Analysis of Financial Statements

Financial statement analysis is the process of examining and assessing the entries recorded in financial statements and then making economic decisions based on that analysis. Establishing a correlation between the strategic entries reported in the balance sheet, income statement, or cash flow statements also assist the analyst in learning about the capacity of the business concerned. From the standpoint of a finance manager, financial statement analysis aids in various business activities like determining the operating performance of the company. Financial statement analysis has different objectives, the most important of which is to be open and give critical information, as this information serves as the main source of input for making wise decisions and comparing the company’s past and present performance.

Types of Financial Statements

The balance sheet, income statement, and cash flow statement are used by businesses to manage their operations and provide transparency to their stakeholders. All three assertions are linked and produce diverse perspectives on a company’s operations and success.

Balance Sheet

A balance sheet is a statement that shows the financial worth of a corporation regarding book value. The assets, liabilities, and shareholders’ assets of a firm are divided into three sections. Short-term assets, such as cash and accounts receivable, reveal a lot about a company’s operational efficiency; liabilities reveal the company’s expense arrangements and the debt capital it is repaying, and shareholder’s equity reveals information on equity investments and retained earnings from periodic net income.

Income Statement

The income statement compares a company’s revenue to its operating expenses to arrive at a bottom line, or net profit or loss. At three separate points, the statement aids in the analysis of corporate efficiency. To evaluate gross profit, it starts with revenues and the direct costs linked with it. After that, it continues to operate profit, which subtracts indirect expenditures like marketing, general, and depreciation. The net income is calculated after deducting interest and taxes.

Cash Flow Statement

The cash flow statement shows how the company’s cash flows from operating, investment, and financing activities are distributed. The top-line item for operating operations is net income, which is carried over to the cash flow statement.

Objectives of Analysis of Financial Statements

Evaluation of Past and Present Performance

Past performance is frequently a reliable predictor of future performance. As a result, a creditor or investor is interested in sales reports, expenditures, net profit, cash flow, and return on invested capital trends. These directions can be used in evaluating an association’s earlier performance and can also be used to predict future accomplishment.

Similarly, a current position analysis shows where the firm is right now. For example, a present position analysis will indicate the various assets owned by a company enterprise as well as the various liabilities owed to the business. It will reveal the company’s cash position, the amount of debt it has in relation to equity, and the reasonableness of inventories and receivables.

Minimising Fraud Risks

This is one of the most important goals of transaction analysis and should not be overlooked. Frequently, we hear that an employee defrauded his employer, resulting in significant losses for the organisation. Analyzing the financial statements will ensure that employees are aware that management is aware of everything that is going on in the company, and that if any suspicions arise about any financial entry, management will be able to investigate the matter and solve it without incurring additional losses.

Getting Rid of Discrepancies

The major goal of financial statements is to document each transaction and ensure that they portray an accurate picture of the company’s financial status. As a result, keeping track of day-to-day transactions such as expenses, income, sales, and purchases is critical so that the company may identify areas for improvement and make informed decisions to minimise disparities.

Net Income projections and Growth Prospects

Financial statement analysis aids in estimating earnings possibilities and growth rates, which are utilised by investors when comparing investment options and other users interested in assessing the potential earnings of businesses. The risk or uncertainty connected with the predicted return is also taken into account by investors. The decision-makers are futurists who are constantly thinking about the future. Financial statements with information on previous performance are analysed and evaluated to anticipate future rates of return and assess risk.

Financial Institutions and Banks Make Loan Decisions

Financial institutions, lending agencies, banks, and others employ financial statement analysis to make appropriate loan or credit decisions. They would be able to properly allocate credit among the various debtors in this manner. Financial statement analysis aids in identifying credit risk, setting loan terms and conditions, interest rate, and maturity date, among other things.

There are more objectives in addition to the ones listed above. The other objectives of analysis of financial statements are:

• To determine the firm’s earning capacity or profitability.
• To evaluate the efficiency of operations and the effectiveness of management.
• To determine the firm’s short- and long-term solvency.
• To figure out why the firm’s profitability and financial situation have changed.
• To make a comparison between businesses.
• To make predictions regarding the company’s future potential.
• To evaluate the firm’s progress over a while.
• To aid in decision-making and management.
• To determine or steer the dividend action.
• To submit critical information for credit approval.

Conclusion

The process of reviewing a company’s financial performance for decision-making purposes is known as financial statement analysis. Stakeholders outside the company use it to assess an organization’s general health as well as its financial performance and business worth and stakeholders from the company utilise it as a financial management monitoring tool. The main goal of any company’s analysis financial statement is to provide the essential information to the readers of the financial statement for making informed decisions, assessing the company’s present and previous performance, predicting the achievement or failure of a company, and so on.