Analysis of Financial Statements: Methods for Assessing Balance Sheets, Revenue, and Cash Flows
Financial statement analysis is a crucial process used to evaluate a company's financial health, performance, and trends. This process involves analysing a company's balance sheet, income statement, and cash flow statement, which are the three main financial statements used in financial analysis.
The income statement offers details on profitability by analysing revenues and expenses. It is broken into three parts: revenue, gross profit, and net income. The cash flow statement, on the other hand, shows how much cash a company has available at the end of a period, detailing cash movement from operating, investing, and financing activities. The balance sheet, meanwhile, provides an overview of a company's assets, liabilities, and shareholder equity.
Common techniques used in financial statement analysis include ratio analysis, trend (horizontal) analysis, vertical (common size) analysis, comparative financial statements, cash flow analysis, and analytical procedures in auditing.
Ratio analysis evaluates different aspects of financial performance such as liquidity, profitability, efficiency, and solvency by calculating financial ratios. Important ratio metrics include the current ratio, net profit margin, asset turnover, and debt-to-equity ratio. Vertical analysis expresses each item in a financial statement as a percentage of a base, facilitating comparison across time or companies. Horizontal analysis, on the other hand, compares historical data to detect growth trends across different time periods.
Analysts may use a combination of these techniques, such as horizontal and ratio analysis, to develop a more nuanced picture of a company's financial profile. For instance, an analyst might use horizontal analysis to identify growth trends and then use ratio analysis to understand the implications of these trends on the company's liquidity, profitability, and solvency.
In addition, cash flow ratios like cash and earnings before interest, taxes, depreciation, and amortization (EBITDA) are used to assess a company's liquidity and operational health. Balance sheet ratios, such as asset turnover, quick ratio, receivables turnover, days to sales, debt to assets, and debt to equity, are used to evaluate a company's efficiency and solvency.
Companies and analysts also use free cash flow statements and valuation statements to analyse the value of a company. Free cash flow statements arrive at a net present value by discounting the free cash flow that a company is estimated to generate over time. Valuation statements, on the other hand, provide an estimate of a company's worth based on various factors, such as its earnings potential, growth prospects, and risk profile.
In conclusion, financial statement analysis is an essential tool for investors, analysts, auditors, and managers. By understanding the key techniques involved in financial statement analysis, one can make informed decisions about a company's financial health, performance, and future prospects.
[1] Investopedia. (2021). Financial Statement Analysis. [online] Available at: https://www.investopedia.com/terms/f/financialstatementanalysis.asp
[2] CFA Institute. (2021). Financial Statement Analysis. [online] Available at: https://www.cfainstitute.org/programs/cfa/curriculum/eq/2021/level-1/reading-22/financial-statement-analysis
[3] Corporate Finance Institute. (2021). Financial Statements Analysis. [online] Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/financial-statement-analysis/
[4] Investopedia. (2021). Common Size Financial Statements. [online] Available at: https://www.investopedia.com/terms/c/common-size-financial-statements.asp
[5] Deloitte. (2021). Statistical and Advanced Techniques in Financial Statement Analysis. [online] Available at: https://www2.deloitte.com/content/dam/Deloitte/us/Documents/audit/us-audit-statistical-and-advanced-techniques-in-financial-statement-analysis.pdf
- The process of financial statement analysis can be valuable for crypto traders when assessing the financial health, performance, and trends of a crypto trading business or personal finance.
- In wealth management, analysts might use a combination of techniques such as horizontal analysis and ratio analysis to understand the impact of trends on a client's liquidity, profitability, and solvency.
- Cash flow ratios, like EBITDA, can help in the crypto trading business to evaluate its liquidity and operational health, while balance sheet ratios can be used to assess its efficiency and solvency.
- To make informed decisions in business, personnel managing a crypto trading company or other business can use free cash flow statements and valuation statements to analyze the value of their company, ensuring they remain competitive in the market.
