What is Finance statement analysis? Financial statement analysis is the process of reviewing and analyzing a company’s financial statement for decision-making purposes, to understand what stage the company is in its life cycle, for benchmarking purposes, and for the overall health of the company.
There are two sources of data when conducting financial statements analysis: primary data sources such as surveys, observations, experiments, questionnaires, focus groups, interviews, etc. while secondary data sources are information collected through government departments like housing, social security, and Bureau of statistics, tax records.
I learn about five methods of financial statement analysis that could be considered with analyzing financial statements.
- Horizontal Analysis (Right to Left) – Horizontal Analysis is used to compare financial statements or percentages from one period to the next or another. i.e. comparing a company’s financial statement for the years 1998 and 1999 on a year-on-year basis. Horizontal analysis is applicable when looking at short-term like two years.
“The formula for Horizontal Analysis is Dollar Change = Current year figure – Base year figure.”
- Vertical Analysis – This is an s up and down analysis, one year at a time, you look at one financial statement at a given time and see the relationship of the various accounts in the financial statement.
- Common Size Statement – A common size financial statement displays items on a financial statement as a percentage of a common base figure. For example, if total sales revenue is used as the common base figure, then other financial statement items—such as operating expenses and cost of goods—will be compared as a percentage of total sales revenue
- Trend Percentage Analysis – Trend analysis may help you understand how your business has fared in the past and predict where your present business operations and practices will take you in the future. If done correctly, it will provide you with ideas for how you might improve things to drive your firm forward. The formula for trend analysis (change in amount) can be derived by subtracting the base year amount from the current year amount. Mathematically, it is represented as Formula – Change in Amount = Current Year Amount – Base Year Amount
- Ratio Analysis – Ratio analysis is a valuable tool that can improve management’s understanding of financial results and trends over time and provide key indicators of organizational performance. Managers typically use ratio analysis to identify strengths and weaknesses to formulate strategic business initiatives. Funders may use ratio analysis to measure business results against other organizations or judge management effectiveness.
For ratios to be useful and meaningful, they must be:
- Calculated using reliable, accurate financial information
- Calculated consistently from period to period
- Used in comparison to other companies in your industry
- Viewed both at a single point in time and as an indication of broad trends and issues over time
Because there are many other essential aspects and indications involved in judging performance, they must be carefully assessed in the correct context.