Financial Statement Analysis General Rules

1- Comparison of two Balance Sheet amounts should use the end of the period balances. Thus if both the numerator and denominator are Balance Sheet amounts do not use averages.

2- Comparison of Balance Sheet amount to Income Statement amount should use average balance (Balance Sheet) Rather than a value at a point in time (year-end balance)

3- Amounts being compared should be meaningful (this is done if a plausible Relationship between the amounts exists and the amounts are homogeneous.

Ex: Sales amounts and commissions ⇒ plausible Relationship

          COGS    ⇔  inventory are both cost based  ⇒ homogeneous

          Sales   ⇔  account receivable both based on sales price ⇒ homogeneous

4- Income Statement is more useful in trend analysis than Balance Sheet, because Income Statement accounts are temporary (nominal) accounts but Balance Sheet balances are real (permanent) accounts.

5- An equal increase in the amounts of numerator and denominator will increase the ratio if numerator is less than denominator and would reduce the ratio if numerator is greater than denominator

6- An equal decrease in the amounts of numerator and denominator will decrease the ratio if numerator is less than denominator and would increase the ratio if numerator is greater than denominator

7- An equal increase or decrease in the % of numerator and denominator will not affect the ratio regardless of whether the numerator amount is greater or lesser than the denominator amount