Financial statement helps to determines the key facts and figure of the company financial statement. Balance sheet, cash flow statement and income statement are the three primary financial statements which company prepare and publish at the end of each accounting year. The financial statement is also known as the company annual report. The financial report prepares and published by the organization at the end of each accounting year helps several users to get the exact ide about the company financial health for the current year and thus help the users to prepare a strategy whether to invest or not on the company to evaluate the company overall ability to perform for the coming year. Financial statement analysis helps the company to determine the overall identification of the given items for the given annual report of the company for the given fiscal period. The trends lines related to the key items included in the financial statement overall a multiple time frame which help to throw light on the company ability or performance (Appannaiah, Reddy and Putty, 2010). The trend line helps to throw light on the company revenues, gross margin, net profit cash and other key facts which are responsible for the company financial growth or debacles. The financial statement helps to provide detailed information about the company financial position in the market and thus help the company to get a clear idea about the current issues and loopholes lies in the company and spate measure need to be taken to accomplish the goal and objective of the company. The financial statement analysis consists of the three basic elements which include income statement, balance sheet, and cash flow statement.
Users of Financial Statement Analysis
The users of the financial statement are many with a common goal or aim to determine and identify the company financial health which eventually helps to them to take effective decision regarding company. The users are as follows,
- Creditors : Creditor are the individuals who lent fund to a firm with a motive to get a return levied with interest, therefore the company cash flows measure is determined in order to get a clear idea about the company ability to pay back its borrowed fund.
- Investors: Investors are the individuals who are both new and prospective investor asses the financial statement which help them to provide an idea about the company ability to continue providing dividends or to generate capital flow or to grow as per the past year financial performances (Britton and Waterston, 2013).
- Management: the firm controller generates and prepare several analyses on the annual report prepared and released at the end of each accounting year which are related to the performance metrics which are not authorized to external stakeholders or users.
Methods of the Financial Statements
The two methods that are used in the analysis of the financial statements are vertical and horizontal analysis. The horizontal analysis shows the comparison of the financial information during a period of time and vertical analysis is the refer to the proportional analysis of the financial statement in which the items are listed in percentage. It means that the items in the income statement are depicted as the percentage of the gross sales and items on the financial position statement are depicted as percentage of the total assets (Helb?k, Lindset and McLellan, 2010). The horizontal analysis shows the results on the multiple periods of time and the vertical analysis shows the proportion of the accounts within a single time period.
The second method to analyse the financial statements is estimating the financial ratios. The ratios are used to estimate the value of one number in comparison to another. The ratios can be compared with the ratios calculated in the previous year which based on the industry average. Most of the financial ratios would be within expectations in the typical financial statement analysis with minimum issues attracting the attentions of the users. The financial ratios are as follows:
The liquidity ratios help to determine and examine the ability of the corporation to pay the all the liabilities. It consists of most significant ratio which help to estimate the financial health of the organization.
Current ratio: The current ratio measures the ability of the corporation to pay the short term obligations. The ratio below one indicates that it will be difficult for the corporation to pay the obligations and the ratio above one implies that the company is not efficiently using its assets resources (Parrino, 2015).
Quick ratio: The quick ratio is same as current ratio but it does not count inventory.
Debt to equity ratio: Debt to equity ratio shows the debt level of the company. The increase in the value of the ratio means the high level of debt and low value means decrease in the value debt level.
Profitability ratios: The profitability ratios show how well the organization can generate the profit.
Profit margin: The increase in the value of the profit means increase in the profitability and decrease in the value means decrease in the profitability.
Gross profit margin: The gross profit margin depicts the sales revenues deducted from cost of goods sold which shows the gross profit of the organization.
Return on equity: The return on equity ratio shows the ability of the company to generate returns from the shareholders’ funds.
Return on the assets: The return on the assets resources shows the ability of the organization to utilize all the asset resources. The high value means the company utilizing the asset resources.
Return on the operating assets: The return on the operating assets shows the ability of the company to generate returns from the business operations. The increase in the value means the company is generating returns from the business operations.
Activity ratios: The activity ratio shows the efficiency of the organization during a specific period of time.
Account payable ratio: The ratio shows how much time the company is taking to pay the suppliers.
Account receivable ratio: The ratio shows how much time the organization is taking to collect all the due amounts (Powers and Needles, 2012).
Fixed turnover ratio: The ratio shows the ability of the company to generate returns from the fixed assets.
Inventory turnover ratio: The inventory turnover ratio shows that the inventory is required to support the sales of the products.
Issues with the Financial Statement Analysis
The financial statement analyse is a significant tool and there are many issue that can interfere in the interpretation of the financial results. The issues are as follows:
- Comparability between the periods: The organizations preparing the financial statements can change accounts in which the financial information is stored. This can lead to the different in the in the results from one period to another.
- Comparability between the organizations. The analysts compare the financial ratios of different organizations to determine the values of the company. However, each organization can aggregate the financial statement information differently and the results of the ratio many not be compared appropriately.
Elements of Financial Statements
Balance sheet helps the company to provide an accurate value of the company assets and liability for the current fiscal year. The balance sheet helps the organization to determine the key facts and figure related to the several significant issues lies in the company overall working condition and thus help to find the issues which obstruct the overall growth of the organization from the asset and liability side. The financial position statement of the company helps to throw light on the solvency and liquidity aspect of the company which help to determine the ability of the company to pay off their liability with the available resources. Short term liability and current liability of the company is determined by the current ratio and quick ratio provides significant information about the company’s ability to debt and equity differences. Balance sheet helps to provide company key ability to pay off their debt as per the calculated balance sheet ratio which include the company current ratio, debt to equity ratio, quick ratio and financial leverage (Weil, 2017). The company key ratio helps to examine the company financial strength and weakness and thus help the organization to prepare a strategy to overcome the key issues determined from the company financial statement. Balance sheet of the company help to analyses the account payable, account receivable, asset turnover ratio, debt equity ratio, financial leverage ratio etc. which help the company to determined and identify the key loopholes and issues resides in the company and thus help to utilize the resources fully which eventually have fruitful impact on the company financial profit part. Balance sheet of the company helps to provide a clear understanding of the key facts and figure related to the asset or resource utilization in the most appropriate way.
Income statement is considered to be financial statement primary element which helps to throw light on the company profit or loss incurred for the given fiscal year. Income statement is the statement which helps to determine the expense incurred or expense done during the accounting period. The company income statement consists of the income and expense incurred for the given fiscal year. The income statement helps to estimate the key financial ratio which helps to provide clear and precise idea about the company financial growth for the given fiscal year. The company depreciation expense is measure with the help of the profit and loss statement. The key financial ratio which is calculated with the help of the profit and loss statement are gross profit margin, earning per share, profit margin, return on stockholder’s equity and times interest earned which is calculated after tax. Gross profit margin helps to throw light on the percentage of sales which is available for expense and profit after the overall cost of the product is deducted from the sales. The gross profit margin differs between the companies with the same segment operating. The incomes statement helps to throw light on the organization key facts and figure which is determined the company ability to earn profit for the given fiscal year.
Cash Flow Statement
Cash flow statement is the differences between the cash inflow and cash outflow for the given fiscal year. The three basic activities of the cash flow statement are investing activities, operating activities, and financing activities. The cash flows from operating activities is the net incomes which is deducted with the expense incurred from the depreciation, increase in the account receivable, decrease in the inventory and decrease due to the account payables. Finally the cash left is the cash provided or used in the operating activities is calculated. Cash flow from the investing activities consist of the cash expenditure which is added with the proceed from the sale of property (if any), the cash calculated by deducting the above with the later provide the cash provided by the investing activities. The cash flow from the financing activities is considered to be vital as it is calculated based on the burrowing of long term debt which is deducted with the two other element which are cash dividends and purchase of the treasury stock which give the cash provided by the financial activities (Parrino, 2015). The cash flow of the statement helps to determine and identify the cash inflow and outflow for the given fiscal year.
Appannaiah, H., Reddy, P. and Putty, R. (2010). Financial accounting. Mumbai [India]: Himalaya Pub. House.
Britton, A. and Waterston, C. (2013). Financial accounting. Harlow: Financial Times Prentice Hall.
Helb?k, M., Lindset, S. and McLellan, B. (2010). Corporate finance. Maidenhead, Berkshire: Open University Press/McGraw-Hill Education.
Parrino, R. (2015). Corporate Finance. Singapore: John Wiley & Sons.
Powers, M. and Needles, B. (2012). Financial accounting. [Mason]: South-Western, Cengage Learning.
Weil, R. (2017). Financial accounting. [Place of publication not identified]: Cengage Learning.