Financial Statement Analysis

Overview

Description

Defined as a method used to review and analyze the financial statements of a business entity, financial statement analysis provides insight into an entity's future performance by reviewing its past performance. This insight can also enhance the decision-making process by identifying problem areas. Financial statement analysis can be achieved through the use of horizontal analysis, vertical analysis, and ratio analysis. Vertical analysis compares line items as a percentage of another, while horizontal analysis compares line items from the current period with those of a previous period. Ratio analysis compares line items across financial statements in various categories, including liquidity, solvency, and profitability.

At A Glance

  • Financial statement analysis uses analytical methods and ratios to evaluate the performance of a business, including the business’s liquidity, solvency, and profitability. Horizontal, vertical, and ratio analysis are common methods used to analyze financial statement information.
  • Horizontal and vertical analysis are two tools commonly used to assess organizational performance. Horizontal analysis helps identify trends over time. Vertical analysis is useful in comparing performance between entities.
  • Liquidity analysis is designed to assess the ability of the business entity to convert assets to cash. Ratios are used to measure and analyze liquidity in these areas: current position, accounts receivable, inventory, and accounts payable.
  • Several ratios, including working capital, current ratio, and quick ratio, are used to assess the current financial position of a business.
  • To assess and measure a company’s ability to manage and collect receivables, two ratios are important: accounts receivable turnover and average collection period.
  • The ratios known as inventory turnover and days payable outstanding are used to analyze and assess how well a business manages its inventory.
  • To analyze how often businesses pay their suppliers, the accounts payable turnover ratio and the days payable outstanding ratio are used.
  • Solvency analysis measures the ability of a business to pay its debt as it matures. The most common solvency ratios are debt-to-equity and times interest earned.
  • The purpose of a profitability analysis is to evaluate overall business efficiency and performance. Dupont analysis and several common measures of profitability are frequently used to evaluate overall business efficiency and performance.
  • Three sections of the corporate annual reports include management discussion and analysis (MD&A), report on internal control, and report on fairness of the financial statements’ presentation.