Financial analysis is one topic I find interesting from the Corporate Financial Accounting classes in LBS because financial literacy is the knowledge necessary to make important financial decisions. Understanding how to analyze a Financial statement can help you make good decisions about budgets, debt, and investing.
The primary objective of accounting is to provide information useful for decision-making and to provide information that supports this objective; accountants must consider the intended users, the types of decisions users make with financial statement information and available means of analyzing the data.
Have you ever asked yourself who are the users of Financials Statements and how well the users can understand these statements? The internal users of Financial statements are the management of an organization, while the external users are Investors, creditors, regulatory agencies, stock market analysts, and auditors.
These individuals and organizations use financial statements for different purposes and bring varying levels of sophistication to understanding business activities. Just as the knowledge level of potential users varies, users’ information needs also vary, depending on the decision at hand, and so, various analysis techniques have been developed.
Below are various methods of analysing financial statements:
- Horizontal analysis studies the behavior of financial statement items over several accounting periods or years. We can simply say it involves using comparative analysis to calculate the percentage changes in financial statement items from one period to another. Horizontal analysis allows investors and analysts to see what has been driving a company’s financial performance over several years and to spot trends and growth patterns. This type of analysis enables analysts to assess relative changes in different line items over time and project them into the future.
Horizontal analysis formular =Current year – Prior year X 100
Prior year
- The vertical analysis uses percentages to compare items within the same time or period. Each item is expressed as a percentage of a significant total for a single financial statement. For example, all income statement items are expressed as a percentage of the sale.
Vertical analysis formula = Statement line item x 100
Total base figure
- A common-size financial statement displays line items as a percentage of one selected or common figure. Creating common-size financial statements makes it easier to analyze a company over time and compare it with its peers. Using common-size financial statements helps you spot trends that a raw financial statement may not uncover.
- Trend Percentages is an analysis of the trend of a Company. It involves comparing financial information, such as net sales, cost of goods sold, operating expenses, gross profit, and inventory, over time to a base period or year.
- Ratio Analysis involves studying various relationships between different items reported in financial statements. This analysis can be expressed in three ways:
- It can be expressed as a ratio. For example, the current ratio of 2:1.
- It can be expressed as a percentage. For example, a profit margin of 2%.
- It can be expressed as an absolute amount. For example, Earnings Per Share of N2.25.
Although ratios are easy to calculate and provide useful insights into business operations, when interpreting analytical results, users should consider limitations resulting from different industry characteristics, differing economic conditions, and the fundamental accounting principles used to produce reported financial information.
#MEMBA11
Written by Tutty Tero
