Financial statement analysis is very important when making several key business decisions.
For example if you are thinking of lending money to a company and you’re trying to decide whether that company is a good credit risk or not you want to know am i going to get my interest payments and am i going to get the principal repaid to me or maybe you are a supplier to a company and you want to know if you can sell goods to them on credit, will they be able to settle their obligations. Or maybe you are thinking of investing in a company you’re thinking of buying stock in a company like Zenith Bank Plc or Seplat Energy Plc, so you want to look at the past performance of that company which is given in their financial statements to try and make predictions about the future going forward what will be the company’s future sales what will be their future profits
We can make judgments based on if sales have been increasing or sales have been declining and I think this trend will continue or reverse and so forth. These financial statements are like a window into a company and they give me a picture of what is going on at this company and what can I expect to happen with respect to profits sales cash flows in the future.
Analysis can be carried out on 3 statements:
- the income statement also called the statement of operations
- the balance sheet which has the company’s assets liabilities and equity accounts/ also called the statement of financial position
- the company’s statement of cash flows which is going to tell us where is this company getting its cash from is it from their operations from business operations or maybe it’s financing maybe they’re borrowing cash
A very important tool for financial analysis is ratio analysis, which can predict a company’s future performance—for better or worse. Ratio analysis can be divided into 5 stated below:
1. Liquidity Ratios
Liquidity ratios tell a company’s ability to pay its debt and other liabilities. By analyzing liquidity ratios, you can gauge if the company has assets to cover long-term obligations or the cash flow is enough to cover overall expenses. If the answers are positive, you may say the company has adequate liquidity, or else there may be problems.
2. Leverage Ratios
Leverage or solvency ratios offer insight into a company’s ability to clear its long-term debts. These ratios evaluate the company’s dependence on debt for its regular operations and the possibility to repay the obligations.
3. Valuation Ratios
Valuation ratios generally rely on a company’s current share price and reveal whether the stock is an attractive investment option at the time. You can also call these ratios are market ratios as they examine a company’s attractiveness in the stock market.
4. Performance Ratios
As the name indicates, performance ratios reveal a company’s market performance (profit or loss). These ratios are also called profitability ratios.
5. Activity Ratios
Activity ratios demonstrate a company’s efficiency in operations. In other words, you can see how well the company uses its resources, such as the assets available, to generate sales.
To be a successful company, we need to ensure we have a solid and good ratio in all areas