Basics of Financial Statement Analysis
Financial statement analysis is an important process that is carried by all organisations to evaluate the financial wellbeing of the business. A financial statement analysis entails evaluating the company’s financial statements for financial decision making. It helps to identify the roadblocks and challenges that the organisation is facing and design policies to address those challenges. The benefits of Financial statement analysis is not just limited to internal parties but also extends to external parties that are interested in the financial health of the business.
The internal parties conduct financial statement analysis to effectively monitor and manage the financial aspect of the organisation. The financial statements of a company record vital financial data on all the financial transaction-related activities carried out by the company. There are various types of financial statements to record every aspect of the business’s activities. These statements include a balance sheet, profit & loss statements, shareholder’s equity statements, cash flow statement, etc.
These financial statements follow some accounting principles to record and maintain financial data, one such popular accounting principle that is generally used is known as GAAP (Generally Accepted Accounting Principles). The standard for financial reporting might differ depending upon the status of the company. Some of the most popular financial analysis techniques used to assess the financial statements include vertical analysis, horizontal analysis, ratio analysis, etc.
Objectives of Financial Statement Analysis
Now that we have a fair understanding of what financial statement analysis is and what all it entails, let’s explore some of the major objectives of financial statement analysis.
- Assessment of historical and present performance
This is among the most important objectives of financial statement analysis. A company’s historical financial performance can provide a lot of insights into how it will perform in the future. It helps to identify a trend that exists in the financial performance of the organisation. Generally, investors, creditors or other probable stakeholders of a company are interested in finding out the historical trends in sales, expenditure, profitability, revenue, return on investment, etc. This past and present track record also give a glimpse into the work culture and managerial performances. A good track record will certainly help to attract more investors or clients.
- Income and growth prediction
The financial statement analysis helps to give a glimpse into the income estimates and growth prospects of an organisation. Now, in today’s competitive world, investors are looking to maximize the return of their investment. They have numerous options to choose from when it comes to investing in an organisation. The financial statement analysis report helps them to make more informed decisions. It also provides them with a fair idea about the risk and uncertainty associated with their investments, making it more transparent for them.
- To evaluate long- term and short term solvency
Financial statement analysis makes the financial standpoint of business more transparent for all stakeholders. It’s an important tool to predict the bankruptcy or other failures associated with the business. Evaluating the long-term and short term solvency is very important for creditors who are loaning out funds to the business. The financial statement analysis also uses ratio analysis techniques which gives an early sign in to any future losses.
Financial statement analysis takes a holistic approach to evaluate and assess the financial well-being of an organisation. It helps to provide deeper insights into the past and future performance after identifying the trends and patterns of various financial variables. It is not just useful for internal reference but also helps investors and creditors to assess the long term and short term solvency of the business.