This article will highlight all the aspects of performing financial statement analysis. It will help any novice understand the purpose, benefits, and needs of this very useful analysis tool.
The thing is if any investors or analyst wants to understand the performance or financial position of a company, they will get the best results by doing a thorough study and analysis of its financial statements.
So, let’s jump into understanding the concept that is Financial Statement Analysis.
What is Financial Statement Analysis?
Financial statement analysis is the study of the financial statements of a company to understand the relationship between the figures shown in the books and the facts stated by the company. The analysis provides the base for comparative and common size analysis.
One of the major benefits of opting for financial statement analysis is that helps determine the prospects of the company. It will provide a clear insight into whether the company will do good or may face a downward trend.
Some more benefits it provides to the companies can be for the different roles it plays:
An Indicator: The financial statement not only indicates financial health but also states facts that tell the efficiency of managerial performance.
An identifier: The analysis will help identify the strong and weak aspects of the firm both operation-wise and financially-wise.
An assessor: It helps with assessing the current profitability of the organization.
A forecaster: The analysis not only helps understand the current financial scenario but also helps in forecasting the future operation and capital expenditure of the company.
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Preparation of Financial Analysis
The main three preparation made before the financial analysis is conducted are:
Adjustment of Errors
This is a very important part of the preparation for the financial analysis. In this, all the measurements are adjusted to remove any sort of redundancy in data or errors made. This way the reported numbers will be even more accurate.
Restating the Financial Statement
Restating the financial statement, that is, the income statement, cash flow statement, and balance sheet will present a more accurate interpretation of the company’s financial performance.
Financial Ratios
The best indicator of the financial statement is when they are converted into financial ratios. And as the ratios get calculated it makes the financial analysis process easy.
Process of Financial Statement
The entire process of financial statement takes place in the following detailed phases:
Phase 1
This is the first step to financial statement analysis. The analysts will begin by stating the purpose of the analysis. The questions whose answers need to be defined are structured and the institutional guidelines for the analysis are stated in this stage.
Phase 2
The next phase is crucial as it involves collecting and organizing all the data. Just to ensure that the analysts have all the data, they will use a questionnaire or the industry norms to extract all the data.
With all this collected information, the team will be able to create the financial table to properly conduct the analysis.
Phase 3
Now that the data is now in place, the next step is to start processing all the databases. This is the stage when the information is converted into a common-size statement and the ratios, graphs, and graphs are prepared.
If required, all the necessary changes are also made in the financial statements and the adjusted statement is prepared.
Phase 4
In this stage, the calculated financial data is presented to the analysts who will interpret the information. This will also be the stage for the experts to analyze and share insights on the financial performance of the company.
Phase 5
Post the analysis, in this phase, the analysts will share their conclusion on the company on basis of the financial data calculated.
And they also frame all the data into a report for a more refined result. If felt necessary, the analyst will also provide recommendations on necessary credit grants and investments.
Phase 6
After this initial analysis process, all that is left is to follow up on the insights and take the necessary steps to follow up with the recommendations. And once these changes are done, another adjusted or updated report is prepared.
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Types of Financial Analysis
There are 4 types of financial analysis recognized by industry experts- horizontal analysis, vertical analysis, internal analysis, and external analysis.
Horizontal Analysis
In this analysis, the items of the financial statement compare across the years. Horizontal Analysis gives insight into the growth and profitability of the company. This analysis is also known by two other terms- Time Series Analysis and Dynamic Analysis.
Vertical Analysis
Vertical analysis refers to the same-year analysis done against the total revenue earn or the assets of the company. It can also be done between any other financial statement items. These are also referred to as cross-sectional or static analyses.
Internal Analysis
Internal management of the company performs the Internal Analysis. The internal members do it and they can get complete access to all the information even the confidential ones. This leads to a more accurate and extensive analysis report.
External Analysis
External parties such as stakeholders, researchers, investors, and other interested parties perform this analysis using publicly published reports and financial statements. The analysis might not be as in-depth as the internal analysis.
Benefits of Performing Financial Analysis
Financial analysis can provide insights into many facets of an organization’s financial health and ongoing performance.
Comparative study
Using financial analysis, the companies will be able to conduct comparative studies between peer companies to check the growth of the firm in the industry.
Long-term and short-term solvency analysis
Solvency analysis will help the company figure out if it will be able to meet its short-term and long-term debt obligations. Based on the outcomes the core management can change their strategies to ensure more debt-free operations.
Measure the company’s profitability
Financial analysis is the key measuring tool to check the company’s profit-earning capabilities and how it will be growing in the future.
And in case the present scenario shows that the company faces losses, then this analysis will help in identifying the factors which can lead to future profits.
Judge the financial strengths
From the profitability analysis and comparative analysis, the company will be able to evaluate the position the company holds in the competitive market.
Conclusion
Financial statement analysis is the go-to tool for many analysts and investors to understand the financial strength and weaknesses of the company. The better the analysis report, the more accurate the insights will be.
Hope this article has convinced you to perform personal financial statement analysis on the companies you are interested in.
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