Introduction to Financial Statement Analysis
Financial Statement analysis is analyzing the relationship between the items recorded in the Financial statement, the statements adapt the method of interpreting, assessing and evaluating the results from the historic records and current records related to the financial position of the company, it also assist in focusing on particular investment decisions of the company.
Explanation
- The whole process of analyzing and evaluating the entries recorded in financial statements and then take economic decisions based on that analysis can be termed as financial statement analysis.
- It also helps the analyst to learn about the financial strengths and economic weakness of the company by establishing a correlation between the strategic entries recorded in the balance sheet, income statement or cash flow statements.
- From the finance manager perspective, analysis of financial statements helps the manager to assess the managerial effectiveness and operational efficiency of the firm.
- By determining the strength and weakness of the company, one can easily measure the creditworthiness of the company in terms of debt payback and leveraging operations.
- From the company’s perspective the statements help in categorizing the types of assets owned by the company, this helps the company to assess all types of assets it owns. Additionally, it also gives a clear picture about the liabilities of the enterprise and the money it owes to all the creditors.
- Other than all these things, the financial statement also helps to evaluate the cash in hand which will help company to make any provisions for future lending or borrowing.
- There are several objectives of Financial statement analysis, the primary one being to be transparent and provide essential information since this information acts as a primary source of input for making an informed decision and compare the past and present performance of the company.
Objectives of Financial Statement Analysis
There are several objectives of the Financial statement analysis, let us discuss some of the major objectives below:
1. Know the Current Position of the Company
Financial statements are very essential for the board and promoters of the company, as it helps them to compare and understand the trend of the company operations. The statements make it easy to compare the past performance with current performance, also it helps to understand the projected vs actual growth of the company. Regular recording of all the financial transactions of the company is very useful to draw a clear picture about the performance of the company, the management will come to know if the company is lagging behind and take an informative decision to stabilize the financial position of the company.
Let us understand this with an example, suppose that the company had planned to double its revenue by 3 years in 2017. So, financial statements from past 3 years will help the board to learn if the objective has been met or no, the figure to look out for here is Revenue as shown below.
Here, we can see that revenue is increasing by average of 30% every year, however by the end of 3 year the revenue increased from 1000 to 1800 which 80% rise. So, this does not meet the company target of 100% growth.
2. Eliminating Discrepancies
The main purpose of financial statements is to record each and every transaction in the statements and make sure they depict a very accurate picture of the financial position of the company. So, recording of day to day transaction related to expense, income, sales, or purchase becomes very important, based on which the company can decide the areas of improvement and make efficient decisions to avoid any discrepancies.
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For instance, while comparing the profits of the company for past two years below is the data:
Here, we can see that the profits have increased for the company but there has been excess in some of the expenses. We can compare the ratio of increase in Gross profits and Net profit. It is clear that the increase in Gross profits is around 35%, whereas the Net profits have only increased by 18%. So, recording every detail in the statement will help them avoid any discrepancy in the future.
3. Future Decision Making
For a futuristic approach to the decisions making quarterly reports come into play, where statements like sales book, purchase orders, manufacturing a/c will have some concrete numbers for the managers to make an effective decision. This helps to have information at your disposal for efficient decision making and with exposure to reliable information, the decision will be an informed one to set futuristic goals.
Example: If the company is operating at consistent levels of increase in sales and operating margin, while suddenly it sees a dip in operating margin for the current year. This may be due to various reasons like increase in raw material price, reduced sales price or an increase in direct expenses like electricity or wages. So, looking at the quarterly report the management can change the future strategy to maintain the ratio of sales and operating margin.
4. Reduce the Chances of Fraud
This may not be the primary objective of Financial statement but it’s advantages is not to be neglected. Often, we come across some or the other scams companies fall prey to, and the amount and money laundering is being slipped under the rug avoiding being recorded in the financial statements. However, if there is a stringent practice to record every transaction in the statement, the employee will be aware of the ongoing transactions in the company.
Conclusion
Financial Statement Analysis is a powerful tool that companies use for decision making and recording every detail in the statements if used in an effective way this analysis can lead to the effective practice of operation and build goodwill in the market.
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