FINANCIAL STATEMENT ANALYSIS
Financial statement analysis (or financial analysis) is the process of
reviewing and analyzing a company's financial statements to make better
economic decisions. These statements include the income statement,
balance sheet, statement of cash flows, and a statement of retained
BASIC FINANCIAL STATEMENTS
The balance sheet, which summarizes what a firm owns and owes at a
point in time.
The income statement, which reports on how much a firm earned in
the period of analysis.
The statement of cash flows, which reports on cash inflows and
outflows to the firm during the period of analysis.
Objective of Balance Sheet
Another name for the balance sheet is the statement of financial position.
Creditors and interested stock investors use the balance sheet to determine
a company's financial standing because it lists what a company owns and
what it owes. The balance sheet contains summarized information on a
company's assets -- the things that it owns and its liabilities -- the debts it
has. When you subtract the company's liabilities from the assets, what is left
is called stockholder's equity, the amount that is held by the company's
owners or stockholders.
Objective of income statement
Income Statement provides the basis for measuring performance of an entity
over the course of an accounting period.
Performance can be assessed from the income statement in terms of the
Change in sales revenue over the period and in comparison to industry
Change in gross profit margin, operating profit margin and net profit
margin over the period
Increase or decrease in net profit, operating profit and gross profit over
Comparison of the entity's profitability with other organizations
operating in similar industries or sectors.
The statement of cash flows reports the cash receipts, cash payments,
and the net change in cash resulting from the operating, investing, and
financing activities of a company during the period. The information in a
statement of cash flows should help investors, creditors, and others assess:
The company’s ability to generate future cash flows. By
examining relationships between items in the statement of cash flows,
investors and others can better predict the amounts, timing, and
uncertainty of future cash flows.
The company’s ability to pay dividends and meet
obligations. Employees, creditors, stockholders, and customers
should be particularly interested in this statement because it alone
shows the flows of cash in a business.
The reasons for the difference between net income and net
cash provided (used) by operating activities. Many financial
statement users investigate the reasons for the difference between net
income and cash provided by operating activities and then they can
assess for themselves the reliability of the income numbers.
The investing and financing transactions during the period. By
examining a company’s investing activities and financing activities, a
financial statement readercan better understand why assets and
liabilities increased or decreased during the period.
Retained Earnings is a balance sheet account that refers to the portion of
company income that is retained by the firm. In other words it is a part of
earnings that is not paid out as dividends or otherwise distributed to owners.
Retained Earnings are calculated by adding net income to last period
retained earnings and subtracting any dividends paid to owners.
Objective Retained Earnings = Beginning RE + Income - Dividends = 9 M
One purpose behind these financial documents is to allow key decision
makers to evaluate the company's current situation and make changes as
needed. Creditors use these statements to make a decision on loans it might
make to the company. Stock investors use these statements to determine
whether the company represents a good investment.
Objectives of Ratio Analysis
Standardize financial information for comparisons
Evaluate current operations
Compare performance with past performance
Compare performance against other firms or industry standards
Study the efficiency of operations
Study the risk of operations
FINANCIAL RATIO ANALYSIS
Financial ratio analysis is the use of relationships among financial
statement accounts to gauge the financial condition and performance of a
We can classify ratios based on the type of information the ratio provides:
Financial ratio analysis and common-size analysis help gauge the
financial performance and condition of a company through an
examination of relationships among these many financial items.
A thorough financial analysis of a company requires examining its
efficiency in putting its assets to work, its liquidity position, its
solvency, and its profitability.
We can use the tools of common-size analysis and financial ratio
analysis, including the DuPont model, to help understand where a
company has been.
We then use relationships among financial statement accounts in pro
forma analysis, forecasting the company’s income statements and
balance sheets for future periods, to see how the company’s
performance is likely to evolve.