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What is financial statement analysis?

Whether you’re drawing up next year’s budget or determining whether or not to greenlight a project, financial statement analysis can help. Learn more about how to analyze your company’s financial statements below.

Introduction to financial statement analysis

According to generally accepted accounting principles (GAAP), businesses are required to keep detailed records of all financial transactions. Relevant information is reported for each accounting period in documents like the balance sheet, cash flow statement, and income statement. The process of analyzing these financial statements is called a financial statement analysis. It can be performed internally as a monitoring tool or externally for assessing investment value and performance.

Types of financial statement analysis methods

There are three main techniques used during an accounting analysis of financial statements. This includes the following:

  • Horizontal analysis: In a horizontal analysis, you take a look at values of line items horizontally, comparing them across multiple years.

  • Vertical analysis: As the name suggests, you compare line items by looking at them vertically with this type of analysis. This examines the impact that each line item has on other components of the business.

  • Ratio analysis: Those who prefer the statistical approach to a financial statement analysis might use a ratio analysis. This uses ratio metrics to define and analyze various relationships between line items. You can bring data points from multiple statements together, breaking them down by performance metric.

Financial statement analysis examples that could be used for comparison include factors like the following:

  • Asset turnover

  • Receivables turnover

  • Debt to assets ratio

  • Quick ratio

  • Tax ratio efficiency

  • Gross profit margin

  • Net profit margin

  • Operating profit margin

  • Cash and earnings before interest

  • Depreciation

  • Return on assets

  • Return on equity

Types of financial statements to analyze

There are three primary financial statements to include in this type of analysis, including the balance sheet, income statement, and cash flow statement. When maintained according to GAAP regulations, these provide greater transparency to stakeholders. All three document types are interrelated, which means they must be looked at together as part of your accounting analysis of financial statements.

Balance sheet

The balance sheet is broken into three sections, showcasing the company’s assets, liabilities, and shareholder’s equity. The relationship between these three components is often broken down into the following equation: Assets = Liabilities + Equity

It forms a vital part of any financial statement analysis, with details pertaining to a company’s expense arrangements and short-term assets like accounts receivable.

Income statement

A financial statement analysis will also look at the income statement, which is a breakdown of all the business’s revenue. It shows net income profit or loss throughout the accounting period. A basic analysis of the income statement will typically involve calculating the net profit margin, operating profit margin, and gross profit margin.

Cash flow statement

The cash flow statement is of particular interest to financial analysts, who will pore over it carefully to gain greater understanding of a business’s financing, investing, and operating activities. Cash flow is very important to a company’s long-term growth prospects, so analysts will look at the sources and day-to-day uses of cash.

How to write financial statement analysis reports

The chief benefit of a financial statement analysis is that it can be adapted to individual business needs. As such, when looking at how to write financial statement analysis reports you can pick the format and methods that make the most sense. A typical framework would look something like this:

  • Introduction including context for the analysis

  • Input of data

  • Processing of data

  • Analysis of processed data

  • Conclusions and follow-up

What’s important is that you include all three of the required documents (balance sheet, income statement, and cash flow statement) in your analysis.

The central focus of any analysis should be to unearth whether the business is capable of generating returns on its capital, grow over time, and generate adequate cash to meet all financial obligations. Finally, it’s important to note that all publicly traded companies within the US must have an annual independent audit performed, which expresses an opinion regarding the financial statements. This can go hand in hand with the analysis.

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