Analyzing Key Financial Statements in Charting the Growth Trajectory of A Company
Whether you’re an individual managing personal funds, a small business owner, or part of a large corporation, understanding and evaluating financial health is essential. The analysis of financial data isn’t just a number game; it’s a critical tool for making informed decisions, gauging performance, and spotting trends.
What exactly is financial statement analysis?
It’s the process of digging into a company’s financial condition to make informed decisions. This is not just a tool for number crunching; it is used by both insiders and outsiders. It is used by outsiders to assess a company’s overall health, financial performance, and business value. Conversely, internal stakeholders utilize it as a useful tool to ensure that the financial ship stays on course.
Types of Financial Statements
Following are the documents used to understand the company’s activities and performance.
Balance Sheet
This is the report card of a company’s financial worth. It breaks down into assets, liabilities, and shareholder equity. Short-term assets, like cash and accounts receivable, provide information on operational effectiveness; liabilities cover expenses and debt; and shareholder equity provides information on investments and retained earnings. The balance sheet must perform a balancing act in which assets and liabilities equal shareholder equity. The company’s book value is a crucial indicator that fluctuates with the tides of financial activity.
Income Statement
Consider this as the narrative of a business’s financial journey, where the net profit or loss is obtained by comparing revenue to expenses. It is a three-act play that opens with revenue and direct costs, moves on to operating profit (after deducting indirect expenses), and ends with net income (after deducting taxes and interest). To determine the gross profit margin, operating profit margin, and net profit margin, which show the company’s cost structure at various stages of operations, analysts typically crunch numbers.
Cash Flow Statement
The cash movements of a company, its financing, investing, and operating activities are revealed in this statement. The top line item for operating activities is net income. Financing activities display the cash flow from debt and equity financing, whereas investing activities cover investments made by the entire company. The bottom line? It tells us how much cash the company has in its pocket.
Free Cash Flow and Other Valuation Statements
To estimate a company’s value, companies and analysts create free cash flow statements and other valuation statements. By discounting the estimated cash flow over time, free cash flow statements forecast the net present value. As they prepare for a potential public offering, private companies may keep a valuation statement on hand.
Methods to Perform Financial Statement Analysis
The following are the methods for performing the financial statement analysis practically:
- Horizontal Analysis: Comparing historical data is the first step in the horizontal analysis process. Horizontal analysis is typically used to identify growth trends over various periods.
- Vertical Analysis: This method compares the different items on a financial statement with one another. One way to express an expense item would be as a percentage of sales for the company.
- Ratio Analysis: A key component of fundamental equity analysis, distinguishes line-item data. Ratio analysis examples include price-to-earnings (P/E), earnings per share, and dividend yield.
Here are some key points:
- Financial statement analysis is a tool used by all parties, both inside and outside the organization, to assess the value and performance of businesses.
- Every business must prepare a balance sheet, income statement, and cash flow statement to financial accounting regulations. These documents are essential for financial statement analysis.
- When it comes to analyzing those financial statements, there are three popular techniques: horizontal, vertical, and ratio analysis. These techniques assist analysts in breaking down the data into a more comprehensive understanding. It is similar to trying different approaches to solve the financial puzzle to get the whole picture.
Sources:
https://pixabay.com/photos/office-pen-calculator-calculation-1574717/
https://www.investopedia.com/terms/f/financial-statement-analysis.asp
https://biztechcommunity.com/stocks-trading/analyze-company-financial-position/
https://happay.com/blog/financial-analysis/