Basic Financial Statement Analysis

Financial Analysis

While F/S summarizes the past performance of an organization; they can also provide users with valuable insights into future performance.

Commonly used tools to evaluate the significance of financial statement data are:

Ratio analysis

expresses the relationship among selected items of financial statement data. Ratio reduce absolute dollar amounts to more meaningful data.

A ratio is a comparative relationship between two or more F/S amounts, the ratios provide incremental information about the financial health of the company beyond the raw amounts presented in the F/S.

Financial ratios are commonly used for three types of inferences which are :

Vertical analysis

evaluates financial statement data expressing each item in a financial statement as a percent of a base amount.

Horizontal analysis (Trend analysis)

evaluates a series of financial statement data over a period of time.

Financial Analysis

Financial analysis is the use of F/S data to evaluate the potential of future economic performance of an enterprise.

Managers

use financial statement analysis to plan, budget and anticipate future needs and problems and to evaluate and control operations.

Lenders

all creditors including financial creditors (bondholders) and commercial creditors (vendors) who extend credit to the company use F/S analysis to evaluate creditworthiness, they concentrate on liquidity measures and financial leverage thus the statement of cash flows is the most relevant to them

Investors

in common stocks use F/S analysis to predict future earnings and cash flows and the company’s potential, the income statement is the most relevant to them.

Benefits of F/S analysis

  • F/S analysis is an important tool to better understand the company’s competitive position.
  • F/S can be analyzed to identify trends in key financial data.
  • F/S analysis can be used to compare financial performance across companies.
  • Financial ratios can be used to assess a company’s current performance as well as its prospects for the future.
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