Understanding the Financial Statements?
Financial statements can be understood as a formal way to record the financial activities of an entity. The reports comprise financial data that helps to determine the overall financial growth and strength of a company. It reflects the outcome of financial and business-related transactions of a company. The information presented in financial statements follows a rigid structure that helps to obtain information quickly.
Financial statements are primarily categorized into three categories that include a balance sheet, income statement or profit & loss statement, cash flow statements. Other types of financial statements include equity statement and comprehensive income statements. The financial statements also contain footnotes that provide extensive information on a range of subjects.
Financial statements contain vital relevant information that helps to assess the company’s financial standing. Financial analysts use various tools and techniques to analyze these financial statements and bring out important information that helps in better decision making. It also helps to identify trends and patterns based on historical data. Let’s delve deeper into some important tools and techniques used to analyze financial statements.
Comparative statements are an important financial statement analysis tools that help to compare different elements of financial statements like Profit and Loss statement and balance sheets. It is used to compare the elements of these financial statements of two or more periods.
Two different comparative statements are prepared to facilitate the comparison of the balance sheet and profit & loss statements. The important elements that are used in comparison for Profit & Loss statements include gross profit, operating profit and net profit. These comparisons help the management to identify the pain points and implement necessary changes.
Common Size Statements
The common size statement tools take a vertical presentation approach to represent financial information. The interesting thing about common size statements is that it doesn’t include the absolute value; instead, it uses percentage form to depict the values. The determining factor or the value that is taken as 100% for the balance sheet is the total assets and revenue for the profit and loss statements.
For example, if the absolute value of sales or revenue is 200 and the profit amount is 100 then profit is recorded as 50% and sales are recorded as 100%. It shows a relation of individual elements as compared to the base elements. In this example, the relation states that the profit is 50% of the revenue.
Ratio analysis is carried out to find meaningful relations between different elements of various financial statements. Ratio analysis is extensively used by financial analysts and business analysts to derive meaningful conclusion and hidden insights from these data points. It is used by both the internal and external parties conduct a financial analysis for a corporation. The main intent is to depict the performing aspects such as profitability, liquidity, solvency, etc.
In the trend analysis technique, the ratio of different elements are computed for multiple periods and if followed by a comparison between different periods. This helps to identify a trend or patterns based on the historical data for a company. It also helps to make future predictions following the same trend and identify winning patterns. After the analysis, an uptrend or downtrend pattern is recognized for different elements and necessary steps are taken to make it favourable.
Cash Flow Analysis
Cash flow analysis is conducted to determine the cash position of the firm, meaning it helps to determine the inflow and outflow of cash to and from the business. There are majorly two types of cash flows, actual cash flow and notional cash flow. It helps to understand how much cash balance a company needs to maintain to operate successfully without facing any cash-crunch issues.