The use of financial statement analysis to check a business’ health can provide answers to multiple questions including:
- How well is a company performing?
- How good is the health of your business?
- How good will it do in the future?
What is Financial Statement Analysis?
A company’s health is closely related with its financial statements.
Being just accounting statements, they may not reveal real state, as company’s Balance Sheet does not include the value of its brands or unique product line, if any. But financial statements are still the most valuable, rather reliable source of measuring company’s performance.
The financial statement analysis includes:
Income Statement or Profit and Loss Account
Usually it contains sales, purchases, stocks, operating incomes and operating expenses. The outcome of balancing these is Gross Profit.
It is a statement of company’s assets and liabilities as on a given date and usually contains investments, debtors, cash and bank balances, advances, owners equity, creditors, borrowings.
Cash Flow Statement
the balance of cash shown in the Balance Sheet is taken after considering the number of transactions. The statement contains category wise receipts and payments from the company, where the category is bundle of similar incomes or expenses recorded at the same stage.
How to Use Financial Statement Analysis
Here are step by step tips that you should be following while analyzing financial statements.
Compare the revenues (sales) of the last three years at least. Values increasing over the years show good performance.
Moderate amount of Owner’s Equity shows confidence to be in business.
Owner’s Equity = Assets – Liabilities = Share Capital + Retained Earnings
See the Cash Flow Statement to learn more about the liquidity position of the company.
If the Net Profit shown in Balance Sheet has ascending trend, it means company is growing.
Common Size Statement is an amazing way to assess company’s health. The percent of sales, a particular expenditure draw is presented with the help of spreadsheets and called as a Common Size Statement.
Financial statements duly audited are preferable to those not audited.
Properly figured out Ratios tell a lot about the health of the company.
Earnings Per Share (or more popularly EPS) of at least last three years shows the trend of company’s performance in terms of profitability.
Footnotes play a significant role in preparation of financial statements. The study of those notes gives a clear understanding of financial statements.
The last but not least, segment wise study of profit and sales gives insights about which product or product line is contributing more in company’s profit margin and vice versa. This information can be obtained from Management Discussion and Analysis.
These are more frequently followed ways to analyze financial statements. Clubbing together all these tips for better understanding and measuring the financial health of a company is as easy as pie.