For most small-business owners and SMEs, analysis of financial statements might appear overwhelming. While most business owners might consider outsourcing the creation of in-depth financial statements to a professional accountant, learning to evaluate them helps in determining the financial health of the organization. It is important to conduct comprehensive financial statement analysis once a year -if not quarterly, to leverage full benefits of the information provided.
What is Financial Statement Analysis?
Financial statement analysis includes reviewing the financial statements of the organization to gain access to an understanding of the financial situation.
Financial statements typically include an income statement, a balance sheet, cash flow statements, and supplementary notes. An internal financial statement analysis is executed by government agencies, employees, or other individuals with access to internal accounting records of a business firm. On the other hand, an external financial statement analysis is executed by outsiders with access to published financial statements. Some of the outsiders include investors, creditors, government agencies, credit agencies, or the general public.
You can look forward to conducting either short-term or long-term financial statement analysis. A short-term financial statement analysis can consider the ability of the firm to ensure the payment of liquidity or short-term debts. On the other hand, a long-term financial statement analysis will look into the ability of the company to pay solvency or long-term debts.
Some of the common tools utilized in the process of financial statement analysis are analysis of common-size statements, cash flow analysis, cost-volume-profit analysis, comparative statement analysis, networking capital analysis, trend analysis, and fund flow analysis.
Common Methods of Financial Statement Analysis
The methodology of financial statement analysis can be executed either through vertical or horizontal analysis, or even analysis mechanism using ratios.
Horizontal financial statement analysis refers to comparing available financial information over a specific period. In this case, the base year is selected as the starting point for ensuring future comparisons. On the other hand, vertical financial statement analysis refers to the proportional analysis of the financial statement. Every item in the line is listed in the form of a percentage of some other line item. The base year here is selected for comparing figures of the statement of the same year.
Some of the common methods of conducting financial statement analysis will include the following ratios:
These help in the measurement of the performance and quality of the management. Some of the instances are accounts receivable turnover ratio, accountable payable turnover ratio, inventory turnover ratio, fixed asset turnover ratio, working capital turnover ratio, and sales-to-working capital ratio.
These help in measuring the ability of the company to continue with its business. Some instances are current ratio, cash coverage ratio, liquidity index, and quick ratio.
These help in measuring the ability of the company to generate profits. Instances are break-even point, gross profit ratio, contribution margin ratio, return on equity, margin of safety, return on operating assets, and return on net assets.
These help in measuring the reliance of the company on operations related to debt to finance. Some of the instances are debt-to-equity ratio, debt service coverage ratio, and fixed charge coverage.
4 Qualities of Ideal Financial Statement
Whether you conduct financial statement analysis on your own or leverage a reliable financial statement analyzer, you should seek some ideal qualities of a great financial statement. Top 4 qualities of ideal financial statement are:
Depicting True Financial Position
The information depicted in financial statements should be true while signifying the fact that only correct idea is used about the company’s existing financial condition. In this case, no material-specific information is withheld during the preparation of financial statements.
You should note that financial statements are presented in a lucid and simple way to make them easy to understand. An individual who might not be well-versed with financial and accounting terminology should be capable of understanding the financial statements without significant difficulty.
The financial statements you prepare should be relevant to the objectives of the organization. It is possible when the individual preparing the statement is capable of effectively using the respective accounting information.
The financial statements you prepare should be presented in a manner that important information gets underlined. It should ultimately attract the reader’s eyes.
Top Benefits of Accurate Financial Statement Analysis
Effective financial statement analysis is pivotal to comply with business regulations and laws. It also helps in meeting specific needs of stakeholders and multiple parties. However, to ensure accurate financial statement analysis, it is important to develop intuition and relevant skills according to the best accounting practices.
Financial statement analysis with the help of a reliable financial statement analyzer from Perfios can benefit companies in several ways. With FSA or Financial Statement Analyzer from Perfios, organizations can leverage the benefits of a unique financial analysis software solution that helps in the automation of the collection, curation, and analysis of financial statements while also generating a detailed report for financial statement analysis & valuation.
As top executives and other members in management tend to depend on accounting towards providing the accurate depiction of the overall effects of their respective decisions, relevant financial statement analysis can help with aspects of corporate governance at the same time. You can go through the following series of tips to ensure accurate financial statement analysis for your organization:
● Be focused on the overall relevance. You should take into consideration the latest trends while analyzing financial information.
● Maintain proper objectivity by understanding that decisions are based on numbers that are listed on the respective financial statements. Accountants in your organization should look into intangible variables also.
● It is imperative for you to trust intuition. It is because the decision to invest in some product should be based on numbers.
The overall business growth depends on the timely and accurate analysis of financial statements. With the rapid development of modern businesses, it is important to place maximum importance on the insights gathered by accountants or a reliable financial statement analyzer.
Paul is an content marketing strategist and serial entrepreneur.