There are several tools for accessing a company’s stability, profitability, performance and
reliability. The analysis of financial ratios helps determine a company’s financial position and
estimate future cash flows, gains, losses, failures and successes. The main objective is to provide
meaningful interpretation of a company’s line of business and where it’s headed in the future.
This information is not only vital to investors, but also to managers who are ultimately
responsible for maximizing shareholders’ value.
By analyzing financial statements of a company, professionals can determine its strengths and
weakness and access overall profitability.
This process involves closely examining the
company’s financial statements, such as annual reports, balance sheets, cash flow statements,
income statements, shareholder’s equity and a variety of other paperwork to define financial
ratios that allow experienced analysts to interpret and forecast a firm’s financial position.
The main concern of using ratio analysis is the misinterpretation of numbers. Translating
physical assets to numbers is not a precise process, and following accounting strict standards
should be a primary focus of any company’s accounting and financial departments.
In order to
effectively and accurately determine a company’s profitability or reliability, one must understand
what that company actually does; what products or services they offer, what its strategies and
business core are. Hence, analyzing financial statements does not only involve defining ratios
and interpreting them, but also learning about a company’s business, its management, structure,
values and mission.
In addition, analyzing ratios in a vacuum should always be avoided. After all, ratios are nothing
more than one number divided by the other. To be properly interpreted they must be compared
with similar parameters. Although it may seem obvious to state that one should only compare
apples to apples, a lack of research on a company’s competitors and its specific industry can
profoundly alter an analysis of its financial statements considering that ratios vary tremendously
among industries and each industry has its own average ratios. An accurate financial analysis
should be developed over time, after extensive banks of data and information have been
collected and by experienced financial professionals, who are not biased and understand the
overall impact of their reviews to the company and its market.
On the other hand, financial statement analysis can be extremely useful and reliable. The ability