firm.
4. Useful for cross-sectional and time series analysis.

Limitations of Financial Statement Analysis

1. Excludes consideration of price level changes.
2. Lacks awareness of accounting procedure changes.
3. Neglects non-monetary aspects in analysis.
4. Doesn't depict real-time financial position due to accounting concepts.

Frequently Asked Questions (FAQs)
Q1. What are the basic tools that are used in Financial Statement Analysis?
A1. The list of basic tools that are used in Financial Statement Analysis is mentioned below:

1. Financial Ratios
2. Vertical Analysis
3. Horizontal Analysis
    

Q2. Name the techniques that are used in Financial Statement Analysis.
A2. There are several techniques used in the analysis of Financial Statements of an organization or business. Here are some mentioned below:

1. Common-Size Statements
2. Comparative Statements
3. Trend Analysis
4. Fund Flow Analysis
5. Cash Flow Statement
6. Ratio Analysis
    

Q3. How do analysts analyze the income statement?
A3. Income Statement Analysis: The income statement analysis can be done in two different ways:
1. Vertical Analysis: The Financial Analyst looks up and down the financial statement to investigate the comparison of line items to the revenue as a percentage. Below listed are the grounds that are taken into consideration during vertical analysis:

1. Tax
2. Interest 
3. Net earnings 
4. Earnings Before Tax (EBT) 
5. Gross profit Depreciation 
6. Cost of Goods Sold (COGS) 
7. Selling General & Administrative (SG&A) 

2. Horizontal Analysis: During horizontal analysis, we look at the year-over-year change in the income statement. The horizontal Analysis can be done with a simple formula that involves dividing the value in Period P by the value in the previous period (P - 1), subtracting 1 from the result, and converting it into a percentage to determine the percent change.