Financial statement is often referred to as the end-product of modern financial reporting which is true to a large extent as it details the stewardship of organisational resources entrusted over a particular period. This financial statement is useful to various internal and external users of the organisation as it helps them know more and make decisions about the organisation by going further to analyse these financial statements.
Financial statement users include the organisation’s management, employees, owners of the organisation, government, creditors/lenders, stock analysts and other financial reporting stakeholders. Each of these users needs the financial statement for their specific purposes, which might not be similar. Each of these users analyses the financial statement so they can make their specific decisions about the organisation and we will take some time to understand some of these methods of analysing financial statements.
Method of financial statement analyses includes vertical analysis, horizontal analysis, trend analysis, Cost, volume and profit analysis and ratio analysis. The purpose and intention will determine which of these methods is preferable. Vertical analysis is a form of proportional analysis where each item in the financial statement is listed as a percentage of another item. For example, in the income statement line items can be listed as a percentage of gross sales while in the balance sheet, items can be listed as a percentage of total assets. Vertical analysis is also sometimes referred to as common size statements Horizontal analysis on the order hand compares historical data which usually has to do with the same line item while deriving percentage growth with consideration to a base year.
Trend analysis is somewhat similar to horizontal analysis but in this case, it makes use of prior years to forecast a trend that the specific line item can take in the future. It is a good way of using historical data to get a sense of our future outcomes will unfold. Cost, volume and profit analysis on the other hand tends to show the relationship between cost incurred, the volume of sales and how they translate to profit for the organisation. It helps to understand how the three variables will react to changes in any of the variables. It is a good way to forecast the profit the organisation will be getting for any changes in sales mix and strategies.
Finally, the most common of them all will be ratio analysis which simply makes use of two variables from the financial statement to tell a story. It helps to understand the connection and interpretation of various sections of the financial statement which goes a long way in helping various users of financial information.
The choice of which method to use is a function of what we want to achieve but what we have established is that each method is unique in itself and they are all useful depending on the information we seek. It is imperative that financial reporting stakeholders understand and chose the right method for analysis of the financial statement to ensure that their financial decisions are informed.
