Financial statement Analysis: Types, Tools and Guidelines

March 01, 2022 Admin
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To understand the strengths and weaknesses of the company, financial statement analysis can be used as a tool. Let’s find out more about the various aspects attached to the financial statement.

 

Financial statement analysis helps in determining the comparison, interpretation of the balance sheet and income statement. To conclude the future course of the company in terms of action plan, the following decision-making aspects are required to be decided:

  • Financial position
  • Investment decisions
  • Profitability analysis
  • Strengths and weaknesses

The above aspects are essential for the disposal of internal parties like lenders, investors, security analysts, etc.

 

Definition: Financial statement analysis

 

Financial statement analysis is an assessment of the financial wellbeing of the company. It explains the relative comparison with the multiple items in the statement to finally establish reasoning for every decision that is going to be taken by the management of the company in future.

 

Tools that are required to complete the financial statement analysis include: 

  • Comparative statement
  • Common Size statement
  • Ratio Analysis
  • Cash Flow statement
  • Fund flow statement
  • Trend Analysis

By using the above tools a financial statement analysis is prepared. However, some of the companies also rely on the financial statements analysis tools as they help in minimizing the manual efforts and offer a consolidated report of the analysis in minimalistic format for the financial expert to go through and process the implementation of the statement further. 

 

Types of financial statement analysis

Though the core nature of the financial statement is to simplify the interpretation of the financial elements in a structured manner. But there are different types that are used for different purposes. Here are the various types of financial statements analysis that you should know about: 


 

1. Internal Analysis 

As the internal management consists of employees, managers, auditors, top level management, therefore the internal analysis consists of the assessment of the overall performance done by the internal management to find out the financial health of the business.


 

2. External Analysis

This is primarily a detailed analysis done by the external management that means investors, statutory bodies and financial institutions. This analysis helps in understanding the financial soundness and status of the business and these analytics reports can be used for various purposes in future. 


 

3. Horizontal Analysis

The comparison of different financial years’ statements from the past years to have a look into the performance and change in trends that was followed by the company, this is what horizontal analysis means. With the help of comparative statements, cash flow statements, trend analysis, horizontal analysis is done. 


 

4. Vertical Analysis

The comparison of different items of financial statements in a year by taking a common base, is known as vertical analysis. This analysis gives a quantitative understanding about the elements, generally the implications from this analysis helps in finding out the forecast that would further help in decision making. Common size statements and ratio analysis are the tools used to accomplish vertical analysis.

 

Guidelines of Financial statement analysis
 

  1. Select appropriate tools for the type of analysis you are planning to do. Ratios are the preferable tool to do financial interpretations.
  2. Notes given at the bottom of the statement are always ideal to refer to, as they offer accuracy with detailed calculation that enables to crosscheck the truthfulness of the facts given by the company.
  3. Financial Statement Analysis being a complex process requires expertise, logical reasoning and right approach in order to conduct an unbiased analysis. There is no substitute for precision. 
  4. While doing comparison of ratios, do not forget to consider the average of the industry benchmarks that are validated by the industry leaders.
  5. Choose only the ratios that can offer maximum information for the analysis.

 

Importance of financial statement analysis

The fulfilment of financial statement analysis works with the involvement of multiple parties both internal and external, like government, stock exchange, economists, financial institutions, trade union, shareholders, creditors, management, employees and customers. So to find out the advantages of the financial statement analysis, we should know the advantages for each party:

  • Management - For  market trends analysis that can be used for forecasting and decision making
  • Government - For taxation implementation. 
  • Investors: For investment purposes and relative comparison with other entities.
  • Creditors: For short and long term solvency.
  • Financial institutions: For validating the creditworthiness of the business.
  • Employees: For understanding the profitability and growth of the company. 

Conclusion:

A financial statement analysis report is prepared with the support of both Internal and external parties as a business is dependent on various aspects that contribute in creating the political and economic environment for any business. To have a consolidated analysis and outlook for the future these financial statements are analysed and the advent of financial analysis tools has seen a steep growth and in the near future it is going to be a game changer for the finance sector and  would also contribute in building a strong economic structure of the nation.

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