What is Financial statement analysis?
Financial statement analysis is the process of reviewing and analyzing a company's financial
statements—such as the balance sheet, income statement, and cash flow statement—to gain
insights into its financial performance, position, and prospects. This analysis is essential for
making informed decisions about investing, lending, or managing a business.
Key Objectives of Financial Statement Analysis:
1. Assess Financial Health: Analyze liquidity, profitability, and solvency to determine how
well the company is managing its resources and obligations.
2. Evaluate Profitability: Determine how efficiently a company is generating profits
relative to its expenses and revenue.
3. Understand Cash Flow: Assess the company's ability to generate cash to cover
operating expenses, investments, and dividends.
4. Measure Efficiency: Identify how effectively the company is utilizing its assets and
managing its liabilities.
5. Support Decision Making: Financial analysis helps investors, creditors, and
management make informed decisions regarding investments, loans, or operational
improvements.
Methods of Financial Statement Analysis:
1. Horizontal Analysis: Compares financial data over multiple periods to identify trends in
a company’s performance over time.
2. Vertical Analysis: Breaks down financial statements by expressing each item as a
percentage of a base figure, allowing easy comparison of financial statements from
different companies or periods.
3. Ratio Analysis: Uses financial ratios (such as profitability, liquidity, solvency, and
efficiency ratios) to evaluate the company’s performance in key areas.
4. Trend Analysis: Looks at historical financial data to identify trends and patterns in
performance metrics such as sales, expenses, and profitability.
5. Comparative Analysis: This involves comparing the company's financial performance
against industry peers or competitors to gauge relative performance.
Key Ratios Used in Financial Statement Analysis:
• Liquidity Ratios: Measure the company’s ability to meet short-term obligations (e.g., current
ratio, quick ratio).
• Profitability Ratios: Assess the company’s ability to generate profit (e.g., net profit margin,
return on assets).
• Leverage Ratios: Evaluate the company’s use of debt (e.g., debt-to-equity ratio).
• Efficiency Ratios: Measure how effectively the company uses its assets (e.g., asset turnover
ratio).
Overall, financial statement analysis provides stakeholders with valuable insights into a company’s
financial well-being and helps guide future decisions.
