analysis of financial statement methodology

Methods of Financial Statement Analysis – All You Need to Know

Financial statement analysis (FSA) means studying the financial statements of a company to get meaningful information for decision-making. External stakeholders also carry out financial statement analysis for several purposes, apart from management. There are several methods of financial statement analysis that management and external stakeholders use.

All these methods vary in calculation and factors used for the financial statement analysis . External stakeholders, including analysts, financial institutions, creditors, lenders, etc., do FSA to understand the company’s health. Moreover, these methods provide a summary of data that helps to analyze and interpret financial data.

Ratio Analysis

Dupont analysis, horizontal analysis, vertical analysis, comparative financial statements, trend analysis, cash flow analysis, statement of changes in working capital, fund flow analysis, performance analysis, final words, methods of financial statement analysis.

The following are the most popular methods of financial statement analysis:

Ratio analysis is amongst the most popular methods of financial statement analysis. There are different types of ratios that help management and analysts to dig out meaningful information.

There are six categories of ratios:

• Profitability ratios
• Liquidity ratios
• Leverage ratios
• Coverage ratios
• Activity ratios
• Valuation ratios

Some popular ratios are the current ratio, PE ratio, debt ratio, and more.

After analysts calculate a ratio (or ratios), they can compare it with the same ratio of previous years. Or, they can also compare it with the industry average or with the competitors. Also, one can compare the ratios with the set standards or the ideal ratio. For instance, the current ratio of 2:1 is excellent. However, the benchmark or ideal ratios vary from industry to industry.

Also Read: Ratio Analysis

To learn more about it, refer to RATIO ANALYSIS

DuPont analysis breaks up the ROE (Return on Equity) formula into three ratios to help in understanding the cause and effect relationship of different factors resulting in ROE. We simply divide net earnings available for equity shareholders by shareholders’ equity in order to calculate ROE. But, DuPont analysis split this formula into a product of net profit margin, asset turnover, and financial leverage.

Refer to DUPONT ANALYSIS for in-depth understanding.

In horizontal analysis, the analysts compare the financial information of one period with the previous years. In this, we compare a line item with the same line item in another period (a year or quarter). The objective is to find any significant change in any line item. For instance, if the cost of goods sold (COGS) rises much more than the increase in sales or gross profit rises but net profit drops.

Keep reading HORIZONTAL ANALYSIS

In the vertical analysis, every line item in the financial statement is calculated as a proportion of another prominent item. Usually, each line item is calculated as a proportion of revenue or sales in the income statement. Each line item is represented as a proportion of total assets on the balance sheet. After calculating ratios, one can compare them with the past years to identify any unusual happenings.

For more, refer to VERTICAL ANALYSIS .

Analysis using the comparative financial statement is similar to the horizontal and vertical analysis. In this method, we prepare the income statement and balance sheet in a way to get a time perspective of the line items. Or, we can say the financial statements show figures for two or more years in a single financial statement. It makes it easy to compare a line item with the previous years.

Also Read: Importance of Ratio Analysis

These figures could either be absolute, absolute increase or decrease from the past year, in terms of percentage or comparison as ratios.

This method of financial analysis is similar to horizontal analysis. In this method also, we compare and review the financial statements for three or more years. Under trend analysis, the earliest year becomes the base year. The objective is to find any pattern in the financial numbers. These patterns could be rising (or falling) sales, any seasonal trend, fluctuations in expenses, and more. An analyst can also use ratios to identify trends (if any) in the financial numbers.

Keep reading TREND ANALYSIS

Other Methods of Financial Statement Analysis

Apart from the above popular methods, there are many more (but less popular) methods that help a business make decisions. These methods do not precisely fall under financial statement analysis, yet they assist analysts, management, and other stakeholders in arriving at a decision. These methods are:

This method helps to study the inflow and outflow of cash and bank balances. Under the cash flow analysis method, we examine the movement of cash rather than changes in the working capital. The study of cash flow tells the purpose: investing, operations, and more, for which the company is using its funds. Moreover, it also shows the source of those funds.

Changes in the working capital method help to study any rise or drop in the working capital. Working Capital is the difference between the current assets and the current liabilities. In other words, current liabilities get deducted from the existing assets to arrive at the value of working capital. However, this method fails to give the reason for the differences in the working capital.

This method also helps to study the sources and uses of the funds for a given period. It tells wherefrom the business is getting the funds and where it is spending them. Moreover, fund flow analysis also assists in highlighting changes (if any) in a company’s financial structure.

Even though a business conducts financial analysis to analyze how it is performing, some non-financial performance measures also help evaluate its performance. A business turns more profitable if it satisfies its stakeholders and achieves its profit targets. Hence, it also establishes non-financial standards, which ultimately help in performance evaluation.

There are various ways that help a business in conducting performance analysis. It includes KPIs (Key Performance Indicators), benchmarking , etc.

In the Black vs. In the Red

This method owes its existence to the period when financial statements were used to be handwritten. ‘In the black’ indicates that the company is in the profitable stage, while ‘in the red’ means the company is not profitable.

Read more about it at In the Black Vs. In the Red

In the absence of the above methods of financial statement analysis, it could be challenging to carry out a financial review. These methods make FSA easier by organizing the collection and evaluation of financial information. Banks, auditors, analyst firms, credit rating agencies, lenders, etc., use these methods to understand the health of a company.

Quiz on Methods of Financial Statement Analysis

Let’s take a quick test on the topic you have read here.

Your answer:

Correct answer:

SHARE YOUR RESULTS

Your Answers

RELATED POSTS

• Objectives of Financial Statement Analysis
• Advantages and Application of Ratio Analysis
• Limitations of Ratio Analysis
• Vertical Analysis – Meaning, Common-size Financial Statements, Benefits, Drawbacks and More
• Profitability Ratios
• Types of Financial Statements

Sanjay Bulaki Borad

MBA-Finance, CMA, CS, Insolvency Professional, B'Com

Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

Leave a Comment Cancel reply

Save my name, email, and website in this browser for the next time I comment.

Sign me up for the newsletter!

Financial Statement Analysis

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on June 08, 2023

Fact Checked

Why Trust Finance Strategists?

Table of Contents

What is financial statement analysis.

Financial statement analysis is one of the most fundamental practices in financial research and analysis.

In layman’s terms, it is the process of analyzing financial statements so that decision-makers have access to the right data.

Financial statement analysis is also used to take the pulse of a business. Since statements center on a company’s key financial details, they are useful for evaluating activities.

This is essential to understanding the firm’s overall performance.

What Are Financial Statements?

According to the American Institute of Public Accounts, financial statements are prepared for the following purposes:

• Presenting a periodical review or report on the progress made by the management
• Dealing with the status of investments in the business and the results achieved during the period under review

Financial statements reflect a combination of recorded facts, accounting conventions, and personal judgments.

The judgments and conventions that are applied are dependent on the competence and integrity of those who make them and on their adherence to generally accepted accounting principles (GAAP) and conventions.

Public companies are forced to keep track of their financial statements in very specific ways through a balance sheet, income statement, and cash flow statement.

However, private companies often underestimate the importance of these statements because they are not required to keep track of them. It’s not that they don’t create them, but they typically don’t use them to their full benefit.

Let’s consider the following important financial documents:

• Balance Sheet: Details a company’s value based on its assets , liabilities , and shareholder equity . We can learn a lot about the efficiency of a business’s operations from its short-term cash flow and accounts receivable.
• Income Statement: An income statement breaks down a company’s earnings by comparing expenses and revenue . It is broken down into separate categories that businesses can use to help them identify profitable areas.
• Cash Flow Statement : This report shows a company’s cash flow in terms of operational activities, financial ventures, and investments .

Tools and Techniques Used For Financial Statement Analysis

Financial statement analysis is centered on the balance sheet, income statement, and cash flow statement. It is the best way to gauge the overall health of a business.

There are several tools and techniques with which this is done, including:

• Fundamental Analysis: This analytical practice is used on a company’s most basic financial levels. It shows the health of the business on a financial level and helps provide insight into the overall value.
• DuPont Analysis: This tool is used to help companies prevent conclusions that are misleading. Sometimes, looking at sheer profitability doesn’t tell the whole story, so DuPont Analysis is used to create a detailed assessment.
• Horizontal Analysis: Here, we compare financial ratios, a specified benchmark, and a specified line item over a specific period. This allows firms to examine changes that have been made and compare them with other behaviors.
• Vertical Analysis: This financial analytical practice shows items within the financial statement as a percentage of the base figure. It’s simple, so it’s the method that most businesses prefer.

Value of Financial Statement Analysis When Analyzing and Reporting Financial Statements

Now that we’ve gone over some of the basics, let’s dive deeper into financial research and analysis. Here’s what makes financial statement analysis such a powerful tool.

Identifying the Industry’s Economic Characteristics

Financial statement analysis can identify several important factors in a business’s marketplace, sometimes finding smaller niches that are other methods miss.

We can use financial statement analysis to determine market size, compare competitors , and investigate the growth rate of a market as it relates to a variable such as spending.

It’s also possible to look beyond your own company and find out how others are faring in new markets before you decide to invest in them.

Another powerful tool that a lot of brands are using is product differentiation analysis. This method crunches financial numbers to see how well a brand’s products and prices are holding up against others in the same market.

There are several factors at play here, including distribution, purchasing, and advertising costs .

Identifying Company Strategies

All entrepreneurs understand the importance of finding the right strategy to meet the needs of their business. They spend a lot of time searching for the perfect one.

When you break it all down, the blueprint is usually the same, whether it’s developing a business plan or developing advanced strategies. That blueprint is defined by data.

The only difference between the two is that a business strategy is focused more on the future and the development of the business.

Once a strategy is established, then it has to be measured. The only true way to get accurate results is to compare financials.

Most strategies evolve, and financial analysis helps steer us in the right direction. For example, a detailed financial statement analysis will reveal the direction your company is moving. It will be the first indicator if growth is not where you want it to be.

Assessing the Quality of a Company’s Financial Statements

All businesses must have a method of efficiently analyzing their financial statements. This process requires three key points of understanding that must always be accounted for.

These can all be found through a sound financial statement analysis.

• Businesses must identify the economic characteristics of their industry and compare their finances to the average.
• Companies must be able to identify which strategies are profitable and which are not.
• Businesses must be able to gauge the quality of their financial statements.

Inaccurate financial statements are common in small businesses. If left unchecked, this will lead down a path of ruin.

Financial research and analysis are the best way to ensure that these valuable reports are steering your growth in the right direction.

Analyzing Profitability and Identifying Potential Business Risks

Every business strategy has risks, and the majority of those risks are felt on a financial level. Therefore, it’s important for businesses to devise ways to identify and mitigate these risks.

While it’s not possible to avoid every risk, we can identify them before they cause too much damage. This is done by keeping a close eye on profitability.

Noteworthily, then, financial statement analysis helps you to keep track of profitability ratios, enabling you to truly measure the overall value of a strategy moving forward.

Preparing Financial Statement Forecasts

Forecasts are how companies predict the direction in which their business is heading. These forecasts need to be aligned with the company’s overall goals.

Income , cash flow, and balance sheets must all be closely monitored to ensure that they are aligned with the organization’s overall growth objectives.

Financial statement analysis is the practice that the world’s leading businesses engage in to stay ahead of their competitors.

Financial Statement Analysis FAQs

What is financial statement analysis.

Financial Statement Analysis is the process of analyzing a company’s financial statements and using this information to gauge its performance over time, assess its current condition, and make predictions about future performance.

Why is Financial Statement Analysis important?

Financial Statement Analysis is an essential tool for investors and financial professionals as it can help them better understand a company’s financial health and improve their decision-making processes when making investments or loan decisions.

What types of Financial Statements are analyzed?

The three main financial statements used in Financial Statement Analysis are the Balance Sheet, Income Statement, and Cash Flow statement.

What analysis techniques are used to review Financial Statements?

Common analysis techniques used in Financial Statement Analysis include trend analysis, vertical and horizontal analyses, ratio analysis, and cash flow statement analysis.

What information can be gathered through Financial Statement Analysis?

Financial Statement Analysis can provide insights into a company’s financial position, performance over time, liquidity and solvency, profitability, the efficiency of operations, and more. It can also be used to assess the quality of accounting practices and risk levels.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

Related Topics

• Are Bonds Current Assets?
• Are Buildings Noncurrent Assets?
• Are Construction Works-In-Progress a Current Asset?
• Are Debt Investments Current Assets?
• Are Fixed Assets Current Assets?
• Are Intangible Assets Current Assets?
• Are Investments Current Assets?
• Are Marketable Securities Current Assets?
• Are Office Supplies a Current Asset?
• Are Supplies a Current Asset?
• Carrying Value or Book Value
• Chart of Accounts
• Combined Leverage
• Components of the Balance Sheet
• Creative Accounting
• Current Liabilities on the Balance Sheet
• Difference Between Trial Balance and Balance Sheet
• Effects of Transactions on a Balance Sheet
• Enterprise Value Formula & Calculation
• Financial Leverage
• Functions and Limitations of Balance Sheet
• Funds From Operations (FFO)
• Horizontal Analysis of Financial Statements
• Income Statement Analysis
• Indifference Analysis
• Is a Loan a Current Asset?
• Is a Patent a Noncurrent Asset?
• Is Accounts Payable a Current Asset?
• Is Accounts Receivable a Current Asset?
• Is Accounts Receivable a Material Component of a Company’s Total Current Assets?

Ask a Financial Professional Any Question

We use cookies to ensure that we give you the best experience on our website. If you continue to use this site we will assume that you are happy with it.

At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.

Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications.

They regularly contribute to top tier financial publications, such as The Wall Street Journal, U.S. News & World Report, Reuters, Morning Star, Yahoo Finance, Bloomberg, Marketwatch, Investopedia, TheStreet.com, Motley Fool, CNBC, and many others.

This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible.

Why You Can Trust Finance Strategists

Finance Strategists is a leading financial education organization that connects people with financial professionals, priding itself on providing accurate and reliable financial information to millions of readers each year.

We follow strict ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources.

Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos.

Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.

Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs.

How It Works

Step 1 of 3, ask any financial question.

Ask a question about your financial situation providing as much detail as possible. Your information is kept secure and not shared unless you specify.

Step 2 of 3

Our team will connect you with a vetted, trusted professional.

Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise.

Step 3 of 3

Get your questions answered and book a free call if necessary.

A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.

Where Should We Send Your Answer?

Just a Few More Details

We need just a bit more info from you to direct your question to the right person.

Tell Us More About Yourself

Is there any other context you can provide.

Pro tip: Professionals are more likely to answer questions when background and context is given. The more details you provide, the faster and more thorough reply you'll receive.

What is your age?

Are you married, do you own your home.

• Owned outright
• Owned with a mortgage

Do you have any children under 18?

• Yes, 3 or more

What is the approximate value of your cash savings and other investments?

• $50k - $250k
• $250k - $1m

Pro tip: A portfolio often becomes more complicated when it has more investable assets. Please answer this question to help us connect you with the right professional.

Would you prefer to work with a financial professional remotely or in-person?

• I would prefer remote (video call, etc.)
• I would prefer in-person
• I don't mind, either are fine

What's your zip code?

• I'm not in the U.S.

Submit to get your question answered.

A financial professional will be in touch to help you shortly.

Part 1: Tell Us More About Yourself

Do you own a business, which activity is most important to you during retirement.

• Giving back / charity
• Spending time with family and friends
• Pursuing hobbies

Part 2: Your Current Nest Egg

Part 3: confidence going into retirement, how comfortable are you with investing.

• Very comfortable
• Somewhat comfortable
• Not comfortable at all

How confident are you in your long term financial plan?

• Very confident
• Somewhat confident
• Not confident / I don't have a plan

What is your risk tolerance?

How much are you saving for retirement each month.

• None currently
• Minimal: $50 - $200
• Steady Saver: $200 - $500
• Serious Planner: $500 - $1,000
• Aggressive Saver: $1,000+

How much will you need each month during retirement?

• Bare Necessities: $1,500 - $2,500
• Moderate Comfort: $2,500 - $3,500
• Comfortable Lifestyle: $3,500 - $5,500
• Affluent Living: $5,500 - $8,000
• Luxury Lifestyle: $8,000+

Part 4: Getting Your Retirement Ready

What is your current financial priority.

• Getting out of debt
• Growing my wealth
• Protecting my wealth

Do you already work with a financial advisor?

Which of these is most important for your financial advisor to have.

• Tax planning expertise
• Investment management expertise
• Estate planning expertise
• None of the above

Where should we send your answer?

Submit to get your retirement-readiness report., get in touch with, great the financial professional will get back to you soon., where should we send the downloadable file, great hit “submit” and an advisor will send you the guide shortly., create a free account and ask any financial question, learn at your own pace with our free courses.

Take self-paced courses to master the fundamentals of finance and connect with like-minded individuals.

Get Started

To ensure one vote per person, please include the following info, great thank you for voting., get in touch with an advisor, submit your info below and someone will get back to you shortly..

How to perform a financial statement analysis

This guide will run through the basics of performing a financial statement analysis, when you need to do it and the importance to your company's financial success. 

20 August 2024

Knowing how to perform a financial statement analysis is a crucial element to understanding the overall financial health of your business. 

You'll get an accurate insight into the profitability of your business and its ability to cover any debts. Analysing your statements will also help you forecast how much you could earn in the future.

What is financial statement analysis?

A financial statement analysis, sometimes called a financial statement review, lets you evaluate and understand the financial statements of your business. 

Why is a financial statement analysis important?

A financial statement analysis is important because it helps you better understand your business's overall financial position and identify areas for improvement.

Helps with financial forecasting

Financial forecasting is a key benefit of financial statements. You can compare different periods, project future earnings and expenses​ and plan for seasonal changes.

Provides insight into a business's financial performance

Financial statements provide insight into a business's financial performance , showing where you're doing well and where you could improve. As well as giving you a clear indication of the financial health of your business, this can help when seeking investors or lenders.

Assess profitability 

Assessing profitability is key to running a sustainable business. Analysing your financial statements will give insight into your ability to make more money than you put in. 

Different types of financial statements

Different types of financial statements are used to give an insight into your company's financial health. There are three you'll regularly use:

Balance sheet 

A  balance sheet  gives an overview of your business's financial position, showing assets (what you own), liabilities (what you owe) and shareholder equity.

Income statement 

The  income statement , often called a profit and loss statement , shows the revenue and expenses of a business, giving insight into whether the company made a profit or loss over a certain period.

Cash flow statement

The  cash flow statement  shows the amount of money coming in and going out of a business.

Financial statement analysis techniques

Financial statement analysis techniques include:

Vertical analysis

A vertical analysis compares items on a financial statement against others to give you a percentage. This gives insight into what you've earned and spent in any area. For example, your income statement could show that 30% of your total expenses are on transport and 20% on wages.

Horizontal analysis

Horizontal analysis compares the same financial statements against each other for two or more periods. This lets you look into performance trends. In horizontal analysis, you'll see revenue, spend, cash flow and others go up or down compared to previous periods. This gives an overview of how your business performance is changing over time and where you can make tweaks.

Ratio analysis

Ratio analysis involves calculating ratios by comparing one component from financial statements against another. You can use these ratios to spot trends and compare them to other years.

Common ratios include gross profit margin, debt-to-equity (what you owe versus what you have) and return on assets or equity.

How to analyse financial statements

To analyse your company's financial statements, choose a set period and follow these steps.

1. Gather your business’s financial statements

Gather your business's financial statements, including your cash flow, balance sheet and income (or profit and loss) statements. MYOB accounting software will generate these based on the transactions and records you kept throughout the period.

2. Apply analysis techniques 

Apply analysis techniques to get a full picture of how your business is tracking. These techniques include horizontal analysis, where you compare your statements to previous years; vertical analysis, where each line on a statement is a percentage of the total, and ratio analysis, where different components are compared.

3. Summarise your findings

Summarise your findings in paragraph form. This gives you an easily digestible snapshot of your business rather than a row of numbers and figures. It's also helpful if you decide to sell your business or take an investment.

Financial statement analysis FAQs

What is the most important part of a financial statement analysis.

The most important part of a financial statement analysis is determining the profitability of your business. This could be generating enough revenue to keep up with any debts and credit, or simply your ability to earn a return on your capital.

What are the main ratios used in a financial analysis? 

The six main financial ratios used in a financial analysis are liquidity, leverage, efficiency, profitability, coverage and market value.

What is considered a good balance sheet ratio? 

A good balance sheet ratio of current assets to current liabilities is between 1.5 and 2. Anything below 1 indicates a business may struggle to pay debts and keep up with expenses. A ratio above 1 indicates it generates enough revenue to keep up-to-date with bills and debts.

Make sense of your money with a financial statement analysis

A financial statement analysis is vital to keep track of the economic status of your business and identify any trends or areas for improvement. Using three core techniques, you can predict profitability and make sense of how much you're spending. 

The best way to boost your analysis is to ensure you have the right accounting software and data on hand – that's where MYOB Business  comes in, with real-time and accurate financial reports at the click of a button. Get started now. 

Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.

Related Guides

Why is it important to measure and track financial ratios arrow right.

Measuring and tracking financial ratios is important because they provide insight into whether your business is financially healthy and running efficiently.

5 important finance analytics to track Arrow right

Find out how to use finance analytics to track the financial performance of your business and why this analysis is vital to business success.

What are financial statements and how are they used? Arrow right

• Skip to primary navigation
• Skip to main content

Better Knowledge. Your Insight Is Sharper

Essential Guide to Understanding Financial Statement Analysis

Updated: August 24, 2024 · Reviewed by: Ahmad Nasrudin

This post may contain affiliate links, meaning we may earn a small commission if you purchase through our links. This helps support our work.

Financial statement analysis is valuable for understanding a company’s financial health and performance. Whether you’re an investor, a lender, or a business owner, knowing how to read and interpret financial statements can help you make informed decisions.

What is Financial Statement Analysis?

Financial statement analysis is the process of evaluating a company’s financial performance and financial position using its financial statements. These statements typically include the income statement, balance sheet, and cash flow statement.

Financial statement analysis is a powerful tool that helps you understand a company’s financial health and performance. By examining a company’s income statement, balance sheet, and cash flow statement, you can gain valuable insights into its profitability, liquidity, solvency, and efficiency.

Why is Financial Statement Analysis Important?

There are several reasons why financial statement analysis is crucial:

• Investment decisions: If you’re an investor, understanding a company’s financial statements can help you decide where to allocate your money. By analyzing a company’s financial performance, you can assess its potential for growth and profitability.
• Credit decisions: Lenders use financial statement analysis to determine a company’s creditworthiness. If a company has a strong financial position, it is more likely to be able to repay its debts.
• Internal management: Companies use financial statement analysis to identify areas for improvement and make informed business decisions. By analyzing their financial performance, companies can identify strengths and weaknesses and make necessary adjustments to their operations.

In summary, financial statement analysis is essential for anyone who wants to understand a company’s financial health and performance. Learning to read and interpret financial statements allows you to make more informed decisions about your investments, loans, and business operations.

What are the Three Main Financial Statements?

Financial statement analysis involves examining a company’s financial performance using three primary statements: the income statement, balance sheet, and cash flow statement.

The Income Statement

The income statement is a snapshot of a company’s profitability over a specific period, typically a quarter or a year. It shows the company’s revenue, expenses, and net income.

• Revenue: The total income a company earns from its sales of goods or services.
• Expenses: The costs incurred by the company in generating revenue, such as salaries, rent, and materials.
• Net Income: The profit or loss a company earns after deducting expenses from revenue.

The Balance Sheet

The balance sheet is a snapshot of a company’s financial position at a specific point in time. It shows the company’s assets, liabilities, and equity.

• Assets: What the company owns, such as cash, inventory, and property.
• Liabilities: What the company owes, such as debts and loans.
• Equity: The residual interest in the assets of the company after deducting liabilities.

The Cash Flow Statement

The cash flow statement shows how a company’s cash inflows and outflows changed over a specific period. It is divided into three sections:

• Operating activities: Cash flows from the company’s core business operations.
• Investing activities: Cash flows from buying and selling long-term assets, such as property and equipment.
• Financing activities: Cash flows from borrowing money, issuing stock, and paying dividends.

How Do I Read and Analyze Financial Statements?

To effectively analyze financial statements, follow these steps:

• Understand the basics: Familiarize yourself with fundamental financial terms and concepts, such as revenue, expenses, assets, liabilities, and equity.
• Compare to industry standards: Benchmark a company’s performance against industry averages and competitors. This helps you identify strengths and weaknesses.
• Analyze financial ratios: Calculate and interpret various financial ratios to assess a company’s financial health, including profitability, liquidity, solvency, and efficiency.
• Look for trends: Examine how a company’s financial performance has changed over time. This can reveal positive or negative trends in its business.

By understanding and analyzing these three financial statements, you can gain valuable insights into a company’s financial health and make informed decisions about investing or lending.

Free Up Your Learning Journey

Note: While those offer many free courses, some might require payment for certificates or additional materials. Please check individual course details.

What are the Key Financial Ratios to Analyze?

Financial statement analysis involves examining a company’s financial performance using various ratios to assess its financial health. Here are some of the key financial ratios to consider:

Profitability ratios

Profitability ratios measure a company’s ability to generate profits. Some common profitability ratios include the following:  

• Profit margin: This ratio shows the percentage of revenue that remains as profit after deducting expenses. A higher profit margin indicates better profitability.
• Return on assets (ROA): This ratio measures how efficiently a company uses its assets to generate profits. A higher ROA indicates that the company generates more profit per dollar of assets.  
• Return on equity (ROE): This ratio measures how efficiently a company uses its shareholders’ equity to generate profits. A higher ROE indicates a better return for investors.  

Liquidity ratios

Liquidity ratios measure a company’s ability to meet its short-term obligations. Some common liquidity ratios include:  

• Current ratio compares a company’s current assets to its current liabilities. A current ratio greater than 1 indicates that the company has enough current assets to cover its current liabilities.  
• Quick ratio  is similar to the current ratio but excludes inventory from current assets. Thus, it provides a more conservative measure of liquidity.  

Solvency ratios

Solvency ratios measure a company’s ability to meet its long-term obligations. Some common solvency ratios include:  

• Debt-to-equity ratio compares a company’s total debt to its total equity. A higher debt-to-equity ratio indicates that the company relies more on debt financing.
• Interest coverage ratio  measures a company’s ability to cover its interest expenses with earnings before interest and taxes (EBIT). A higher interest coverage ratio indicates  a stronger financial position.  

Efficiency ratios

Efficiency ratios measure a company’s ability to use its assets efficiently. Some common efficiency ratios include:

• Inventory turnover ratio  measures how efficiently a company manages its inventory. A higher  ratio indicates that the company sells its inventory quickly.  
• Accounts receivable turnover ratio  measures how efficiently a company collects customer payments. A higher ratio indicates that the company collects payments promptly.

By analyzing these key financial ratios, you can gain valuable insights into a company’s financial health and make informed decisions about investing or lending.

What are the Common Pitfalls in Financial Statement Analysis?

Financial statement analysis is a powerful tool, but knowing its limitations is important. Here are some common pitfalls to avoid:

Overreliance on past performance

While past performance can provide valuable insights, it does not guarantee future results. Companies can experience significant changes in their financial performance due to various factors, such as economic conditions, industry trends, and management decisions. Therefore, it’s crucial to consider both historical data and future prospects when analyzing financial statements.

Ignoring non-financial factors

Financial statements provide quantitative data, but it’s essential also to consider qualitative factors that can impact a company’s performance. These factors include:

• Management quality: The quality of a company’s management team can significantly influence its success.
• Industry trends: Industry-specific factors, such as technological advancements or regulatory changes, can affect a company’s financial performance.
• Competitive landscape: A company’s position and competitive advantage can also impact its financial results.

Misinterpreting ratios

Financial ratios are valuable tools for analyzing financial statements but should not be interpreted in isolation. They should be considered in conjunction with other financial data and industry benchmarks. For example, a high-profit margin may be positive, but it could also indicate that the company is charging excessively high prices.

Where Can I Learn More?

If you’re interested in learning more about financial statement analysis, there are many resources available:

• Online courses: Platforms like Coursera and edX offer financial statement analysis courses that can provide a structured learning experience.
• Books: Numerous books on the subject are available, ranging from introductory guides to advanced textbooks. My go-to international financial statement analysis book is  Int ernational Financial Statement Analysis by Thomas R. Robinson.
• Financial news and analysis: Websites like The Wall Street Journal, Bloomberg, and Investopedia provide articles, news, and analysis on financial statements and their implications.

By understanding these common pitfalls and utilizing the available resources, you can effectively analyze financial statements and make informed decisions about your investments or business ventures.

How Can I Improve My Financial Statement Analysis Skills?

Financial statement analysis is a skill that can be honed through practice and continuous learning. Here are some tips to help you improve your abilities:

• Practice regularly: One of the best ways to improve your financial statement analysis skills is to practice regularly. Analyze financial statements from different industries and companies to gain exposure to various financial situations. This will help you develop your ability to identify patterns, trends, and potential red flags.
• Seek feedback: Get feedback on your analysis from experienced professionals or online communities. This can help you identify areas where you can improve and gain new perspectives. Consider joining online forums or discussion groups dedicated to financial analysis.
• Stay updated: Keep up-to-date with changes in accounting standards and industry trends. Accounting standards can evolve over time, and industry-specific developments can affect financial statements. Staying informed will ensure that your analysis is accurate and relevant.

What is the Difference Between Financial Statement Analysis and Financial Modeling?

Financial statement analysis and financial modeling are related but distinct concepts.

• Financial statement analysis involves examining historical financial data to understand a company’s past performance and financial health. It helps you assess a company’s profitability, liquidity, solvency, and efficiency.
• Financial modeling involves creating projections of a company’s future financial performance based on various assumptions and scenarios. It helps you forecast revenue, expenses, and cash flow.

While financial statement analysis provides insights into a company’s past, financial modeling helps you anticipate its future performance.

Can I Use Financial Statement Analysis to Value a Company?

Financial statement analysis can be a valuable tool for valuing a company. Several valuation methods rely on financial statements, including:

• Discounted cash flow (DCF) analysis: This method estimates a company’s future cash flows and discounts them back to their present value.
• Comparable company analysis: This method compares a company’s valuation to similar companies in the same industry.
• Precedent transaction analysis: This method compares a company’s valuation to recent similar company transactions.

Analyzing financial statements and using appropriate valuation methods can help you make informed decisions about investing in or acquiring a company.

How Can I Use Financial Statement Analysis to Make Investment Decisions?

Analyzing a company’s financial statements can help you assess its financial health, growth potential, and risk. This information can also help you make informed investment decisions.

• Assessing financial health: Financial statements can help you assess a company’s overall financial health. By analyzing profitability, liquidity, and solvency ratios, you can determine if a company is generating profits, meeting its short-term and long-term obligations, and using its assets efficiently.
• Evaluating growth potential: Financial statements can also help you evaluate a company’s growth potential. Look for trends in revenue, earnings, and other key financial metrics. A company’s consistently growing revenue and profits may be a good investment opportunity.
• Assessing risk: Financial statement analysis can help you identify potential risks associated with an investment. For example, a company with high debt levels may be more vulnerable to economic downturns.
• Making informed decisions: By combining your analysis of financial statements with other factors, such as industry trends, competitive landscape, and management quality, you can make more informed investment decisions.

What are the Limitations of Financial Statement Analysis?

While financial statement analysis is a valuable tool, it has some limitations:

• Quality of financial reporting: The accuracy and reliability of financial statements depend on the quality of a company’s accounting practices. Some companies may engage in fraudulent or misleading accounting practices, which can distort their financial picture.
• Subjectivity: Some financial ratios and valuation methods involve subjective judgments. For example, when estimating future cash flows, analysts may use different assumptions, which can lead to varying valuations.
• Non-financial factors: Financial statements only provide a quantitative view of a company’s performance. Non-financial factors, such as technological advancements, regulatory changes, or consumer preferences, can also significantly impact a company’s success.

Therefore, it’s important to use financial statement analysis in conjunction with other sources of information and consider both quantitative and qualitative factors when making investment decisions.

Take the first step towards financial freedom. Explore our investing fundamentals.

• Types of Financial Ratios: Their Analysis and Interpretation
• Valuation Ratio: Formula And Its Interpretation
• Efficiency Ratio: Type, Formula, Interpretation
• Cash Flow Ratios: Examples, Formulas, and Interpretations
• Liquidity Ratio: Examples, Formulas, How to Calculate

About Ahmad Nasrudin

Introverted writer with a passion for storytelling. Leveraged analytical skills from financial background (equity research, credit risk) at a leading rating agency to enhance writing with a unique statistical and macroeconomic perspective. Learn more about me

• Business Size: How Business Scale Shapes Success (Importances, Measurement, Classification)
• Values, Attitudes and Lifestyles (VALS): Categories and Why They Matter
• Roles of Business: Satisfying Needs and Wants and Creating Value, Jobs, Income
• Sociocultural Environment: Key Factors Impacting Businesses
• Stakeholder Conflict: Balancing Interests for Business Success (Types, Examples, Resolution)

• Search Search Please fill out this field.

What Is Financial Analysis?

• How It Works

Corporate Financial Analysis

Investment financial analysis, types of financial analysis, horizontal vs. vertical analysis, the bottom line.

• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Financial Analysis: Definition, Importance, Types, and Examples

Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-related transactions to determine their performance and suitability. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to warrant a monetary investment.

Key Takeaways

• If conducted internally, financial analysis can help fund managers make future business decisions or review historical trends for past successes.
• If conducted externally, financial analysis can help investors choose the best possible investment opportunities.
• Fundamental analysis and technical analysis are the two main types of financial analysis.
• Fundamental analysis uses ratios and financial statement data to determine the intrinsic value of a security.
• Technical analysis assumes a security's value is already determined by its price, and it focuses instead on trends in value over time.

Investopedia / Nez Riaz

Understanding Financial Analysis

Financial analysis is used to evaluate economic trends, set financial policy, build long-term plans for business activity, and identify projects or companies for investment.

This is done through the synthesis of financial numbers and data. A financial analyst will thoroughly examine a company's financial statements—the income statement, balance sheet, and cash flow statement. Financial analysis can be conducted in both corporate finance and investment finance settings.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company's own historical performance.

For example, return on assets (ROA) is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several companies in the same industry and compared to one another as part of a larger analysis.

There is no single best financial analytic ratio or calculation. Most often, analysts use a combination of data to arrive at their conclusions.

In corporate finance, the analysis is conducted internally by the accounting department and shared with management in order to improve business decision-making. This type of internal analysis may include ratios such as net present value (NPV) and internal rate of return (IRR) to find projects worth executing.

Many companies extend credit to their customers. As a result, the cash receipt from sales may be delayed for a period of time. For companies with large receivable balances, it is useful to track days sales outstanding (DSO), which helps the company identify the length of time it takes to turn a credit sale into cash. The average collection period is an important aspect of a company's overall cash conversion cycle .

A key area of corporate financial analysis involves extrapolating a company's past performance, such as net earnings or profit margin, into an estimate of the company's future performance. This type of historical trend analysis is beneficial to identify seasonal trends.

For example, retailers may see a drastic upswing in sales in the few months leading up to Christmas. This allows the business to forecast budgets and make decisions, such as necessary minimum inventory levels, based on past trends.

In investment finance, an analyst external to the company conducts an analysis for investment purposes. Analysts can either conduct a top-down or bottom-up investment approach.

A top-down approach first looks for macroeconomic opportunities, such as high-performing sectors, and then drills down to find the best companies within that sector. From this point, they further analyze the stocks of specific companies to choose potentially successful ones as investments by looking last at a particular company's fundamentals.

A bottom-up approach, on the other hand, looks at a specific company and conducts a similar ratio analysis to the ones used in corporate financial analysis, looking at past performance and expected future performance as investment indicators.

Bottom-up investing forces investors to consider microeconomic factors first and foremost. These factors include a company's overall financial health, analysis of financial statements, the products and services offered, supply and demand, and other individual indicators of corporate performance over time.

Financial analysis is only useful as a comparative tool. Calculating a single instance of data is usually worthless; comparing that data against prior periods, other general ledger accounts, or competitor financial information yields useful information.

There are two types of financial analysis as it relates to equity investments: fundamental analysis and technical analysis.

Fundamental Analysis

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company's earnings per share (EPS), in order to determine the business's value.

Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security's current price in order to see whether the security is undervalued or overvalued.

Technical Analysis

Technical analysis uses statistical trends gathered from trading activity, such as moving averages (MA).

Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. Technical analysis attempts to predict market movements by looking for patterns and trends in stock prices and volumes rather than analyzing a security’s fundamental attributes.

When reviewing a company's financial statements, two common types of financial analysis are horizontal analysis and vertical analysis . Both use the same set of data, though each analytical approach is different.

Horizontal analysis entails selecting several years of comparable financial data. One year is selected as the baseline, often the oldest. Then, each account for each subsequent year is compared to this baseline, creating a percentage that easily identifies which accounts are growing (hopefully revenue) and which accounts are shrinking (hopefully expenses).

Vertical analysis entails choosing a specific line item benchmark, and then seeing how every other component on a financial statement compares to that benchmark.

Most often, net sales are used as the benchmark. A company would then compare the cost of goods sold, gross profit, operating profit, or net income as a percentage of this benchmark. Companies can then track how the percentage changes over time.

Examples of Financial Analysis

In Q1 2024, Amazon.com reported a net income of $10.4 billion. This was a substantial increase from one year ago when the company reported a net income of $3.2 billion in Q1 2023.

Analysts can use the information above to perform corporate financial analysis. For example, consider Amazon's operating profit margins below, which can be calculated by dividing operating income by net sales.

• 2024: $15,307 / $143,313 = 10.7%
• 2023: $4,774 / $127,358 = 3.7%

From Q1 2023 to Q1 2024, the company experienced an increase in operating margin, allowing for financial analysis to reveal that the company earned more operating income for every dollar of sales.

Why Is Financial Analysis Useful?

The financial analysis aims to analyze whether an entity is stable, liquid, solvent, or profitable enough to warrant a monetary investment. It is used to evaluate economic trends, set financial policies, build long-term plans for business activity, and identify projects or companies for investment.

How Is Financial Analysis Done?

Financial analysis can be conducted in both corporate finance and investment finance settings. A financial analyst will thoroughly examine a company's financial statements—the income statement, balance sheet, and cash flow statement.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company's own historical performance. A key area of corporate financial analysis involves extrapolating a company's past performance, such as net earnings or profit margin, into an estimate of the company's future performance.

What Techniques Are Used in Conducting Financial Analysis?

Analysts can use vertical analysis to compare each component of a financial statement as a percentage of a baseline (such as each component as a percentage of total sales). Alternatively, analysts can perform horizontal analysis by comparing one baseline year's financial results to other years.

Many financial analysis techniques involve analyzing growth rates including regression analysis, year-over-year growth, top-down analysis, such as market share percentage, or bottom-up analysis, such as revenue driver analysis .

Lastly, financial analysis often entails the use of financial metrics and ratios. These techniques include quotients relating to the liquidity, solvency, profitability, or efficiency (turnover of resources) of a company.

What Is Fundamental Analysis?

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company's earnings per share (EPS), in order to determine the business's value. Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security's current price in order to see whether the security is undervalued or overvalued.

What Is Technical Analysis?

Technical analysis uses statistical trends gathered from market activity, such as moving averages (MA). Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.

Financial analysis is a cornerstone of making smarter, more strategic decisions based on the underlying financial data of a company.

Whether corporate, investment, or technical analysis, analysts use data to explore trends, understand growth, seek areas of risk, and support decision-making. Financial analysis may include investigating financial statement changes, calculating financial ratios, or exploring operating variances.

U.S. Securities and Exchange Commission. " Amazon.com Form 10-Q for the Quarter Ended March, 31, 2024 ," Page 4.

• Terms of Service
• Editorial Policy
• Privacy Policy

What is Financial Analysis?

Types of financial analysis, vertical analysis, horizontal analysis, leverage analysis, growth rates, profitability analysis, liquidity analysis, efficiency analysis, rates of return, valuation analysis.

• Scenario & Sensitivity Analysis

Variance Analysis

Financial analysis best practices, video explanation of types of financial analysis, additional resources.

Using financial data to assess a company’s performance and make recommendations for the future

Financial analysis involves using financial data to assess a company’s performance and make recommendations about how it can improve going forward. Financial analysts primarily carry out their work in Excel , using a spreadsheet to analyze historical data and make projections of how they think the company will perform in the future.

This guide will cover the most common types of financial analysis performed by professionals. Learn more in CFI’s Financial Analysis Fundamentals Course .

The most common types of financial analysis are:

• Profitability
• Scenario & Sensitivity

This type of financial analysis involves looking at various components of the income statement and dividing them by revenue to express them as a percentage. For this exercise to be most effective, the results should be benchmarked against other companies in the same industry to see how well the company is performing.

This process is also sometimes called a common-sized income statement, as it allows an analyst to compare companies of different sizes by evaluating their margins instead of their dollars.

Horizontal analysis involves taking several years of financial data and comparing them to each other to determine a growth rate. This will help an analyst determine if a company is growing or declining, and identify important trends.

When building financial models , there will typically be at least three years of historical financial information and five years of forecasted information. This provides 8+ years of data to perform a meaningful trend analysis, which can be benchmarked against other companies in the same industry.

Image: CFI’s Financial Analysis Course .

Leverage ratios are one of the most common methods analysts use to evaluate company performance. A single financial metric, like total debt, may not be that insightful on its own, so it’s helpful to compare it to a company’s total equity to get a full picture of the capital structure. The result is the debt/equity ratio .

Common examples of ratios include:

• Debt/equity
• Debt/EBITDA
• EBIT/interest ( interest coverage )
• Dupont analysis – a combination of ratios, often referred to as the pyramid of ratios, including leverage and liquidity analysis

Analyzing historical growth rates and projecting future ones are a big part of any financial analyst’s job. Common examples of analyzing growth include:

• Year-over-year ( YoY )
• Regression analysis
• Bottom-up analysis (starting with individual drivers of revenue in the business)
• Top-down analysis (starting with market size and market share)
• Other forecasting methods

Image: CFI’s Budgeting and Forecasting Course .

Profitability is a type of income statement analysis where an analyst assesses how attractive the economics of a business are. Common examples of profitability measures include:

• Gross margin
• EBITDA margin
• EBIT margin
• Net profit margin

Learn more in CFI’s Financial Analysis Fundamentals Course .

This is a type of financial analysis that focuses on the balance sheet, particularly, a company’s ability to meet short-term obligations (those due in less than a year). Common examples of liquidity analysis include:

• Current ratio
• Net working capital

Efficiency ratios are an essential part of any robust financial analysis. These ratios look at how well a company manages its assets and uses them to generate revenue and cash flow.

Common efficiency ratios include:

• Asset turnover ratio
• Fixed asset turnover ratio
• Cash conversion ratio
• Inventory turnover ratio

As they say in finance, cash is king, and, thus, a big emphasis is placed on a company’s ability to generate cash flow. Analysts across a wide range of finance careers spend a great deal of time looking at companies’ cash flow profiles.

The Statement of Cash Flows is a great place to get started, including looking at each of the three main sections: operating activities, investing activities, and financing activities.

Common examples of cash flow analysis include:

• Operating Cash Flow (OCF)
• Free Cash Flow (FCF)
• Free Cash Flow to the Firm (FCFF)
• Free Cash Flow to Equity (FCFE)

At the end of the day, investors, lenders, and finance professionals, in general, are focused on what type of risk-adjusted rate of return they can earn on their money. As such, assessing rates of return on investment (ROI) is critical in the industry.

Common examples of rates of return measures include:

• Return on Equity (ROE)
• Return on Assets (ROA)
• Return on Invested Capital (ROIC)
• Dividend Yield
• Capital Gain
• Accounting Rate of Return (ARR)
• Internal Rate of Return (IRR)

The process of estimating what a business is worth is a major component of financial analysis, and professionals in the industry spend a great deal of time building financial models in Excel. The value of a business can be assessed in many different ways, and analysts need to use a combination of methods to arrive at a reasonable estimation.

Approaches to valuation include:

• The cost to build/replace
• Comparable company analysis
• Precedent transactions
• Discounted cash flow analysis

Learn more in CFI’s Valuation Modeling Course .

Scenario & Sensitivity Analysis

Another component of financial modeling and valuation is performing scenario and sensitivity analysis as a way of measuring risk. Since the task of building a model to value a company is an attempt to predict the future, it is inherently very uncertain.

Building scenarios and performing sensitivity analysis can help determine what the worst-case or best-case future for a company could look like. Managers of businesses working in financial planning and analysis (FP&A) will often prepare these scenarios to help a company prepare its budgets and forecasts.

Investment analysts will look at how sensitive the value of a company is as changes in assumptions flow through the model using Goal Seek and Data Tables .

Check out CFI’s Sensitivity Analysis Course to learn more!

Variance analysis is the process of comparing actual results to a budget or forecast . It is a very important part of the internal planning and budgeting process at an operating company, particularly for professionals working in the accounting and finance departments.

The process typically involves looking at whether a variance was favorable or unfavorable and then breaking it down to determine what the root cause of it was. For example, a company had a budget of $2.5 million of revenue and had actual results of $2.6 million. This results in a $0.1 million favorable variance, which was due to higher than expected volumes (as opposed to higher prices).

Learn more in CFI’s Budgeting and Forecasting Course .

All of the above methods are commonly performed in Excel using a wide range of formulas, functions, and keyboard shortcuts . Analysts need to be sure they are using best practices when performing their work, given the enormous value that’s at stake and the propensity of large data sets to have errors.

Best practices include:

• Being extremely organized with data
• Keeping all formulas and calculations as simple as possible
• Making notes and comments in cells
• Auditing and stress testing spreadsheets
• Having several individuals review the work
• Building in redundancy checks
• Using data tables and charts/graphs to present data
• Making sound, data-based assumptions
• Extreme attention to detail, while keeping the big picture in mind

Watch this short video to quickly understand the twelve different types of financial analysis covered in this guide.

Thank you for reading this CFI guide to types of financial analysis. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA) certification, designed to transform anyone into a world-class analyst. To learn more and continue advancing your career, these additional CFI resources will be helpful:

• Comparable Company Analysis
• Financial Ratios
• Projecting Income Statement Line Items
• Valuation Methods
• Bottom-Up Forecasting
• See all accounting resources
• Share this article

Create a free account to unlock this Template

Access and download collection of free Templates to help power your productivity and performance.

Already have an account? Log in

Supercharge your skills with Premium Templates

Take your learning and productivity to the next level with our Premium Templates.

Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI's full course catalog and accredited Certification Programs.

Already have a Self-Study or Full-Immersion membership? Log in

Access Exclusive Templates

Gain unlimited access to more than 250 productivity Templates, CFI's full course catalog and accredited Certification Programs, hundreds of resources, expert reviews and support, the chance to work with real-world finance and research tools, and more.

Already have a Full-Immersion membership? Log in

• Recently Active
• Top Discussions
• Best Content

By Industry

• Investment Banking
• Private Equity
• Hedge Funds
• Real Estate
• Venture Capital
• Asset Management
• Equity Research
• Investing, Markets Forum
• Business School
• Fashion Advice
• Technical Skills
• Finance Articles

Analysis of Financial Statements

It is a procedure of studying a company's financial reports  

Currently an investment analyst focused on the  TMT  sector at 1818 Partners (a New York Based Hedge Fund), Sid previously worked in private equity at BV Investment Partners and BBH Capital Partners and prior to that in investment banking at UBS.

Sid holds a  BS  from The Tepper School of Business at Carnegie Mellon.

Prior to joining UBS as an Investment Banker, Himanshu worked as an Investment Associate for Exin Capital Partners Limited, participating in all aspects of the investment process, including identifying new investment opportunities, detailed due diligence,  financial modeling  &  LBO  valuation and presenting investment recommendations internally.

Himanshu holds an  MBA  in Finance from the Indian Institute of Management and a Bachelor of Engineering from Netaji Subhas Institute of Technology.

• What Is Analysis Of Financial Statements?
• How To Analyze Financial Statements?

What is Analysis of Financial Statements?

The analysis of financial statements is a procedure of studying a company's financial reports for decision-making purposes.

This technique is used by many stakeholders, including credit and equity investors, the government, the general public, and internal decision-makers. Stakeholders also have various interests, and they prefer to use various strategies to achieve their requirements.

In addition, equity investors use financial analysis to determine and predict an organization's long-term profit potential and the sustainability and growth of dividend payments.

Creditors also use these statements to ensure that the interest and principal on the company's debt securities ( such as bonds ) can and will be paid on time. External stakeholders use it to assess an organization's general status and financial performance .

Internal stakeholders use analysis as a personal financial management monitoring tool. These stakeholders can evaluate and measure the value and risk of their investments, to which they can then make decisions regarding their current positions.

A financial statement is also a technique for assessing and displaying an organization's risks, performance, financial health, and prospects using specialized approaches.

In this article, we will cover the three types of financial statement analysis, how each form of financial analysis can be applied, and the main techniques analysts can use to analyze any statements.

Key Takeaways

• Internal and external stakeholders can use financial statement analysis to assess business performance and value.
• All companies must prepare a balance sheet, income statement, and cash flow statement, which shape the foundation for financial statement analysis.
• Analysts apply three techniques when analyzing the financial status: horizontal, vertical, and ratio analysis.

How to analyze financial statements?

A company's financial statements track crucial financial data on all aspects of its operations. As a result, they may be assessed based on their past, current, and future performance.

Financial reports are subject to  generally accepted accounting principles  ( GAAP ) as a requirement by the SEC. There are three main types that a corporation must prepare under these standards:

• Income statement
• Balance Sheet
• Cash flow statement

Additional statements that are common for public companies to publish are:

• Notes to accounts
• Statement of changes in equity

There are many techniques and equations that can be used to analyze these statements, such as fundamental analysis , the DuPont analysis , horizontal and vertical analysis , and the use of financial ratios .

Each technique is specific to what information is trying to be analyzed.

In addition, the following are five of the most prevalent techniques used in financial statement analysis:

• Horizontal analysis : analyzes data over two or more years by comparing the values of line items.
• Vertical analysis : examines the vertical impacts of line items on other sections of the business as well as the proportions of the company.
• Ratio analysis: creates statistical links using important ratio measures.
• Fundamental analysis : determining the worth of an asset and analyzing the factors that may impact its price in the future.
• DuPont analysis : a strategy to resolve many drivers of return on equity ( ROE )

The different types of  financial statements are:

Balance Sheet 

A balance sheet shows a corporation's assets, liabilities, and shareholder equity at a certain point in time. It serves as the foundation for calculating investor returns and assessing a company's financial structure.

It also shows what a company owns and owes and how much money shareholders have invested. Balance sheets can be combined with other essential financial accounts to conduct basic analysis or calculate financial ratios .

Assets or liabilities that do not display on a company's balance sheet are referred to as off-balance sheet ( OBS ) items. They are, nonetheless, assets and liabilities of the organization, even though they are not recorded on the balance sheet.

• Balance sheets should be compared to previous periods.
• Off-balance sheet items are usually ones the company does not own or are not a direct obligation of the company.
• Investors can use ratios from a balance sheet to get an overview of a company's financial health .
• Because various sectors have varied ways of financing, balance sheets should be compared to those of other enterprises in the same industry.
• Users can use the balance sheet to determine whether a company has a positive net worth .
• Also, to determine whether it has enough cash and short-term assets to cover its obligations and whether it is highly indebted compared to its peers.

This statement of a company's financial worth is expressed as book value , and it is divided into three sections:

Usually, assets can be used to manufacture commodities, fund operations, and drive expansion. Physical assets could be machinery, property, raw materials, and inventories. Intangible assets are patents , royalties, and other intellectual property.

Companies account for their assets and categorize them based on criteria representing their liquidity, how easily they can be converted to cash, whether they are physical or non-physical assets, and how they are utilized to produce value.

Assets are classified into two categories: 

• Current assets can be converted to cash in one year or less, and non-current or long-term assets cannot.
• Assets like cash and accounts receivable can reveal much about a company's operational efficiency.

Assets  = Liabilities + Shareholders’ Equity

2. Liabilities

Any money owed to a third party by a corporation, ranging from bills owed to suppliers to interest on bonds given to creditors to rent, utilities, and salaries, are considered liabilities.

For example, short-term liabilities include payroll expenses and accounts payable , which include money owed to vendors, monthly utilities, and other expenses. Wages payable consider the total amount of accrued income that employees have not received.  

Current liabilities have a one-year due date and are presented in order of maturity. On the other hand, long-term liabilities are payable after one year at any time. It also includes the company's expense arrangements and the debt capital it is repaying.

Tax relief is offered in advance of an accounting expense/unpaid liabilities, or revenue is accrued but not taxed until it is received, resulting in deferred tax liabilities —the amount of taxes that have accrued but will not be paid for another year.

3. Shareholders' equity

Shareholders' equity is the amount returned to shareholders if a company's total assets were liquidated and all of its debts repaid. Analysts typically use this financial statistic to assess a company's financial health.

It contains data on equity capital investments and retained earnings from periodic net income. It is also known as net assets since it equals a company's total assets less its liabilities or debt owed to non-shareholders.

Income Statement

An income statement presents the income and expenses of a firm. It compares a company's revenue to its operating expenditures to reach a bottom line, such as net profit or loss.

It also displays if a firm is profitable or losing money over a certain period to explain the efficacy of the business's plans at the start of a financial quarter. This report with the balance sheet and cash flow statement helps understand your company's financial health.

In addition, it supports business owners in determining if they can profit by growing sales, lowering expenditures, or doing both. Business owners can also use income statements to determine if their strategies have paid off.

An income statement is the main component of a company's performance reports that must be filed with the  Securities and Exchange Commission  (SEC).

This report has three sections, each of which helps in the analysis of business efficiency at three separate levels, as shown below:

• First, calculate gross profit, and the formula is:

Gross Profit = Revenue – Cost of Goods Sold

• Then, the operating profit subtracts indirect expenses like marketing costs, general costs, and depreciation.
• Finally, the net income is calculated after subtracting interest and taxes.

The computation of gross profit margin , operating profit margin , and net profit margin , which each divides profit by revenue, is a common part of basic income statement analysis.

Profit margin indicates where a company's costs are low or high at various stages of its operations.

Cash Flow Statement

The cash flow statement ( CFS ) outlines the inflow and outflow of cash and cash equivalents ( CCE)  into and out of business.

I. CFS shows how the company's cash flows from the main three operations: operating, investment, and financing.

a. Operating Activities  ( OCF ): This shows how much money a firm makes from its products or services, such as salary, wage, rent, income tax , and interest payments .

b. Investing Activities  ( ICF ): This category includes asset purchases or sales, loans paid to suppliers or received from customers, and any payments associated with mergers and acquisitions ( M&A ).

c. Financing Activities  ( CFF ): The sources of cash from investors and banks and how cash is delivered to shareholders.

• Include any dividends, stock repurchase payments, and principal debt repayment (loans) paid by the industry corporation.

II. This statement estimates a company's ability to manage its cash position or how successfully it generates cash to meet debt commitments and support operational expenses. 

III. The direct and  indirect methods  are the two approaches for calculating cash flow .

As seen below, the cash follows statement has various outlines that describe its activities:

The top-line item for operating activities is net income , which is carried over to the cash flow statement. Moving to the next line, which is investing activities, comprises cash flows associated with firm-wide investments.

Then, the cash flow from debt and equity financing is included in the financing activities section. Ultimately, the bottom line reveals how much cash a business has on hand.

Everything You Need To Master Financial Statement Modeling

To Help you Thrive in the Most Prestigious Jobs on Wall Street.

Edited by Colt DiGiovanni | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful  WSO  resources:

• Account Balance
• Interest Rate
• Market Capitalization
• Stock Exchange

Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling.

or Want to Sign up with your social account?

• Travel & Expense Management Software
• Employee Tax Benefits
• Branch Petty Cash
• FleetXpress
• Prepaid cards
• World Travel Card
• Customer Speaks
• Press Release
• Partner with us

Financial Statement Analysis: A Summary of Your Business Performance

Table of Contents

Introduction

“Accounting does not make balance sheets or corporate earnings more volatile. Accounting just increases the transparency of volatility in earnings.”

– Diane Garnick

Financial statement analysis as a concept may be fundamental, but one that has stood the test of time and remains relevant. While the concept may be closely associated with many accounting jargon and spreadsheets, its implications reverberate throughout the entire business landscape.

Irrespective of location, size, or sector, this analytical practice isn’t merely an option but an imperative. By meticulously dissecting financial statements, you unearth a treasure trove of insights illuminating a company’s fiscal health, operational efficiency, and growth potential. 

Whether you’re a fledgling startup seeking investment or a conglomerate navigating turbulent markets, analyzing your financial statements must serve as your compass, guiding strategic decisions and safeguarding your financial future. 

In this article, we attempt to unravel the essence of this critical practice and explore its relevance in modern business.

Read About: 10 Best Financial Management Tools for CFOs

What is financial statement analysis?

It is a structured process that dissects a company’s financial statements to develop valuable insights into its financial performance, stability, and overall health. It involves scrutinizing the balance sheet, income statement, and cash flow statement to interpret past and present financial data, providing a comprehensive understanding of a company’s operational efficiency, liquidity, solvency, and profitability.

As a stakeholder or investor, this practice enables you to assess the company’s ability to generate profits, manage debts, and generate cash flow . By calculating key financial ratios such as liquidity, leverage, and profitability ratios, you can gauge the company’s financial strength and evaluate its performance against industry benchmarks.

Moreover, financial analysis isn’t limited to numerical comparisons; it delves deeper into trends, patterns, and anomalies within the data. This holistic examination allows you to identify potential risks and opportunities, aiding in making informed decisions. 

Whether you are a shareholder, creditor, manager, or potential investor, financial statement analysis empowers you to make sound financial judgments, driving sustainable growth and mitigating potential pitfalls for the company.

Purpose of financial statement analysis

The goal is to understand a company’s financial performance and position comprehensively. By understanding the financial statements, stakeholders gain insights into the company’s profitability, liquidity, solvency, and operational efficiency. 

For instance, consider a retail enterprise: through financial analysis, stakeholders can assess its ability to generate profits from sales, manage its inventory turnover effectively, and maintain a healthy cash flow to meet its operational needs. 

Ratios like the current ratio and return on assets can be calculated to evaluate the company’s liquidity and profitability. This analysis aids in making informed decisions, whether for potential investments, credit decisions, or strategic planning, by identifying strengths to leverage and weaknesses to address within the company’s financial structure .

Read More: Financial System: What is it, Importance, Components, Functions & Challenges

What are the key components of financial statements used in the analysis?

Financial statement analysis evaluates key components like the Balance Sheet, providing insights into financial position; the Income Statement, offering profitability insights; and the Cash Flow Statement, revealing cash management efficiency. 

These components empower stakeholders to assess a company’s stability, profitability, and operational effectiveness.

1. Balance sheet

The Balance Sheet presents a snapshot of a company’s financial position at a specific point in time. It outlines the company’s assets, liabilities , and shareholders’ equity, portraying the fundamental equation that assets equal liabilities plus equity. This component allows you to assess the company’s solvency and financial stability. 

The proportion of current assets to current liabilities provides insights into short-term liquidity, while the overall structure of assets versus long-term debt reveals the company’s financial structure.

2. Income statement

The profit and loss income statement showcases a company’s revenue, expenses, and net income over a defined period. You can evaluate the company’s profitability and operational efficiency through this component. 

Key metrics like gross and net profit margin offer an understanding of the company’s ability to generate profit from its operations. By comparing revenue growth to expense growth, you gauge the company’s cost management and potential for sustainable earnings.

3. Cash flow statement

The Cash Flow Statement tracks the inflows and outflows of cash within a company during a specified period. It is indispensable in assessing a company’s ability to generate and manage cash. 

This statement is crucial for determining the company’s liquidity and financial flexibility. Operating, investing, and financing activities are categorized, revealing whether the company generates enough operational cash flow to cover investments and debt obligations. 

By examining this statement, you can comprehend the company’s ability to fund expansion, repay debt, and weather unforeseen financial challenges.

Quick Read: TOP 10 Financial Planning Tools That Accelerate Growth

Importance of financial statement analysis in decision-making

As a CFO, you rely on this analysis to decipher intricate financial data, precisely guiding strategic choices. It enables you to gauge the company’s financial health, evaluate profitability, and assess risk exposure. 

You can fine-tune budget allocation, optimize resource utilization, and formulate growth strategies by interpreting ratios and trends. This analysis aids in identifying cost inefficiencies, ensuring optimal cash flow management, and determining the feasibility of capital projects. 

Moreover, when communicating with stakeholders and investors, the insights derived from financial statement analysis lend credibility to your decisions. In essence, it empowers you, as a CFO, to steer the company with informed financial acumen, minimizing uncertainties and maximizing opportunities.

Objectives of financial statement analysis

• Assess financial health : Through analysis, you gain a clear picture of a company’s financial stability, helping you understand its ability to meet short-term obligations and navigate economic fluctuations.
• Evaluate profitability : The analysis allows you to determine the company’s profitability and gauge its capacity to generate earnings from operations.
• Predict future performance : By identifying trends and patterns, you can forecast potential financial performance, aiding in proactive decision-making.
• Allocate resources efficiently : Financial statement analysis aids in allocating resources optimally, ensuring that budgets align with the company’s financial objectives.
• Identify operational efficiency : The analysis unveils insights into operational effectiveness, helping you identify cost reduction and process improvement areas.
• Assess risk exposure : You can gauge the company’s risk exposure by assessing its debt levels, liquidity ratios, and ability to manage financial challenges.
• Evaluate investment opportunities : The analysis assists in evaluating potential investment opportunities, providing insights into the potential returns and risks associated with different ventures.
• Support strategic planning : The data extracted from an analysis of financial statements guides the formulation of long-term strategies, aligning with the company’s financial position and goals.
• Facilitate regulatory compliance : A financial analyst ensures that the financial statements adhere to financial reporting regulations and enhances transparency in financial reporting.
• Enhance stakeholder communication : With informed insights, you can confidently communicate with stakeholders, investors, and creditors, reinforcing your decisions with data-driven explanations.

Types of financial statement analysis

1. horizontal analysis.

This type involves comparing financial data across multiple periods to identify trends and changes in essential line items. As you delve into horizontal analysis, you can uncover shifts in revenue, expenses, and other financial metrics over time.

2. Vertical analysis

The analysis focuses on expressing each line item on financial statements as a percentage of a base item. This approach provides insights into the relative proportion of different components within the same period, aiding in pinpointing areas of significance.

3. Ratio analysis

This analysis entails calculating various financial ratios by comparing specific items on financial statements. Ratios like liquidity, leverage, profitability, and debt-to-equity ratios, offer in-depth insights into a company’s financial performance.

4. Common size analysis

The analysis involves presenting each line item on financial statements as a percentage of a common base, often total revenue or assets. This technique facilitates easy comparison across different companies or periods.

5. Trend analysis

This kind of analysis examines the trajectory of financial data over multiple periods, helping you identify patterns and potential changes. This type of analysis assists in predicting future financial performance based on historical data.

6. Industry comparative analysis

By benchmarking a company’s financial performance against industry averages, you can assess how well it is faring compared to its competitors. This approach provides context and reveals strengths and weaknesses.

7. Qualitative analysis

While quantitative data forms the foundation, qualitative analysis complements it by considering non-financial factors such as management quality, market trends, and industry dynamics. This holistic approach offers a comprehensive view of a company’s performance.

8. Credit analysis

This analysis evaluates a company’s creditworthiness and ability to meet its debt obligations. As you undertake credit analysis, you scrutinize the company’s cash flow, debt levels, and financial stability to assess its capacity to repay loans.

9. Valuation analysis

An analysis that seeks to determine the intrinsic value of a company’s stock or assets is a valuation analysis. This type of analysis is essential for investors looking to make informed decisions about buying or selling securities.

10. Scenario analysis

In scenario analysis, you explore potential outcomes based on varying assumptions and external factors. This approach helps you prepare for different possibilities and their impact on the company’s financial performance.

Each type of financial statement analysis offers a unique perspective, contributing to a comprehensive understanding of a company’s financial health and performance.

Read More: Financial Modelling: Types, Process, Components and Software

How to analyze financial statements?

Navigating the world of financial statement analysis requires a systematic approach that uncovers crucial insights hidden within the numbers. 

• Gather accurate data: Obtain the latest financial statements, ensuring they are correctly prepared and error-free.
• Understand accounting principles: Familiarize yourself with the accounting principles and standards for preparing financial statements. This knowledge is fundamental for accurate analysis.
• Normalize data: Adjust for any irregularities or accounting anomalies to ensure a clear basis for comparison. Exclude one-time or non-recurring items for accurate insights.
• Horizontal comparison: Compare data across different periods to detect trends, changes, and patterns in financial performance over time.
• Vertical evaluation: Express each line item as a percentage of a base item to understand the composition and relative significance of different components.
• Ratio calculation: Key financial ratios offer quantifiable insights into liquidity, profitability, and financial leverage.
• Quantitative interpretation: Analyze the calculated ratios by comparing them against historical data or industry benchmarks. Identify deviations that signify potential strengths or weaknesses.
• Common size perspective: Convert line items into total revenue or assets percentages for easy cross-company or cross-period comparisons.
• Trend identification: Scrutinize the trajectory of financial data over multiple periods to identify consistent patterns and extrapolate potential future performance.
• Contextualize industry performance: Benchmark the company’s financial indicators against industry averages to comprehend its competitive positioning.
• Qualitative factors: To complement your quantitative analysis, consider non-financial factors like market trends, management quality, and industry dynamics.
• Cash flow scrutiny: Analyze the cash flow statement to assess the company’s ability to generate and manage cash. Focus on different activities – operating, investing, and financing.
• Scenario assessment: Anticipate and analyze various scenarios to gauge their potential impact on the financial statements.
• Creditworthiness evaluation: Delve into the company’s creditworthiness by assessing cash flow, debt levels, and overall financial stability.
• Intrinsic value determination: Utilize valuation methods to estimate the intrinsic value of company assets or stock.
• Conclusion formation: Summarize your findings and draw informed conclusions about the company’s financial health, operational efficiency, and growth prospects.
• Effective communication: Present your analysis to stakeholders clearly and precisely, supporting your conclusions with data-driven explanations.

Advantages of financial statement analysis

• Insightful decision-making: Gain a deeper understanding of your enterprise’s financial health, empowering you to make informed and strategic decisions.
• Performance evaluation: Assess your company’s profitability, liquidity, and operational efficiency to identify areas of strength and opportunities for improvement.
• Risk assessment: Evaluate potential risks by analyzing debt levels, cash flow trends, and overall financial stability, enabling you to mitigate challenges proactively.
• Resource allocation: Optimize resource allocation by identifying areas of inefficiency, ensuring that budgets align with financial objectives.
• Investment decisions: Evaluate investment opportunities more effectively, understanding potential returns and associated risks for more confident choices.
• Stakeholder confidence: Demonstrate transparency and credibility to stakeholders and investors by basing decisions on data-driven financial insights.
• Strategic planning: Develop long-term strategies aligned with your enterprise’s financial position and goals, fostering sustainable growth.
• Operational efficiency: Identify cost reduction and process improvement areas, enhancing overall operational effectiveness.
• Regulatory compliance: Ensure adherence to financial reporting regulations, enhancing transparency in financial reporting practices.
• Adaptability: Armed with insights from financial statement analysis, adjust strategies and tactics in response to changing market conditions and unforeseen challenges.

Read About: Difference Between Cost Accounting and Financial Accounting

Limitations of financial statement analysis

Financial statement analysis, while a powerful tool, comes with its inherent limitations that you should be aware of while making business decisions:

• Limited historical context : Financial statements reflect historical data, which might not capture real-time market dynamics or emerging trends. As a result, relying solely on past performance might lead to inaccurate projections in rapidly changing environments.
• Accounting assumptions : Financial statements are prepared based on specific accounting principles and assumptions that can vary across industries or companies. These differences might hinder accurate cross-company comparisons or fail to capture the actual economic reality.
• Incomplete information : While financial statements provide a wealth of data, they might lack certain qualitative aspects crucial for decision-making, such as management competency, pending legal issues, or shifts in consumer sentiment.
• Window dressing : Companies might manipulate or “window dress” financial statements to give stakeholders a more favorable image. This practice could distort the accuracy of the data you’re analyzing.
• Non-financial factors : Financial statements predominantly focus on quantitative data, often overlooking non-financial factors like employee morale, brand reputation, or technological innovation that can significantly impact a company’s performance.
• External factors : The analysis doesn’t consider external factors such as changes in regulations, geopolitical events, or shifts in consumer preferences, which can substantially affect a company’s financial standing.
• Comparison challenges : While benchmarking against industry averages is common, industries can be diverse. Financial statement analysis might not fully account for these nuances, leading to inaccurate comparisons.
• Inflation effects : Financial statements might not fully adjust for inflation, which could distort the value of assets, liabilities , and earnings over time.
• Quality of data : The accuracy of financial statement analysis heavily relies on the accuracy of the underlying data. Inaccuracies or errors in recording transactions can lead to flawed conclusions.
• One dimensional view : Financial statement analysis focuses primarily on financial metrics, potentially neglecting broader strategic considerations, customer satisfaction, or employee engagement that influence overall business success.

In navigating these limitations, it’s essential to complement financial statement analysis with qualitative research, external information sources, and a holistic understanding of your industry to make well-rounded and informed decisions.

Read More: Financial Accounting: Definition, Types, Functions & Examples

Real-world applications of financial statement analysis

A statement analysis of finances finds diverse applications within an enterprise, serving as a compass for informed decision-making. It guides investment strategies, aiding in identifying profitable opportunities and aligning resource allocation. 

An analysis such as this assists in evaluating the company’s financial health, aiding strategic planning and operational optimization. Furthermore, financial statement analysis empowers effective stakeholder communication, bolstering transparency and investor confidence. It’s indispensable for credit assessment, enabling prudent lending decisions while facilitating risk management through insights into liquidity and solvency. 

It equips enterprises with predictive capabilities by revealing trends and patterns, fostering adaptability in ever-evolving markets. In essence, it’s an essential toolkit that enables enterprises to navigate complexities, capitalize on opportunities, and ensure sustainable growth.

1. Investment decision-making

Making decisions about significant investments for your organization is one of the most critical real-world applications of financial statement analysis. Enterprises use this analysis to evaluate potential investment opportunities, ensuring that financial resources are allocated strategically to yield the best returns. 

For instance, consider a manufacturing company contemplating an expansion into a new market. By thoroughly analyzing financial statements of various locations, the company can assess factors like 

• Revenue growth, 
• Profitability margins,
• Cash flow patterns. 

Suppose the analysis reveals a market with consistent revenue growth and healthy profit margins(net or gross profit). In that case, the company may choose to invest in that region, confident in its potential for generating substantial returns. 

Thus, it serves as a guiding light for enterprises, enabling them to make informed investment decisions that align with their financial objectives and drive growth.

2. Credit analysis and risk assessment

Enterprises, especially financial institutions, employ this analysis to evaluate the creditworthiness of potential borrowers, safeguarding themselves against potential defaults and minimizing risks. 

For instance, envision a bank considering a loan application from a small business seeking expansion funds. By meticulously examining the company’s financial statements, including liquidity ratios, debt levels, and cash flow trends, the bank can gauge the business’s ability to service the loan. 

Suppose the analysis suggests the business has a stable cash flow and manageable debt levels. In that case, the bank may approve the loan with favorable terms, confident it can meet its repayment obligations. 

Therefore, such analyses become a shield against financial uncertainties, allowing enterprises to make informed credit decisions that balance supporting growth and managing potential risks.

Quick Read: 6 Best Cash Flow Management Software

In conclusion, financial statement analysis is not just a historical tool but a timeless guide that allows you to stay in control. By harnessing its power, you can transcend data points and improve your choices, providing higher success rates. 

While the nuances of data interpretation may change, the essence of deriving meaning from numbers persists. The fusion of quantitative metrics and qualitative insights crafts a comprehensive understanding of a company’s health and trajectory, aiding strategic decisions. 

As we progress, financial statement analysis will remain an essential ally, ensuring enterprises, investors, and decision-makers stay ahead of the curve, poised to navigate new challenges and capture emerging opportunities.

There are five key methods of financial statement analysis: 1. Horizontal Analysis: Comparing financial data over multiple periods to identify trends and changes. 2. Vertical Analysis: Expressing line items as percentages of a base item to assess composition. 3. Ratio Analysis: Calculating and interpreting financial ratios to gauge performance and health. 4. Common Size Analysis: Presenting line items as percentages of total revenue or assets for cross-period or cross-company comparisons. 5. Trend Analysis: Examining the trajectory of financial data to predict future performance based on historical trends.

The five main types of financial statements are: 1. Income Statement: Displays revenues, expenses, and net income for a specific period. 2. Balance Sheet: Lists assets, liabilities, and equity at a given period of time. 3. Cash Flow Statement: Tracks cash inflows and outflows from operating, investing, and financing activities. 4. Statement of Retained Earnings: Depicts changes in retained earnings over time. 5. Statement of Changes in Equity: Illustrates changes in equity due to transactions beyond net income.

Three-statement financial analysis involves assessing a company’s financial health using the three core financial statements: the income statement, balance sheet, and cash flow statement. This holistic approach provides insights into profitability, liquidity, and overall operational performance.

The balance sheet presents a snapshot of a company’s financial position at a specific moment, detailing assets, liabilities, and equity. On the other hand, the income statement reports a company’s revenues, expenses, and net income over a defined period, providing insight into its profitability.

Financial statement analysis involves a detailed examination of financial data to extract insights and make informed decisions. A financial statement review is a less comprehensive assessment conducted by an external auditor to ensure the statements comply with accounting standards and are free from material misstatement.

The three types of balance sheets are comparative balance sheets, common-size balance sheets, and consolidated balance sheets. Comparative balance sheets show changes over multiple periods, common-size balance sheets express each item as a percentage of total assets or liabilities, and consolidated balance sheets aggregate the financial position of various subsidiaries into a single entity.

Yes, financial statement analysis plays a crucial role in credit evaluation and lending decisions. By scrutinizing a borrower’s financial statements, lenders assess their creditworthiness, repayment capacity, and overall financial stability before extending credit.

Financial statement analysis is integral in mergers and acquisitions. It helps evaluate the target company’s financial health, growth prospects, and synergies with the acquiring company. This analysis guides negotiations and ensures the deal aligns with the acquiring company’s financial objectives.

Financial statement analysis provides insights into various operational aspects. It helps identify cost inefficiencies, areas for process improvement, and resource allocation strategies. This analysis assists in optimizing operations, enhancing efficiency, and maximizing profitability.

Economic factors and seasonality can significantly impact financial statement analysis. Economic downturns can lead to decreased revenues and profitability, affecting financial ratios. Seasonal fluctuations may cause cash flow and working capital variations, influencing a company’s overall financial health.

In addition to financial data, non-financial factors like management quality, brand reputation, market trends, and technological innovation should be considered. These qualitative aspects provide a well-rounded understanding of a company’s performance and growth potential.

Yes, several software tools are designed to aid in financial statement analysis. These tools streamline the process, automate calculations, and provide visualizations for better insights. Examples include Excel with financial functions, specialized financial analysis software, and accounting software with built-in analysis features.

Related Posts:

• 10 Best Treasury Management Systems and Software
• Accounting Principles: A Comprehensive Guide 2024
• Financial Planning: What is it, Types, Objectives,…
• Financial Analysis: What is it, Types, Objectives,…
• Difference Between Financial Accounting and…
• Financial Statement: Definition, Objectives, Types,…

Corporate Finance: Definition, Concepts, Best Practices and Challenges

Discussion about this post, table of contents toggle table of content toggle, related articles, get started with happay now.

If you are looking to understand how our products will fit with your organisation needs, fill in the form to schedule a demo.

Schedule a demo

© 2023 Happay

Welcome Back!

Login to your account below

Remember Me

Retrieve your password

Please enter your username or email address to reset your password.

6 Steps to an Effective Financial Statement Analysis

• By Dubos J. Masson, PhD, CTP, FP&A
• Published: 3/9/2018

(Ed. Note: This article has been updated.)

For any financial professional, it is important to know how to effectively analyze the financial statements of a firm.

This requires an understanding of three key areas:

• The structure of the financial statements.
• The economic characteristics of the industry in which the firm operates.
• The strategies the firm pursues to differentiate itself from its competitors.

There are generally six steps to developing an effective analysis of financial statements.

1. Identify the industry economic characteristics.

First, determine a value chain analysis for the industry—the chain of activities involved in the creation, manufacture and distribution of the firm’s products and/or services. Techniques such as Porter’s Five Forces or analysis of economic attributes are typically used in this step.

2. Identify company strategies.

Next, look at the nature of the product/service being offered by the firm, including the uniqueness of product, level of profit margins, creation of brand loyalty and control of costs. Additionally, factors such as supply chain integration, geographic diversification and industry diversification should be considered.

Expert Tips, Resources, Inspiration

Stay up to date on all things treasury with AFP's monthly FP&A in Focus newsletter.

3. Assess the quality of the firm’s financial statements.

Review the key financial statements within the context of the relevant accounting standards. In examining balance sheet accounts, issues such as recognition, valuation and classification are keys to proper evaluation. The main question should be whether this balance sheet is a complete representation of the firm’s economic position. When evaluating the income statement, the main point is to properly assess the quality of earnings as a complete representation of the firm’s economic performance. Evaluation of the statement of cash flows helps in understanding the impact of the firm’s liquidity position from its operations, investments and financial activities over the period—in essence, where funds came from, where they went, and how the overall liquidity of the firm was affected.

4. Analyze current profitability and risk.

This is the step where financial professionals can really add value in the evaluation of the firm and its financial statements. The most common analysis tools are key financial statement ratios relating to liquidity, asset management, profitability, debt management/coverage and risk/market valuation. With respect to profitability, there are two broad questions to be asked: how profitable are the operations of the firm relative to its assets—independent of how the firm finances those assets—and how profitable is the firm from the perspective of the equity shareholders. It is also important to learn how to disaggregate return measures into primary impact factors. Lastly, it is critical to analyze any financial statement ratios in a comparative manner, looking at the current ratios in relation to those from earlier periods or relative to other firms or industry averages.

5. Prepare forecasted financial statements.

Although often challenging, financial professionals must make reasonable assumptions about the future of the firm (and its industry) and determine how these assumptions will impact both the cash flows and the funding. This often takes the form of pro-forma financial statements, based on techniques such as the percent of sales approach.

6. Value the firm.

While there are many valuation approaches, the most common is a type of discounted cash flow methodology. These cash flows could be in the form of projected dividends, or more detailed techniques such as free cash flows to either the equity holders or on enterprise basis. Other approaches may include using relative valuation or accounting-based measures such as economic value added.

The next steps

Once the analysis of the firm and its financial statements are completed, there are further questions that must be answered. One of the most critical is: “Can we really trust the numbers that are being provided?” There are many reported instances of accounting irregularities. Whether it is called aggressive accounting, earnings management, or outright fraudulent financial reporting, it is important for the financial professional to understand how these types of manipulations are perpetrated and more importantly, how to detect them.

Dubos J. Masson, PhD, CTP, FP&A is Clinical Associate Professor of Finance for the Kelley School of Business, Indiana University.

Copyright © 2024 Association for Financial Professionals, Inc. All rights reserved.

See what’s in store at the treasury and finance conference, AFP 2024, October 20-23, in Nashville. Check out the Session Explorer here.

Home » Explanations » Financial statement analysis » What is financial statement analysis?

What is financial statement analysis?

Definition and explanation, techniques of financial statement analysis.

• Limitations

Financial statement analysis is a function that involves the evaluation of reported financial statements of an entity, to aid stakeholders and users of those statements in their decision making. It seeks to establish relationships between various financial parameters so as to gain a better understanding of the entity’s financial health and performance. Financial statement analysis benefits both internal stakeholders (like management and existing shareholders) as well as external stakeholders (like potential investors, lenders and suppliers).

Financial statements typically include income statement , cash and fund flow statements and balance sheet . They record detailed financial transactions of the entity for a specific time period and thus reveal both financial performance and financial position of its business. A further analysis of these financial statements facilitates stakeholders with a lot of information which works as a key in their decision making process.

On the part of management, financial statement analysis reveals and identify areas of the organization that call for corrective actions, from investors’ perspective, it is a tool for gauging financial outlook and deciding upon the viability of their investment in the entity, and for vendors and suppliers, it helps dig into the entity’s creditworthiness and guides them in deciding whether or not they should consider providing goods and/or services to the entity on credit.

While there are several techniques of financial statement analysis, the three most widely used techniques are briefly discussed below:

1. Horizontal analysis

Horizontal analysis involves evaluation of financial statements on a historical basis. Under this technique, financial data is compared across time periods. For example, the progression of sales is evaluated over the years to evaluate the sales growth rate of the entity.

Horizontal analysis uses a base period and one or more comparison periods. The result of this analysis is generally expressed as a percentage with reference to the specified base period. The formula used to calculate percentages in a horizontal analysis is given below:

To understand the practical working of horizontal analysis, click here .

Benefits of horizontal analysis technique:

This technique of financial statement analysis offers the following advantages:

• Horizontal analysis helps identify and analyze trends and patterns in entity’s financial performance.
• By analyzing the progression of various financial parameters over the years, it helps in identifying areas of the strengths and weaknesses in the entity’s financial operations. For example, management can analyze the growth in entity’s profitability in relation to the growth in sales revenue over the years which may reveal actions needed to be taken towards cost control.
• This analysis provides a basis for estimating the entity’s future performance as well as assists in setting benchmarks or standards for forthcoming years.

Drawbacks of horizontal analysis technique:

Horizontal analysis technique also suffers from certain drawbacks; such as:

• It only compares relative financial performance without considering performance in absolute terms.
• Under this type of analysis, a change in classification of reported accounts can lead to misleading results.
• It can be manipulated to indicate desired but misleading results; for example, a comparison of line items amongst different quarters of the same year can lead to significantly different results when compared to the same quarter of different years.

2. Vertical analysis

As the name suggests, vertical analysis involves the assessment of various line items of a financial statement as a percentage of a specific base line item. For example, various expenses on an income statement are expressed as a percentage of sales and the share of each type of asset is expressed as a percentage of total assets. The percentages under a vertical analysis are derived by the following formula:

To understand the practical working of vertical analysis, click here .

Benefits of vertical analysis technique:

• It is an easy representation of relationship between various line items of the financial statement.
• It helps understand the relative share of each line item. For example, if direct material is a significant percentage of sales in relation to say, direct labor , the management can understand its impact on profitability and can thus focus a greater attention towards any possibility of reducing or controlling it.
• Since a vertical analysis converts absolute numbers to percentage terms, It can be employed for inter-firm comparison with other entities within the industry by equating companies of different scales.
• It helps in identifying trends to aid comparison over time periods.

Drawbacks of vertical analysis technique:

• It requires a standard benchmark percentage defined for the analysis to be meaningful and to actually assist in decision making. For example, a company may know that its marketing expenses are 10% of its sales; however without a defined standard percentage, it may not be able to decide on the reasonableness of this derived percentage.
• Need for consistency in base – for an appropriate comparison from year to year or company to company, the base used for comparison must be the same.

3. Ratio analysis

Ratio analysis involves evaluating relationship between various line items of financial statements like income statement and balance sheet. This is done by calculating various financial ratios and comparing them with some set standards. On the basis of this comparison, management can take corrective steps and other stakeholders can make informed decisions according to their specific situations.

The ratios that are derived to perform a financial statement analysis are typically categorized as follows:

• Liquidity ratios: measure an entity’s ability to service its near-term debts as well as to meet its near-term fund requirements. A typical set of liquidity ratios includes current ratio , quick or liquid ratio, absolute liquid ratio , and current cash debt coverage ratio etc.
• Solvency ratios: measure the long-term stability of a business entity by evaluating its ability to meet its fund requirements over a long period of time. These typically include debt to equity ratio , fixed assets to equity ratio , current assets to equity ratio , and capital gearing ratio etc.
• Profitability ratios: measure the ability of a commercial entity to generate profits for its stockholders or owners. These ratios can include gross and net profit ratio , P/E ratio, EPS ratio , and return on capital employed ratio etc.
• Activity ratios: measure the efficiency of a business entity to utilize or convert its assets into sales revenue or liquid funds. These ratios can include inventory turnover ratio , receivables turnover ratio , and fixed assets turnover ratio etc.

Benefits of ratios analysis technique:

• Ratios analysis indicates an entity’s financial health as well as its operational efficiency through various parameters (e.g., liquidity and solvency) which other analysis techniques may not address.
• This analysis indicates the entity’s current position and any necessary remedial actions that it needs to take. It, thus, helps management in financial activity planning of the entity.
• Ratios analysis provides a standard for inter-firm comparison.

Drawbacks of ratios analysis technique:

• Ratios analysis can give erroneous results if there is a difference in accounting presentation of different entities compared or different periods considered in the analysis.
• Its results are often limited to quantitative analysis only, and not qualitative analysis. For example, balance sheet may exhibit a healthy current ratio but will not reveal the level of obsolescence present in the inventory considered in the calculation.

Purpose of financial statement analysis

Financial statement analysis has considerable utility for all stakeholders of an entity. Some of its salient purposes are mentioned below:

• The primary purpose: The primary purpose of performing a financial statement analysis is to dig into financial health as well as operational efficiency of the entity through its various analysis techniques.
• Aids industry comparison: It helps stakeholders gauge where the entity’s financial performance stands as compared to its peers in the industry. This is possible even when other entities operate at materially different scales.
• Aids historical comparison: It helps identify trends in financial performance as well as understand the financial progression of the entity over the years.
• Forecasting and budgeting: The interpretation of financial statement analysis can help management take budgeting decisions. Stakeholders can also estimate and project future performance based on results of financial analysis.
• Basis for decision making: The ultimate goal of the analysis is to provide stakeholders with a means to evaluate financial performance giving them a basis for comprehensive decision making.

Limitations of financial statement analysis

While financial statement analysis is an important and useful exercise, it does suffer from certain limitations. These can include:

• High dependency on accuracy of financial statements: A financial statement analysis can be inaccurate and in fact can even be manipulated if the base financial statements are inaccurate.
• Change in accounting policies: Any change in accounting methodology or presentation can result in erroneous results, hampering the efficacy of inter-period or inter-firm comparison.
• Focus on quantitative analysis: While exercising a financial statement analysis, the primary focus is on quantitative data. The non-monetary and qualitative aspects that impact financial performance are often side-lined under.
• Only a tool not a solution: The analysis of financial statements is only a means to an end. The actual success of the analysis requires expert analysts to meaningfully interpret, analyze and then take appropriate and timely decisions about the matters involved.

All in all, financial statement analysis is an extremely vital function as it has utility for both internal and external stakeholders. Generally, a large part of this financial analysis is presented in annual reports along with the reported financial statements. This is done so that the information is easily accessible by all stakeholders. However, a leader is only as good as his team; thus for financial statement analysis to be meaningful, the financial statements themselves must be accurate and the interpretations applied must be meaningful.

Leave a comment Cancel reply

• Financial Statement Analysis: An Introduction

Featured in:

Financial Statement Analysis is a method of reviewing and analyzing a company’s accounting reports (financial statements) in order to gauge its past, present or projected future performance. This process of reviewing the financial statements allows for better economic decision making.

Globally, publicly listed companies are required by law to file their financial statements with the relevant authorities. For example, publicly listed firms in America are required to submit their financial statements to the Securities and Exchange Commission (SEC). Firms are also obligated to provide their financial statements in the annual report that they share with their stakeholders. As financial statements are prepared in order to meet requirements, the second step in the process is to analyze them effectively so that future profitability and cash flows can be forecasted.

Therefore, the main purpose of financial statement analysis is to utilize information about the past performance of the company in order to predict how it will fare in the future. Another important purpose of the analysis of financial statements is to identify potential problem areas and troubleshoot those.

© Shutterstock.com | samui

Here, we will look at 1) the users of financial statement analysis , 2) the methods of financial statement analysis , 3) key accounting reports (the balance sheet, income statement, and statement of cash flows) and how they are analyzed , 4) other financial statement information , and 5) problems with financial statement analysis .

USERS OF FINANCIAL STATEMENT ANALYSIS

There are different users of financial statement analysis. These can be classified into internal and external users. Internal users refer to the management of the company who analyzes financial statements in order to make decisions related to the operations of the company. On the other hand, external users do not necessarily belong to the company but still hold some sort of financial interest. These include owners, investors, creditors, government, employees, customers, and the general public. These users are elaborated on below:

1. Management

The managers of the company use their financial statement analysis to make intelligent decisions about their performance. For instance, they may gauge cost per distribution channel, or how much cash they have left, from their accounting reports and make decisions from these analysis results.

Small business owners need financial information from their operations to determine whether the business is profitable. It helps in making decisions like whether to continue operating the business, whether to improve business strategies or whether to give up on the business altogether.

3. Investors

People who have purchased stock or shares in a company need financial information to analyze the way the company is performing. They use financial statement analysis to determine what to do with their investments in the company. So depending on how the company is doing, they will either hold onto their stock, sell it or buy more.

4. Creditors

Creditors are interested in knowing if a company will be able to honor its payments as they become due. They use cash flow analysis of the company’s accounting records to measure the company’s liquidity , or its ability to make short-term payments.

5. Government

Governing and regulating bodies of the state look at financial statement analysis to determine how the economy is performing in general so they can plan their financial and industrial policies. Tax authorities also analyze a company’s statements to calculate the tax burden that the company has to pay.

6. Employees

Employees need to know if their employment is secure and if there is a possibility of a pay raise. They want to be abreast of their company’s profitability and stability. Employees may also be interested in knowing the company’s financial position to see whether there may be plans for expansion and hence, career prospects for them.

7. Customers

Customers need to know about the ability of the company to service its clients into the future. The need to know about the company’s stability of operations is heightened if the customer (i.e. a distributor or procurer of specialized products) is dependent wholly on the company for its supplies.

8. General Public

Anyone in the general public, like students, analysts and researchers, may be interested in using a company’s financial statement analysis. They may wish to evaluate the effects of the firm on the environment, or the economy or even the local community. For instance, if the company is running corporate social responsibility programs for improving the community, the public may want to be aware of the future operations of the company.

METHODS OF FINANCIAL STATEMENT ANALYSIS

There are two main methods of analyzing financial statements: horizontal or trend analysis, and vertical analysis. These are explained below along with the advantages and disadvantages of each method.

Horizontal Analysis

Horizontal analysis is the comparison of financial information of a company with historical financial information of the same company over a number of reporting periods. It could also be based on the ratios derived from the financial information over the same time span. The main purpose is to see if the numbers are high or low in comparison to past records, which may be used to investigate any causes for concern. For example, certain expenditures that are high currently, but were well under budget in previous years may cause the management to investigate the cause for the rise in costs; it may be due to switching suppliers or using better quality raw material.

This method of analysis is simply grouping together all information, sorting them by time period: weeks, months or years. The numbers in each period can also be shown as a percentage of the numbers expressed in the baseline (earliest/starting) year. The amount given to the baseline year is usually 100%. This analysis is also called dynamic analysis or trend analysis.

Advantages and Disadvantages of Horizontal Analysis

When the analysis is conducted for all financial statements at the same time, the complete impact of operational activities can be seen on the company’s financial condition during the period under review. This is a clear advantage of using horizontal analysis as the company can review its performance in comparison to the previous periods and gauge how it’s doing based on past results.

A disadvantage of horizontal analysis is that the aggregated information expressed in the financial statements may have changed over time and therefore will cause variances to creep up when account balances are compared across periods.

Horizontal analysis can also be used to misrepresent results. It can be manipulated to show comparisons across periods which would make the results appear stellar for the company. For instance, if the profits for this month are only compared with those of last month, they may appear outstanding but that may not be the case if compared with the same month the previous year. Using consistent comparison periods can address this problem.

Vertical Analysis

Vertical analysis is conducted on financial statements for a single time period only. Each item in the statement is shown as a base figure of another item in the statement, for a given time period, usually for year. Typically, this analysis means that every item on an income and loss statement is expressed as a percentage of gross sales, while every item on a balance sheet is expressed as a percentage of total assets held by the firm.

Vertical analysis is also called static analysis because it is carried out for a single time period.

Advantages and Disadvantages of Vertical Analysis

Vertical analysis only requires financial statements for a single reporting period. It is useful for inter-firm or inter-departmental comparisons of performance as one can see relative proportions of account balances, no matter the size of the business or department.

Because basic vertical analysis is constricted by using a single time period, it has the disadvantage of losing out on comparison across different time periods to gauge performance. This can be addressed by using it in conjunction with timeline analysis, which shows what changes have occurred in the financial accounts over time, such as a comparative analysis over a three-year period. For instance, if the cost of sales comes out to be only 30 percent of sales each year in the past, but this year the percentage comes out to be 45 percent, it would be a cause for concern.

KEY FINANCIAL STATEMENTS & HOW THEY ARE ANALYZED

The main types of financial statements are the balance sheet, the income statement and the statement of cash flows. These accounting reports are analyzed in order to aid economic decision-making of a firm and also to predict profitability and cash flows.

I. The Balance Sheet

© Wikimedia Commons

The balance sheet shows the current financial position of the firm, at a given single point in time. It is also called the statement of financial position. The structure of the balance sheet is laid out such that on one side assets of the firm are listed, while on the other side liabilities and shareholders’ equity is shown. The two sides of the balance sheet must balance as follows:

Assets = Liabilities + Shareholders’ Equity

The main items on the balance sheet are explained below:

Current Assets

Current assets held by the firm refer to cash and cash equivalents. These cash equivalents are assets that can be easily converted into cash within one year. Current assets include marketable securities, inventory and accounts receivable.

Long-term Assets

Long-term assets are also called non-current assets and include fixed assets like plant, equipment and machinery, and property, etc.

A firm records depreciation of its fixed, long-term assets every year. It is not an actual expense of cash paid, but is only a reduction in the book value of the asset. The book value is calculated by subtracting the accumulated depreciation of prior years from the price of the assets.

Total Assets = Current Assets + Book Value of Long-Term Assets

Current Liabilities

Current liabilities of the firm are obligations that are due in less than one year. These include accounts payable, deferred expenses and also notes payable.

Long-term Liabilities

Long-term liabilities of the firm are financial payments or obligations due after one year. These include loans that the firm has to repay in more than a year, and also capital leases which the firm has to pay for in exchange for using a fixed asset.

Shareholders’ Equity

Shareholders’ equity is also known as the book value of equity or net worth of the firm. It is the difference between total assets owned by a firm and total liabilities outstanding. It is different from the market value of equity (stock market capitalization) which is calculated as follows: number of shares outstanding multiplied by the current share price.

Balance Sheet Analysis

The balance sheet is analyzed to obtain some key ratios that help explain the health of the firm at a given point in time. These metrics are as follows:

Debt-Equity Ratio = Total Debt / Total Equity

The debt-equity ratio is also called a leverage ratio. It is calculated to assess the leverage, or gearing, of a firm to show how much it relies on debt to finance its activities. This ratio has pertinent implications for the financial health of the firm and the risk and return of its shares.

Market-to-Book Ratio = Market Value of Equity / Book Value of Equity

The market-to-book ratio is used to reflect any changes in a firm’s characteristics. The variations in this ratio also show any value added by the management and its growth prospects.

Enterprise Value = Market Value of Equity + Debt – Cash

The enterprise value of a firm shows the underlying value of the business. It reflects the true value of the firm’s assets, not including any cash or cash equivalents, while unencumbered by the debt the firm carries.

II. The Income Statement

© Wikimedia Commons | Microsoft

The purpose of an income statement is to report the revenues and expenditures of a firm over a specific period of time. It was previously also called a profit and loss account. The general structure of the income statement with major components is as follows:

Sales revenue

– Cost of goods sold (COGS)

= Gross profit

– Selling, general and administrative costs (SG&A)

– Research and development (R&D)

= Earnings before interest, taxes, depreciation and amortization (EBITDA)

– Depreciation and amortization

= Earnings before interest and taxes (EBIT)

– Interest expense

= Earnings before taxes (EBT)

= Net income

The net income on the income statement, if positive, shows that the company has made a profit. If the net income is negative, it means the company incurred a loss.

Earnings per share can be derived from knowing the total number of shares outstanding of the company:

Earnings per Share = Net Income / Shares Outstanding

Income statement Analysis

Some useful metrics based on the information provided in the income statement and the balance sheet are as follows:

Profitability Ratios:

1. Net profit margin: This ratio calculates the amount of profit that the company has earned after taxes and all expenses have been deducted from net sales.

Net profit Margin =Net Income / Net Sales

2. Return on Equity: This ratio is used to calculate company profit as a percentage of total equity.

Return on Equity = Net Income / Book Value of Equity

Valuation Ratios:

Price to earnings ratios (P/E ratio)

The P/E ratio is used to evaluate whether the value of a stock is proportional to the level of earnings it can generate for its stockholders. It assesses whether the stock is overvalued or undervalued.

(P/E) Ratio = Market Capitalization / Net Income = Share Price / Earnings per Share

III. The Statement of Cash Flows

The statement of cash flows shows explicitly the sources of the firm’s cash and where the cash is utilized. It is essentially a statement whereby the net income is adjusted for non-cash expenses and any changes to the net working capital. It also reflects changes in cash coming from, or being used by, investing and financing activities of the firm. The structure and main components of the cash flow statement are as follows:

Cash from operating activities = Net income + Depreciation ± Changes in net working capital

Cash from financing activities = New debt + New shares – Dividends – Shares repurchased

Cash from investment activities = Capital expenditure – Proceeds from sales of long-term assets

All three of the above determine the bottom line: changes in cash flows.

Cash Flows Statement Analysis

In order to measure how much cash is available to the company for investments without outside financing or money diverting from operations, it is useful to conduct a simple cash flow statement analysis. The free cash flow, as the name suggests, allows a company to be able to pay dividends, repay its debts, buy back its stock and also make new investments to facilitate future growth. The excess cash produced by the company, free cash flow, is calculated as follows:

+ Amortization/Depreciation

– Changes in Working Capital

– Capital Expenditures

= Free Cash Flow

Some analysts also study the cash flow from operating activities to see if the company is earning “quality” income. In order for the company to be doing extremely well, the cash from operating activities must be consistently greater than the net income earned by the company.

OTHER FINANCIAL STATEMENT INFORMATION

Apart from the key financial statements, complete financial reporting statements also include the following:

Business and Operating Review

The business and operating review is also called “management discussion and analysis”. It serves as a preface to all the complete reporting statements in which the management talks about recent events, discloses essential information regarding expansion and future plans, and discusses significant developments in the business industry.

The business and operating review is a good place for the company to share any good news with the general public. They have room to elaborate on plans that would help enhance the company’s image and address any unpleasant events that may have occurred, to show the customers that they truly care about talking openly to their customers.

Statement of Change in Shareholders’ Equity

The statement of change in shareholders’ equity is also known as equity analysis. It provides information about all the changes in the company’s equity value over a certain time period. It reconciles the opening balances of the equity accounts with the closing balances. There are two types of changes expressed in the statement of change in shareholders’ equity:

• Changes arising from any transactions conducted with shareholders of the company. For example, issuing new shares, paying dividends, purchasing treasury stock, and issuing bonus shares, etc.
• Changes that are a result of alterations in the comprehensive income of the company. These changes might include revaluation of fixed assets, net income for the period and fair value of for-sale investments, etc.

Notes to the Financial Statements

Notes to the financial statements are basically additional information provided in a company’s financial statements. These notes provide details and information that are left out of the main reporting documents. They are important for the sake of clarity on many points as they outline the accounting methodology used for recording certain transactions. The notes to the financial statements are essentially footnotes because if included in the main statements, they would obscure the important information, as they are generally quite elaborate and detailed.

The following notes are usually used to impart important disclosures for explaining the numbers on the financial statements:

• Notes that show the basis for presentation
• Notes that advise on significant accounting policies
• Notes about valuing inventory
• Notes about depreciating assets
• Notes about intangible assets
• Notes that disclose subsequent events
• Notes about employee benefits
• Notes that reveal contingency plans

PROBLEMS WITH FINANCIAL STATEMENT ANALYSIS

Financial statement analysis is a brilliant tool to gauge the past performance of a company and predict future performance, but there are several issues that one should be aware of before using the financial statement analysis results blindly, as these issues can interfere with how the results are interpreted. Some of the issues are:

Comparability between Companies

This is a big issue for analysts because they can seemingly compare financial statement analyses between different companies on the basis of ratios used, but in reality it may not paint an accurate picture. The financial ratios of two different companies may be compared to see how they match up against each other, but each company may aggregate all their information different from each other in order to draw up their accounting statements. This may lead to incorrect conclusions drawn about a company in relation to other companies in the industry.

Comparability between Periods

The change in accounts where financial information is stored may skew the results of the financial statement analysis, from one period to the next. For example, if a company records an expense in one period as cost of goods sold , while in another period, it is recorded as a selling and distribution expense, the analysis between those two periods would not be comparable.

Operational Information

Analysts do not take into account operational information of a company, as only financial information is analyzed and reviewed. There may be several indicators in operational information of the company which may be predictors of future performance, for example, the number of backlogged orders, any changes in licenses or warranty claims submitted to the company or even changes in the culture and work environment. Therefore, analysis of financial information may only relay half the story.

Image credit: Wikimedia Commons under  public domain , Wikimedia Commons | Microsoft under  public domain .

Comments are closed.

Related posts

4 Brilliant Tips for Dealing With Angry Customers

A couple years back, I worked as a customer service representative for a tech company. I enjoyed the …

Startup Hubs Around the World: Helsinki

A seemingly unlikely candidate in the ‘Global Startup Hub Leaders’ category, Helsinki has emerged as …

Time Interest Earned Ratio Analysis Explained

Businesses are often started by taking loans, unless you’re already rich, of course. As a company …

408,000 + job opportunities

Not yet a member? Sign Up

join cleverism

Find your dream job. Get on promotion fasstrack and increase tour lifetime salary.

Post your jobs & get access to millions of ambitious, well-educated talents that are going the extra mile.

First name*

Company name*

Company Website*

E-mail (work)*

Login or Register

Password reset instructions will be sent to your E-mail.

• Business Essentials
• Leadership & Management
• Credential of Leadership, Impact, and Management in Business (CLIMB)
• Entrepreneurship & Innovation
• Digital Transformation
• Finance & Accounting
• Business in Society
• For Organizations
• Support Portal
• Media Coverage
• Founding Donors
• Leadership Team

• Harvard Business School →
• HBS Online →
• Business Insights →

Business Insights

Harvard Business School Online's Business Insights Blog provides the career insights you need to achieve your goals and gain confidence in your business skills.

• Career Development
• Communication
• Decision-Making
• Earning Your MBA
• Negotiation
• News & Events
• Productivity
• Staff Spotlight
• Student Profiles
• Work-Life Balance
• AI Essentials for Business
• Alternative Investments
• Business Analytics
• Business Strategy
• Business and Climate Change
• Creating Brand Value
• Design Thinking and Innovation
• Digital Marketing Strategy
• Disruptive Strategy
• Economics for Managers
• Entrepreneurship Essentials
• Financial Accounting
• Global Business
• Launching Tech Ventures
• Leadership Principles
• Leadership, Ethics, and Corporate Accountability
• Leading Change and Organizational Renewal
• Leading with Finance
• Management Essentials
• Negotiation Mastery
• Organizational Leadership
• Power and Influence for Positive Impact
• Strategy Execution
• Sustainable Business Strategy
• Sustainable Investing
• Winning with Digital Platforms

Financial Statement Analysis: The Basics for Non-Accountants

• 15 Aug 2019

What is one thing that creditors, investors, management, and regulatory authorities all have in common? In order to do their job well, all of them rely in one way or another on financial statement analysis.

Creditors rely on financial statements to evaluate whether a company or organization will be able to pay back a debt. Regulatory authorities, like the US Securities and Exchange Commission (SEC), rely on financial statements to determine whether a company meets the accounting standards required of a publicly traded company. Investors rely on financial statements in order to understand whether investing in a company would be profitable. And management relies on financial statements to make intelligent business decisions and communicate with investors and key stakeholders.

Access your resource today.

“Accounting is the language of business , and a company’s financial statements are its way of communicating accounting information to its owners and the taxing government,” says Thomas R. Ittelson, author of Financial Statement: A Step-by-Step Guide to Understanding and Creating Financial Reports and Visual Guide to Financial Statements: Overview for Non-Financial Managers & Investors . “This includes sales, costs, expenses, profits, and assets.”

Simply put, the business world could not exist in its current form without financial statements.

But what is financial statement analysis? What are the most common types of financial statements? And how do you conduct an analysis? Learn more about this fundamental business skill below.

What is Financial Statement Analysis?

Financial statement analysis is the process an individual goes through to analyze a company’s various financial documents in order to make an informed decision about that business.

While the specific data contained within each financial statement will vary from company to company, each of these documents is designed to offer insight into the health of the company. They are also essential to monitoring a company’s performance over time, as well as understanding how a company is progressing toward key strategic initiatives.

At its heart, says Ittelson, financial statement analysis allows an individual to “watch where the money, goods, and services go.”

Related: Finance vs. Accounting: What's the Difference?

Common Types of Financial Statements

Companies will often produce a number of financial statements, each of which is tailored to the needs of a particular audience. The information contained in each of these documents will vary by necessity.

The most common types of financial statements that you may encounter include: Balance sheets, income statements, cash flow statements, and statements of shareholder equity.

1. Balance Sheets

A balance sheet is designed to communicate the “book value” of a company. It’s a simple accounting of all of the company’s assets, liabilities, and shareholders’ equity, and offers analysts a quick snapshot of how a company is performing and expects to perform.

Most balance sheets follow this basic formula:

Assets = Liabilities + Shareholders’ Equity

An asset is anything the company owns which has a quantifiable value. This may include physical property (vehicles, real estate, unsold inventory, etc.), as well as non-physical property (patents, trademarks, etc.).

Liabilities refer to money the company owes to a debtor. This may include outstanding payroll expenses, debt payments, rent and utility payments, money owed to suppliers, taxes, bonds payable, and more.

Shareholders’ equity is a term that generally refers to the net worth of a company. It reflects the amount of money that would be left if all assets were sold and all liabilities paid. This money belongs to the shareholders, whether they are a private owner or public investors.

2. Income Statements

An income statement is a report that a company generates in order to communicate how much money it has earned over a period of time. They’re often found as quarterly and annual reports.

In addition to communicating top-line revenue, income statements detail a number of other metrics that can be helpful to analysts and investors. These include:

• Operating expenses, which detail every expense the company encountered during the reporting period
• Depreciation, which quantifies the extent to which a company’s assets (for example, aging equipment or vehicles) have lost value over time
• Net income, which subtracts the company’s expenses from its gross revenue in order to determine its total level of profits or loss
• Earnings per share (EPS), which divides net income by the total number of outstanding shares

3. Cash Flow Statement

A cash flow statement is a report that details how a company receives and spends its cash. These are also called cash inflows and outflows.

A company can only operate as long as it has the money to cover its expenses. Cash flow reflects a company’s ability to operate in both the short- and the long-term, and is used by investors, creditors, and regulators to determine whether a company is in good financial standing.

Cash flow statements are typically split into three sections:

• Operating activities, which details cash flow generated from the company delivering upon its goods or services, including both revenue and expenses
• Investing activities, which details cash flow generated from the buying or selling of assets, such as real estate, vehicles, and equipment (using free cash and not debt)
• Financing activities, which details cash flow from both debt and equity financing

4. Statement of Shareholders’ Equity

The statement of shareholders’ equity is a financial statement that details changes in the equity held by shareholders, whether those shareholders be public or private investors.

A statement of shareholders’ equity will typically report changes in the number of shares and value of common and preferred stock , as well as details about whether or not the company has purchased back any stock previously held by shareholders (called treasury stock ) and other data points.

5. Management’s Discussion and Analysis (MD&A)

The MD&A is a document written by the company’s management, which is designed to accompany financial reports.

While it is not a financial document in and of itself, an MD&A will typically provide additional context about why the company performed the way that it did during the reporting period, which can be incredibly helpful to investors, analysts, and creditors.

According to the SEC , “The purpose of MD&A is to provide investors with information that the company’s management believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations. It is intended to help investors to see the company through the eyes of management.”

While an MD&A should always be taken with a grain of salt, the Sarbanes-Oxley Act of 2002 mandates that senior corporate officers personally certify in writing that the company's financial statements comply with SEC disclosure requirements and fairly present, in all material aspects, the operations and financial condition of the issuer.

“Officers who sign off on financial statements that they know to be inaccurate will go to jail (if and when caught),” Ittelson says.

How to Conduct Financial Statement Analysis

Typically, professionals will follow one of two common methods to analyze a company’s financial statements: Vertical and horizontal analysis, and ratio analysis.

Vertical and Horizontal Analysis

Vertical and horizontal analysis are two related, but different, techniques used to analyze financial statements. They each refer to the way in which a financial statement is read, and the comparisons that an analyst can draw from that reading. Both types of analysis are critical to gaining an accurate understanding of the information provided in a financial statement.

• Vertical analysis is the process of reading down a single column in a financial statement. Whereas horizontal analysis is used to identify trends over time, vertical analysis is used to determine how individual line items in a statement relate to another item in the report. For example, in an income statement, each line item might be listed as a percentage of gross sales.

• Horizontal analysis, on the other hand, refers to the process of reading current financial data in comparison to previous reporting periods. Also called “trend analysis,” reading a financial statement in this way allows an individual to see how different financial metrics have changed over time: For example, whether liabilities have increased or decreased from Q1 to Q2.

Ratio Analysis

Ratio analysis is the process of analyzing the information in a financial report as it relates to another piece of information in the same report.

There are many different kinds of ratios which can help you gain insight into the health of a company. These are generally broken into the following broad categories:

• Profitability Ratios: These ratios offer insight into how profitable a company is. Some important profitability ratios include gross profit ratio, return on equity, break-even point, return on equity, and return on net assets.
• Liquidity Ratios: Liquidity ratios offer insight into how liquid a company is, which is important in measuring a company’s ability to stay in business. Some important liquidity ratios include cash coverage ratio, current ratio, and liquidity index.
• Leverage Ratios: Leverage ratios offer insight into how much a company is dependent on debt to maintain its operations. Some important leverage ratios include debt to equity ratio, debt service coverage ratio, and fixed charge coverage.
• Activity Ratios: Activity ratios offer insight into how well a company is utilizing resources. Some important activity ratios include accounts payable turnover rate, accounts receivable turnover rate, inventory turnover rate, and working capital turnover rate.

Once you have calculated a ratio for the current period, you can compare it against previous periods to understand how the company is performing over time. It’s also possible to compare the ratio against industry standards to understand if the company in question is under- or over-performing.

Learning the Skills You Need for Success

If you want to learn how to perform financial statement analysis, either for your own interest or to better perform the duties of your job, a number of options can help you gain the skills you need.

You could pursue a self-taught route, reviewing publicly available financial statements in order to familiarize yourself with the way that financial data is typically presented. Paired with mentorship opportunities at your organization, this can be a great way of learning the basics, but it isn’t your only option.

Taking an online class focused on finance or financial accounting are other potential paths you can take to gain the skills you need.

Do you want to take your career to the next level? Explore our online finance and accounting courses , which can teach you the key financial concepts you need to understand business performance and potential. To get a jumpstart on building your financial literacy, download our free Financial Terms Cheat Sheet .

About the Author

What is Financial Statement Analysis? Types, Limitations, Objectives

• Post last modified: 10 August 2023
• Reading time: 40 mins read
• Post category: Management Accounting

• What is Financial Statement Analysis?

Financial statement analysis is the process of examining and interpreting a company’s financial statements to assess its financial performance, position, and overall health. This analysis helps various stakeholders, including investors, creditors, analysts, and management, gain insights into a company’s strengths, weaknesses, opportunities, and risks. It involves evaluating the relationships between different financial figures and using various metrics and ratios to make informed decisions and predictions about the company’s future prospects.

Financial Statement Analysis is largely a study of the relationship among the various financial factors in a business as disclosed by a single set of statements and a study of the trends of these factors as shown in series of statement

Table of Content

• 1 What is Financial Statement Analysis?
• 2 Financial Statement Analysis Definition
• 3.1 Assessment of Past Performance and Current Position
• 3.2 Loan Decision by Financial Institutions and Banks
• 3.3 Prediction of Net Income and Growth Prospects
• 3.4 Prediction of Bankruptcy and Failure
• 3.5 Interpretation of Financial Statements
• 4 Steps involved in Financial Statement Analysis
• 5 Limitations of Financial Statements
• 6.1 On the Basis of Materials Used
• 6.2 On the Basis of Modus Operand
• 7.1 Cross-sectional Analysis
• 7.2 Time Series Analyse
• 7.3 Cross-sectional Cum Time Series Analysis
• 8 Process of Financial Statement Analysis
• 9.1 Common Size Analysis
• 9.2 Horizontal Common Size Analysis
• 9.3 Vertical Common Size Analysis
• 10.1 Comparative Income Statement
• 10.2 Comparative Balance Sheet

Financial Statement Analysis Definition

Objectives of financial statement analysis.

Financial Statement analysis can be used by different users and decision makers to achieve the following objectives:

Assessment of Past Performance and Current Position

Loan decision by financial institutions and banks, prediction of net income and growth prospects, prediction of bankruptcy and failure, interpretation of financial statements.

Past performance is often a good indicator of future performance. Therefore, an investor or creditors in interested in the trend of past sales, expenses, net income, cash flow and return on investment. These trends offer a means for judging management’s past performance and are possible indicators of future performance.

Similarly, the analysis of the current position indicates where the business stands today. For instance, the current position analysis will show the types of assets owned by a business enterprise and the different liabilities due against the enterprise. It will tell what the cash position is, how much debts the company has in relation to equity and how reasonable the inventories and receivables are.

Financial statement analysis is used by financial institutions, loaning, agencies, banks, and others to make sound loan or credit decisions. In this way, they can make proper allocation of credit among the different borrowers. All lenders are primarily concerned with the repayment of loans and payment of interest on the due dates.

This requires comprehensive investigation and analysis of the financial statements submitted by the borrowers. Financial statement analysis help in determining credit risk, deciding terms and conditions of loan if sanctioned, interest rate, maturity date etc.

Financial Statement analysis helps in predicting the earning prospects and growth rate in the earnings which are used by investors while comparing investment alternatives and other users interested in judging the earning potential of business enterprises. Investors also consider the risk or uncertainty associated with the expected return.

The decision-makers are futuristic and are always concerned with the future financial statements which contain information on past performances analyzed and interpreted as a basis for forecasting future rates of return and for assessing risk.

Financial statement analysis is a significant tool in predicting the bankruptcy and failure probability of business enterprises. Financial Statement analysis accomplishes this through the evaluation of solvency position.

After being aware of probable failure, mangers and investors both can take preventive measures to avoid or minimize losses. Corporate management can effect changes in operating policy, reorganise financial structure or even go for voluntary liquidation to shorten the length of time losses.

The analysis of financial statements means a critical examination of statements for better understanding and drawing fruitful conclusions. It is only an analytical study of statements that can help draw dependable conclusions. Therefore, analysis becomes a pre-requisite for the interpretation of financial data in the form of an annual account and statement. The technique of analysis depends upon the objectives of analysis

Steps involved in Financial Statement Analysis

There are three steps involved in the financial statement analysis and they are:

• Selection : The first step involved refers to the selection of information relevant to the purpose of evaluation from the total of information contained in the financial statements
• Classification of Information : The second step involved is the classification or grouping of information in such a manner to focus on the significant relationships.
• Selection of Information : The final step is the interpretation which includes drawing of inferences and conclusions

Limitations of Financial Statements

The Financial Statements suffer from certain limitations, which are mentioned below :

• The financial statements do not show qualitative change which undoubtedly affects greatly the performance of an undertaking. The financial accounts do not account for events such as changes in management, labor strikes, changes in government policies affecting enterprise, etc. The financial analyst should try to assess the impact of qualitative changes on the profitability of the concerning enterprise.
• Financial statements are historical in nature. They tell nothing about the future. Since the financial analyst is concerned with analysis and interpretation for the formulation of future business policies, he should restructure the statements in such a manner, that they become more intelligible and useful for projections for the future.
• Generally, the audited Profit and Loss Account and Balance Sheet are considered dependable statements. If the analyst is compelled to use the unaudited accounting statements, he should first ascertain their truth. It is very difficult to verify the correctness of the Income Statement and Position Statement without the basic information in the form of ledger accounts and other records.
• The concept of the accounting period is not technically correct. The Profit and loss Account is prepared for an accounting year which is generally a period of one year. This gives rise to the problem of cost and income allocation. In fact, real profit or loss can be calculated only at the end with the units is closed down. The annual accounts can best be considered interim reports.
• The Profit or loss figure as shown by a Profit and Loss Account is not necessarily a correct figure which is influenced by the personal judgment of the management regarding depreciation, inventory valuation and provisions for various reserves and contingencies. The management can manipulate profit/loss figures to serve their interests. The financial analyst should see that the income has been rightly computed by following consistent accounting policies.
• The balance sheet is a static document, which means, documents showing the economic position of an enterprise on one given date. The Balance sheet is prepared on the last day of a financial year. i.e on 31st December, 31st March, or 30th June. Generally, the Balance Sheet is prepared and published very late after the close of the accounting year. The Balance sheet loses much of its significance and practical utility due to a long time gap between the close of an accounting year and the actual publication of the same. financial analysts should always bear this limitation in mind.
• Assets shown in the Balance Sheet might not be shown at their fair or current values. Goodwill is an item that is closely related to profits. If a company suffers loss continuously for the last few years, that it no more enjoys the goodwill as shown in the books of the company. But the companies continue to show goodwill at the usual figure despite continuous losses

Types of Financial Statement Analysis

In a business environment there are various parties who analyse financial for various purposes. Financial Statement Analysis are broadly classified into two categories and these two categories are further classified into two subcategories:

• On the basis of Materials Used
• On the basis of Modus Operand

On the Basis of Materials Used

On the basis of materials used, financial statement analysis can be further divided into two sub-categories, which are given below:

• External Analysis is performed by the external stakeholders of the organisation namely investors, customers, creditors, government agencies, economists, vendors, etc. These external stakeholders do not have access to internal organisational records and they relies on financial statements published in annual reports of the organisation.
• Internal Analysis is performed by the management executives of the organisation to examine financial and operating performance of the company. These are more reliable as compare to external analysis because the concerned person is given access to all the internal data and policies.

On the Basis of Modus Operand

On the basis of modus operand, financial statement analyses can be further divided into two sub categories, which are given below:

• Horizontal analysis is also known as dynamic analysis and it is that type of analysis in which financial statements of two or more consecutive accounting period are analysed. The figures of all accounting periods are written horizontally in a particular column that represents years and these figures can represent graphically also. Initial year will be taken as the base year and figures for every year is compared with that of the base year. Horizontal analysis is most applicable when an organisation examines the direction of trend for a period of several years several years. Comparative statements and trend analysis are two main techniques under horizontal analysis.
• Vertical analysis of financial analysis is also known as ‘Static Analysis’ and it is that type of analysis in which study is conducted only for one particular period. Under this analysis each item of financial statement is expressed in terms of percentage of the same item in the base year. Common size statements and ratio analysis are two important tools to perform vertical analysis.

Techniques of Financial Statement Analysis

Techniques of financial statement analysis are generally classified in to three categories:

Cross-sectional Analysis

Cross-sectional analysis or inter firm analysis is one of the most significant techniques of financial statement analysis. Under this technique, financial characteristics of a particular organisation are analysed in with the pecuniary characteristics of another organisation. For example, if ABC Industries Ltd. has earned 20% return on investment (RoI) in the FY year 2017 and another company named XYZ Industries Limited has earned 22% (RoI). This data does not show that XYZ Industries Limited is more efficient in generating profits and under this case, we need to analyse various other components also.

Time Series Analyse

Time series analyse is also known as intra firm comparison and under this technique the relationship between two or more items of financial statements for being examined. This comparison can be done by using, financial statement of one organisation for different period of time or financial statement of two or more organisations for a particular period of time.

Cross-sectional Cum Time Series Analysis

Cross-sectional cum time series analysis a technique that is most effective to analyse the financial statements and under this technique both the techniques cross-sectional and time series analysis, are applied together to analyse financial statements.

There are many tools or methods that are used under this technique and following are the most commonly used methods for analysing financial statement:

• Comparative financial statements: Under this method comparative financial accounts (comparative balance sheet, comparative profit and loss account and comparative cash flow statement) are prepared for a number of years. It helps in identification of loopholes and suggests corrective measures.
• Common size statements: Under this method figures of financial statements are shown in analytical percentage. The figures of all items are shown as the percentage of their relevant head (i.e. total assets and total liabilities in the balance sheet, total sales/revenue in the profit and loss account). The total percentage of each head is taken as 100.
• Fund Flow Analysis: It involves the analysis of funds flow statement which acts as additional statement to the profit and loss account and balance sheet. It shows the changes in financial position that are based on working capital and cash. It also provides information about sources of funds and their use during a particular period.
• Ratio Analysis: It is one of the most significant methods to measure the interrelationship between two or more related variables in the financial statements. Ratio analyses reduce large figures in understandable relationship. An analyst can draw meaningful conclusion by evaluating and relating various ratios. Generally ratios are categorized into three major categories namely, Liquidity Ratios, Solvency Ratios, Profitability Ratios and Activity Ratios.
• Percentage change analysis: It explains the changes in accounting figures of various variables of financial statements in percentage terms.
• Management’s Discussion and Analysis is that part of annual report which provides the overview of preceding year’s operations and company performance. Under this section management also explains their goals for the upcoming year.

Process of Financial Statement Analysis

Following is the process for conducting financial statement analysis:

Components of Financial Statement Analysis

You have studied earlier that the financial statements of an organisation are used for reporting the financial position of the company for public use. The financial statement analysis are categorised majorly into two parts:

Let us now study about these components in detail as follows:

Common Size Analysis

You have studied earlier that the traditional financial statements of an organisation are used for reporting the financial position of the company for public use. Whenever an investor intends to compare the financial statements of two organisations, there is a need for a common scale in order to match the two distinct businesses for investment purposes.

As organisations are different in size, growth, etc. comparing the traditional financial statements might lead to misleading interpretations affecting the investors.

For example, A Ltd. has liabilities worth ₹10, 00,000 while B Ltd. has liabilities worth ₹100, 00,000. Does this information from their balance sheets imply that A Ltd. is less risky than B Ltd.?

In reality, it depends in part on the size of the companies, their asset size, the industries that the two companies belong to, etc. This led to the use of common size analysis for decision-making purposes. Common size analysis is a popular method of financial statement analysis, which makes use of common size financial statements.

These financial statements display all items as percentages of a common base figure. Each item in the financial statement is reported in the form of a percentage. This percentage is arrived at by using a base figure. For example, every item on the income statement of an organisation is reported as a percentage of sales.

There are three reasons to use common-size analysis:

• Comparing financial information of an organisation from one period to the next.
• Comparing financial information of an organisation relative to its competitors.
• Comparing financial information of various companies in different parts of the world when the reporting currency is different. e.g., A Company like Uniliver plc. which has operations in several countries and the financials are in different currencies like Great British Pound (GBP), United States Dollars (USD), and Indian Rupee (INR) etc. The use of Common size analysis which translates absolute amounts in different currencies into percentages makes comparisons and financial analysis more meaningful and simpler.

The most widely used common size analysis methods are as follows:

Horizontal Common Size Analysis

Vertical common size analysis.

Although both methods are similar considering that the figures in financial statements are converted to percentages however, they differ in the base used to compute the percentages. Let us discuss the two methods in detail in the subsequent sections.

Horizontal common-size analysis uses one type of financial statement at a time. However, instead of using only a year’s financial statement, horizontal common analysis makes use of the same type of financial statement over several consecutive years.

Usually, three years of information is used for horizontal analyses, although it is common to extend the evaluation for measuring long-term trends in the organisation’s performance.

For instance, if an organisation performs a horizontal analysis on its income statement, it would use the income statements for 2011, 2012 and 2013. The figures in each succeeding period are expressed as a percentage of the amount in the baseline year, with the baseline amount being listed as 100%.

Consider the following illustration:

Income statement information of Dell Inc. as ended March, 2013 is as follows:

Assuming 2011 is the base year, 2012 and 2013 revenues will be calculated as follows, respectively:

Thus, the horizontal analysis of Dell’s Income Statement would be as follows:

This analysis shows that the percentages of revenue for 2012 and 2013 first increased and later decreased the 100% benchmark of 2011. The financial statement user would interpret this as an increase and later decrease in Dell Inc.’s sales performance.

Revenue for 2013 may be misleading at first glance, however, further analysis reveals that the decrease in 2013 represents only 7% fall compared to the 100% benchmark of revenue in 2011. In reality, the COGS in 2013 have come down by 11% compared to the benchmark COGS in 2011. Thus, the company is in a better position in managing its resources.

Another type of common size analysis is the vertical analysis method. Vertical analysis refers to the proportional analysis of a financial statement, where each item on a financial statement is recorded as a percentage of another item.

This implies that each item on the income statement of an organisation is recorded as a percentage of the gross sales. On the other hand, each item on the balance sheet of an organisation is recorded as a percentage of the total assets.

For example, if the cost of goods sold has consistently been recorded as 40% of sales in the past four years for an organisation, a percentage of 48% in the fifth year would raise an alarm for further analysis. Moreover, vertical analysis is helpful for timeline analysis.

An example of vertical analysis of an income statement as follows:

Vertical analysis of a balance sheet uses the common base as the total assets of an organisation. However, for a deeper analysis, users tend to use the total of all liabilities as the base for calculating line item liabilities in a balance sheet and the total of all equity accounts as base when calculating all equity line item percentages.

This has been illustrated in the following example:

From the above analysis it can be interpreted that:

• The relative investment in fixed assets is 30% of total assets
• Total current liabilities are 20% of total liabilities and equity
• Current assets account for 20% of the total assets

Comparative Financial Statement Analysis

Comparative financial statements are those statements which provide all the desired financial information for two or more financial years. This statement is use to compare results of current financial statement with previous accounting period of the firm or with that of the competitors.

Under this method, the components of financial statement (i.e. Balance sheet and Income statement) are used for comparative purposes and all the items are presented in terms of figures and as well as in percentage.

Comparative statements determines any increase, decrease and percentage change in the corresponding amount of two or more than two years and this analysis is used by various stakeholders such as, managers, investors, creditors, analyst, etc. It reflects organisation’s ability to deal with solvency, liquidity, profitability related issues.

The methods used under the comparative statements are as follows:

Comparative Income Statement

Comparative Income Statement shows the financial performance of the firm in comparison of prior period data of the firm or of competitors. It provides information regarding expenses and income of the firm for two or more than two years.

It also provides the information about various changes in absolute figure and in the form of percentage. It provides a view of business performance over a time and supports financial manager in decision making practices.

Comparative Income Statement of Infosys for year ended March 31, 2017 is as follows:

Comparative Balance Sheet

Comparative Balance Sheet shows the current financial position of the firm in comparison to prior period data. Comparative balance sheet records all the items of balance sheet side by side under relevant head of three main components (i.e. Assets, Liabilities and Share capital) of balance sheet.

Generally it is presented at the end of financial year for the past 3 years data. While some firms like financial institutions use other versions which shows all the data at the month end or at the quarter end. However, in both versions it provides a clear picture of firm’s financial position to the analyst.

Comparative Balance Sheet of Infosys for year ended March 31, 2017 is as follows:

• Lal, J. (2009). Accounting for management. 5th Revised ed. (pages: 164-232) Mumbai: Himalaya Pub. House.
• Sinha, G. (2009). Financial Statement Analysis (1st ed., pp. 97-133). Delhi: Prentice Hall India.

Financial Accounting

( Click on Topic to Read )

• 4 Accounting Conventions
• What Is Accounting Standards?
• What is Accounting Equation?
• What is Source Documents?
• What i s Accounting Cycle?
• Classification Of Accounts
• 3 Branches of Accounting
• What is Double Entry System of Accounting?
• What i s Journal In Accounting?
• What is Ledger In Accounting?
• What is Posting In Accounting?
• What is Trial Balance?
• What is Accounting Errors?
• What is Depreciation In Accounting?
• What is Financial Statements?
• What is Departmental Accounts?
• What is Branch Accounting?
• Accounting for Dependent Branches
• Independent Branch Accounting
• Accounting for Foreign Branches

Corporate Finance

• What is Corporate Finance?
• Long Term Financing
• What is Inventory Management?
• External Sources Of Finance
• Short Term Financing
• Time Value Of Money
• Capital Assets Pricing Model (CAPM)
• What is Capital Rationing?
• What is Capital Budgeting?
• What is Cost o f Capital?
• What is Dividend?
• Dividend Theories
• What is Dividend Policy?
• What is Cash Management?
• Types of Derivatives Contract
• What is Inventory Control?
• What is Consumer Financing?

Management Accounting

• What is Management Accounting?
• Types of Accounting
• What is a Management Accountant?
• Inventory Control Techniques
• Determination Of Working Capital
• What is Cash Flow Statement?
• Determination of Working Capital

You Might Also Like

Target costing: definition, features, objectives, process, advantages, what is contract costing definition, types, features, procedure, management accountant, standard costing and variance analysis, what is process costing features, types, advantages & limitations, process, what is cost control definition, features, process, advantages, disadvantages, what is cost sheet components, advantages, treatment and adjustments, what is absorption costing advantage, limitation, standard costing: definition, features, types, advantages, disadvantages, what is marginal costing definition, features, advantages, limitations, what is joint cost methods: average cost, physical quantity, survey, sales revenue, management accounting and developed costing systems, leave a reply cancel reply.

You must be logged in to post a comment.

World's Best Online Courses at One Place

We’ve spent the time in finding, so you can spend your time in learning

Digital Marketing

Personal Growth

Development

Table of contents

Mastering financial statements: how to read and analyze them.

Have questions on formation, banking and taxes?

Schedule a FREE consultation with a formation and compliance expert today 📞

Have you ever stared at a financial statement and felt puzzled? You’re not alone!

For many, these documents can seem like a daunting puzzle filled with numbers, jargon, and cryptic abbreviations. 

But what if we told you that mastering financial statements could be your ticket to making informed decisions—whether you’re managing your finances, evaluating investments, or navigating business strategies? 

In this blog, we’ll demystify the world of balance sheets, income statements, and cash flow reports.

We’ll equip you with the essential skills needed to read between the lines of these crucial documents and uncover insights that can shape your financial future. 

Get ready to transform confusion into confidence with doola , as we provide you with practical tips and financial tools that will have you analyzing financial statements like a pro in no time! 

What Are Financial Statements?

Financial statements are essential documents that provide a snapshot of a company’s financial performance and position.

There are three main types of financial statements: the balance sheet, income statement, and cash flow statement. 

These three financial statements are interconnected and provide a complete picture of a company’s financial performance and position. 

1. Balance Sheet

The balance sheet , or the statement of financial position, summarises a company’s assets, liabilities, and equity at a specific time. Assets include cash, inventory, equipment, etc.

Liabilities represent debts or obligations to be paid off, and equity represents the value left by shareholders after deducting liabilities from assets.

The balance sheet follows the basic accounting equation: Assets = Liabilities + Shareholders’ Equity. This means all assets must equal the liabilities and equity on the balance sheet.

2. Income Statement

The income statement shows a company’s revenue and expenses for generating that revenue during a specific period. 

It starts with sales or revenue at the top and then subtracts various expenses, such as cost of goods sold (COGS), operating expenses , taxes, interest expense, etc., to arrive at net income or profit.

Net income is an essential number on the income statement, indicating whether a company made a profit or incurred losses during a period.

3. Cash Flow Statement

The cash flow statement tracks all cash inflows and outflows within an organization during a particular period. 

It can be divided into three sections: operating activities (cash flows from day-to-day operations), investing activities (cash flows related to buying or selling long-term assets), and financing activities (cash flows associated with raising capital).

The cash flow statement helps investors understand how effectively a company manages its cash resources by showing where it gets and how it uses it.

What Are Financial Ratios?

Financial ratios are essential for understanding and analyzing a company’s financial statements. They provide valuable insights into how well it can cover its debts, or how much profit it’s earning.

In simple terms, financial ratios are mathematical calculations that compare different figures from a company’s financial statements to assess its performance. These figures include revenues, expenses, assets, liabilities, and equity. 

By examining the relationships between these numbers, we can better understand how well the company manages its resources and generates profits. 

Various financial ratios can be used to evaluate different aspects of a company’s operations and, when combined, paint a more comprehensive picture.

Balance Sheet

The balance sheet is a key financial statement that every business owner and investor should be familiar with. It tells you how much business assets you have and how much money you owe in liabilities. 

Assets can include cash, accounts receivable, equipment, inventory, or investments. Liabilities include accounts payable, accrued expenses, and long-term debt such as mortgages and other loans.

Let’s look at each balance sheet’s components, starting with assets. It includes all the value you have on hand, such as cash and the amount in the business bank account.

Some of it is less liquid, like equipment or inventory, and accounts receivable or payments you’re due to receive.

Assets are usually listed in order of liquidity – meaning how quickly they can be converted into cash. Cash is typically listed first, followed by short-term and long-term investments such as property or equipment.

Liabilities are the money you have to subtract from your assets. It gives you a rough idea of how much value your business has to work with.

It typically involves monthly payments to vendors or contractors, which could be considered a short-term liability. 

Liabilities are also listed in order of due date: current liabilities (due within one year) are followed by long-term liabilities (due after one year). Long-term liabilities, like business loan debt, last longer.

Lastly, equity is the money you have put into the business.

It includes retained earnings (profits reinvested back into the company), drawing (the money you pay yourself), common stock (the value of shares issued to shareholders), and any other capital contributions made by owners.

Now that we understand how a balance sheet is structured, let’s discuss how to analyze it effectively.

One way to do this is by calculating financial ratios using numbers from both sides of the balance sheet. 

How to Analyze a Balance Sheet with Financial Ratios

To gain deeper insights into a company’s financial position, it is crucial to analyze the balance sheet using various financial ratios, such as the current, quick, and debt-to-equity ratios.

Current Ratio

The current ratio measures a company’s ability to meet its short-term obligations with its current assets. A high current ratio indicates the company has enough liquid assets to cover its short-term debts.

It measures your liquidity to determine how easily your current assets can be converted to cash to cover your short-term liabilities.

To calculate the current ratio, divide the total current assets by the total current liabilities. 

Here is the current ratio of Barney’s Barn:

Current Ratio = Current Assets / Current Liabilities

Current Ratio = 33,000 / 11,000 = 3

Ratio = 3:1 

Ideally, a current ratio of 2:1 or higher is healthy, showing that the company can quickly pay off its short-term debts.

Quick Ratio

The quick ratio, also known as the acid-test ratio, measures a company’s ability to meet its debt obligations with its most liquid assets (cash and cash equivalents). 

Unlike the current ratio, which includes all current assets in its calculation, this ratio only considers highly liquid assets that can be converted into cash quickly.

To calculate the quick ratio, divide total liquid assets (current assets – inventory) by total current liabilities. 

For example, the current asset value of Barney’s Barn is $24,000 (excluding equipment value)

So, the Quick Ratio = 24,000 / 11,000 = 2.18

Ratio = 2.18:1

A quick ratio of 1:1 or higher indicates that the company has enough liquid resources to cover its immediate debts without relying on inventory sales.

Debt-to-Equity Ratio

The debt-to-equity (D/E) ratio compares a company’s long-term debt with its shareholders’ equity. It shows how much of a company’s financing comes from borrowing money versus equity. 

To calculate the D/E ratio, divide total liabilities or debt by shareholders’ equity. It only includes long-term debt, such as bank loans, not short-term liabilities, like accounts payable.

So, the debt-to-equity ratio of Barney’s Barn = 10,000 / 25,000 = 0.4

Ratio = 0.4:1

A high D/E ratio indicates that most of the company’s financing comes from debt, making it riskier for investors.

A lower D/E ratio is generally considered favourable, meaning the company has more funding through capital investment rather than borrowing.

Income Statement

The income statement, also known as the profit and loss statement, reflects a company’s revenues, expenses, and profits for a financial reporting period. It shows how much revenue a company generated and how much it has spent on expenses during that period.

It is crucial to know the different components of an income statement to better understand how to read and analyze it. The first is the revenue or sales section, which shows the total money generated from selling goods or services. 

After revenue comes the cost of goods sold (COGS) section. This section includes all direct costs associated with purchasing goods the company sells.

The difference between revenue and COGS gives the gross profit margin.

General expenses include recurring costs to keep the business running. It may include rent, which will be the same month to month, while others, like utilities and office supplies, may fluctuate.

The next is operating earnings or EBITDA (Expenses Before Interest, Taxes, Depreciation, and Amortization).

It equals the total amount you can take home after subtracting expenses from revenue, excluding taxes.

Income tax expense is the estimated income tax paid or owed during the reporting period, which is part of the IT in EBITDA.

The last part of an income statement is net income or net profit, which is calculated by subtracting all expenses from gross profit margin.

Net Income represents the bottom line for a business’ operations after all other sources of revenue have been accounted for.

How to Analyze an Income Statement with Financial Ratios

The income statement is divided into three main sections: gross profit, operating profit, and net profit.

Each component can be further analyzed using various financial ratios to gain valuable insights into a company’s profitability.

Gross Profit Margin

The gross profit margin is calculated by dividing the gross profit (revenue minus cost of goods sold) by total revenue. This ratio indicates how much profit a company generates from its sales after deducting the COGS.

It will tell you how much money your business makes per dollar earned. You can improve this ratio by lowering your COGS (reducing the wholesale cost of goods and services) or raising prices.

Here is the calculation of Barney’s Barn’s gross profit margin:

Gross Profit Margin = (Sales Revenue – COGS) / Sales Revenue

Gross Profit Margin = (9,000 – 4,000) / 9,000 = 0.55, or 55%

So, Barney’s gross profit margin is 55%, meaning he keeps $0.55 of every dollar he earns as gross profit.

Operating Profit Margin

The operating profit margin measures how much operating earnings (revenue minus all expenses except interest and taxes) are generated for every dollar of sales.

While it is similar to gross profit margin, it also takes general expenses into account.

For Barney’s Barn, the calculation will be:

Operating Profit Margin = Operating Earnings (EBITDA) / Sales Revenue

Operating Profit Margin = 2,750 / 9,000 = 0.31, or 31%

A higher operating margin implies the company has better control over its costs and can generate more profits. Since COGS and general expenses are something you can control, you should focus on the operating profit margin to earn more profit.

Net Profit Margin

The net profit margin reflects the net income (operating income minus taxes) earned for every dollar of revenue generated. This ratio considers all expenses incurred by the business, including taxes.

Here is the calculation of Barney’s Barn’s net profit margin:

Net Profit Margin = Net Income / Sales Revenue

Net Profit Margin = 1,850 / 9,000 = 0.21, or 21%

So, for every dollar Barney earns, he keeps $0.21. A higher net profit margin indicates strong profitability, but a lower net profit margin could mean the company is not generating enough profits to cover its expenses and taxes.

Cash Flow Statement

The cash flow statement is an indispensable tool for companies following the accrual method of accounting. It provides a clearer picture of a company’s financial health by adjusting for non-cash items and tracking actual cash inflows and outflows.

In the accrual method, you may raise an invoice of $1,000 and record that as accounts receivable under asset. However, you don’t have the money on hand yet.

So, a cash flow statement reverses those transactions where you don’t have cash on hand.

Below are the key components of cash flow statements:

• Cash, Beginning of Period is the cash on hand at the beginning of the month.
• Net income is the total income for the month. 
• Additions to cash reverse expenses that are listed on the books but haven’t been paid out yet. 
• Subtractions from cash reverse any transactions recorded as revenue for the month but not actually received. 
• Net cash from operating activities is the cash that came into business during the month.

How to Analyze a Cash Flow Statement with Financial Ratios

Analyzing a cash flow statement with financial ratios tells you how much cash you have on hand to cover liabilities. It also tells you how much cash you earned during the month. Here are three formulas to help you do that.

Current Liability Coverage Ratio

The current liability coverage ratio measures a company’s ability to meet its short-term financial obligations using its current assets. It compares the current cash flow against the debt you need to pay in the near future.

First, you must calculate your current average liability. You can do that by adding all your current liabilities at the beginning and end of an accounting period and dividing by 2. For example, Barney’s total current liabilities are $1,000 at the beginning of March and $900 at the end.

So, his current average liability is = (1,000 + 900) / 2 = $950.

Now, we can calculate his current average liability ratio using the formula below:

Current Average Liability Ratio = Net Cash from Operating Activities / Average Current Liabilities

Current Average Liability Ratio = 200 / 950 = 0.21, or 21%

A ratio lower than 1:1 indicates that the company will not have enough liquid assets to cover its debts in the near future.

Cash Flow Coverage Ratio

The cash flow coverage ratio measures a company’s ability to generate enough operating cash flow to cover its interest expenses and long-term debt payments. It is calculated by dividing the net cash flow by total debt (interest + principal).

This ratio takes into account all debt, both long-term and short-term.

Therefore, the ratio is calculated for the year rather than a month. So, you can add up the monthly operating cash flow for the year to get her annual cash flow.

Since we only have a statement of one month in which the cash flow from operations was exactly $700, we can assume the total cash flow for the year is $8,400 ($700*12).

So, the calculation for Barney’s Barn will look like this:

Cash Flow Coverage Ratio = Net Cash Flow from Operations / Total Debt

8,400 / 6,200 = 1.35

A cash flow coverage ratio above 1.0 indicates that a company generates ample operating cash flows to cover its debt obligations.

Cash Flow Margin Ratio

The cash flow margin ratio is a critical metric for understanding a company’s financial strength and stability. It tells you how much cash you earned for every dollar in sales for a reporting period.

So, if Barney made $1,200 in net sales for March, his cash flow margin ratio would look like this:

Cash Flow Margin = Net Cash from Operating Activities / Net Sales

700 / 1,200 = 0.58, or 58%.

By following these tips, you will be on your way to mastering financial statements and gaining valuable insights into a company’s financial health. If you are unsure, consult an expert in financial statements to guide you through the process.

Harness the Power of Financial Statements with doola

Mastering financial statements may seem like a daunting task at first, but with the right tools and support from doola , it becomes much more manageable. 

Get started with doola Bookkeeping , a comprehensive software that automates your financial record-keeping and simplifies reporting. 

Our team of Certified Public Accountants are well-versed in all aspects of financial reporting and analysis, allowing us to provide valuable insights and guidance.

Book a consultation to find out how we can help you harness the power of understanding financial statements for your business.

Free e-book

How to form a US LLC in 5 minutes

A beginner-friendly guide on the basics of LLCs. Learn about formation, banking, and taxes.

Schedule a FREE consultation with a US CPA today 📞

Keep reading

Start your dream business and keep it 100% compliant

Turn your dream idea into your dream business.

A beginner-friendly guide on the basics of LLCs. Learn about formation, banking, and taxes. Get ready to turn your dream idea into your dream US business.

Cookie consent

By continuing to browse this website, you agree to the storing of cookies on your device to enhance site navigation, analyze site usage, and assist in our marketing efforts. Learn more.

Analysis of Financial Statements: 4 Methods | Financial Management

The methods used in analysis of financial statements are as follows: 1. Comparative Financial Statements 2. Common-Size Statements 3. Trend Ratios 4. Ratio Analysis.

Method # 1. Comparative Financial Statements:

Comparative financial statements are statements of financial position of a business designed to provide time perspective to the consideration of various elements of financial position embodied in such statements.

Comparative financial statements reveal the following:

I. Absolute data (money values or rupee amounts)

ADVERTISEMENTS:

II. Increase or reduction in absolute data in terms of money values

III. Increase or reduction in absolute data in terms of percentages

IV. Comparison in terms of ratios

V. Percentage of totals

Financial statements of two or more firms can also be compared for drawing inferences. This is called ‘interfirm comparison’.

I. Comparative Income Statement:

A comparative income statement shows the absolute figures for two or more periods and the absolute change from one period to another. Since the figures are shown side by side, the user can quickly understand the operational performance of the firm in different periods and draw conclusions.

II. Comparative Balance Sheet:

Balance sheets as on two or more different dates are used for comparing the assets, liabilities and the net worth of the company. Comparative balance sheet is useful for studying the trends of an undertaking.

Advantages:

The comparative financial statements are useful for analysis of the following:

a. Comparative statements indicate trends in sales, cost of production, profits etc. and help the analyst to evaluate the performance of the company.

b. Comparative statements can also be used to compare the performance of the firm with the average performance of the industry or interfirm comparison. This helps in identification of the weaknesses of the firm and remedial measures can be taken accordingly.

Disadvantages:

The comparative financial statements suffers from the following weaknesses:

i. Interfirm comparison can be misleading if the firms are not identical in size and age and when they follow different accounting procedures with regard to depreciation, inventory valuation etc.

ii. Inter-period comparison may also be misleading, if the period has witnessed changes in accounting policies, inflation, recession etc.

From the following particulars pertaining to ABC Ltd. you are required to prepare a comparative Income Statement and interpret the changes:

cookielawinfo-checkbox-functional11 monthsThe cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional".cookielawinfo-checkbox-necessary11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookies is used to store the user consent for the cookies in the category "Necessary".cookielawinfo-checkbox-others11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Other.cookielawinfo-checkbox-performance11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Performance".viewed_cookie_policy11 monthsThe cookie is set by the GDPR Cookie Consent plugin and is used to store whether or not user has consented to the use of cookies. It does not store any personal data.

• General Finance & Investments

How to Read a Financial Report: Wringing Vital Signs Out of the Numbers, 10th Edition

ISBN: 978-1-394-26869-6

September 2024

Tage C. Tracy

Learn how to read, understand, analyze, and interpret different types of financial reports

In the newly revised and updated 10th Edition of How to Read a Financial Report, seasoned accounting, financial, and business consultant Tage C. Tracy guides readers through reading, understanding, analyzing, and interpreting various types of financial reports, including cash flow, financial condition, and profit performance reports. This book also reveals the various connections between different financial metrics, reports, and statements, discusses changes in accounting and finance reporting rules, current practices, and recent trends, and explains how financial information can be manipulated, such as through inclusion or omission of certain KPIs.

This bestselling guide uses jargon-simplified and easy-to-understand language to make the information accessible to all, regardless of finance or accounting background. Updates to the 10th Edition include:

• Relevant terminology and issues critical to understand in today's economic environment.
• New material on loans, debt, and using financial reports and statements to understand performance.
• The connection of capital including debt and equity to the income statements and cash flow statements.
• Expanded financial analysis tools and ratios that provide a deeper understanding of a company's financial performance and strength.
• A more in-depth overview of how company's may engineer financial results and how understanding cash flows can help root out fraud.

An essential all-in-one guide on the art of reading a financial report and avoiding common pitfalls and misconceptions, How to Read a Financial Report earns a well deserved spot on the bookshelves of all business leaders and investors who want to be able to read and understand financial reports and statements like a professional.

Over the past 30+ years, Tage C. Tracy has operated a financial consulting firm focused on offering CFO/executive-level support and planning services to private companies on a fractional basis, working primarily with startups, rapid growth companies, strategic exits and acquisitions, and turnarounds and challenged environments.

Asking the better questions that unlock new answers to the working world's most complex issues. UK

Trending topics

AI insights

Sustainability in business

EY Center of Board Matters

Technology leaders' agenda

EY podcasts

EY webcasts

EY helps clients create long-term value for all stakeholders. Enabled by data and technology, our services and solutions provide trust through assurance and help clients transform, grow and operate.

EY.ai - A unifying platform

Strategy, transaction and transformation consulting

Technology transformation

Tax function operations

Climate change and sustainability services

EY Ecosystems

EY Nexus: business transformation platform

Discover how EY insights and services are helping to reframe the future of your industry.

Case studies

How Microsoft built a new mobility model for cross-border talent

13 May 2024 EY Global

Private equity

How GenAI is empowering talent at a PE-backed consumer brand

08 May 2024 EY Global

Strategy and Transactions

How carve-outs positioned an automotive giant for future growth

11 Apr 2024 EY Global

We bring together extraordinary people, like you, to build a better working world.

Experienced careers

Student careers

Technology careers

Belonging at EY

EY-Parthenon careers

At EY, our purpose is building a better working world. The insights and services we provide help to create long-term value for clients, people and society, and to build trust in the capital markets.

Press release

Scotland forecast revised upwards with GDP highest since pandemic

14 Aug 2024 EY UK

Two consecutive years of growth in new car registrations

05 Aug 2024 James White

UK economy had a strong start to 2024 with more GDP growth to come

23 Jul 2024 Rob Joyce

No results have been found

Recent Searches

How can you adapt your IPO strategy in a dynamic market?

The EY Global IPO Trends Q2 2024 covers the news and insights on the global, area and regional IPO markets for the first half of 2024. Learn more.

How can the moments that threaten your transformation define its success?

Leaders that put humans at the center to navigate turning points are 12 times more likely to significantly improve transformation performance. Learn More.

Artificial Intelligence

EY.ai - a unifying platform

Select your location

Financial statement close process assessment

What EY can do for you

With the insights gained from the EY financial statement close process assessment, you can move forward with more confidence in your close process. The financial report helps you understand whether, where and why mistakes are made or bottlenecks happen or extra effort is expended. It can also point you toward improvements in reliability, accuracy, speed and cycle time, and efficiency needed by the company you’re running today, or the one you expect to run tomorrow. Based on the assessment, our financial information findings can help you:  

• Compare current performance against leading practices
• Improve the quality of data captured through your closing process to limit the number of adjustments
• Identify improvements for reducing the number of days to close the books
• Help point the way to better content for KPIs, management reporting and dashboards
• Identify opportunities to reduce finance function costs

How the EY assessment works

Your EY audit teams can use a combination of qualitative and quantitative methods to evaluate your financial statement close process. We conduct the following five-step assessment and report our findings and recommendations back to you:

1. Benchmark analysis

Using an independent, high-quality database of metrics, our teams can evaluate your company’s financial statement close process performance against leading practices. 

2. Maturity assessment

Our maturity assessment tool allows you to self-assess the current performance for each of the key finance sub-processes (i.e., process and policy, reporting and management performance, organization, data, people and technology) as compared to leading practices and determine the expected future state.

3. Detailed review of the financial statement close process activities

For each key sub-process, our teams assess the quality of procedures in place and the execution timing and velocity; investigate risks and controls in place; and provide you with gap analyses, insights and recommendations. We can also review your current close process and identify issues that slow the process down. As a result, we can provide you with findings and recommendation that can help you spend less time producing financial reporting and achieve a more robust and well-documented process.

4. Review of dashboards, KPIs and monthly reporting packages

Our team assesses the quality and relevance of your dashboards, KPIs and monthly reporting packages. We review objectives, processes, computations and frequencies. Based on our review, we can provide improvement recommendations for your KPIs to harmonize with the other materials and for your dashboards and monthly reporting packages to increase their relevance and effectiveness.

5. Findings and recommendations report

This financial report includes all results of the diagnostic and also outlines findings and recommendations to help you build a more effective finance function.

Delivering enhanced value to your business

Sylvain Friedman

Our latest thinking.

The Board Imperative: Champion CROs to boost risk governance and growth

Boards can bolster resilience, seize new opportunities and create long-term value by collaborating with and further empowering their CRO. Learn more.

• Legal and privacy
• Modern slavery statement
• Connect with us
• Our locations
• Open Facebook profile
• Open X profile
• Open LinkedIn profile
• Open Youtube profile

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

Information

• Author Services

Initiatives

You are accessing a machine-readable page. In order to be human-readable, please install an RSS reader.

All articles published by MDPI are made immediately available worldwide under an open access license. No special permission is required to reuse all or part of the article published by MDPI, including figures and tables. For articles published under an open access Creative Common CC BY license, any part of the article may be reused without permission provided that the original article is clearly cited. For more information, please refer to https://www.mdpi.com/openaccess .

Feature papers represent the most advanced research with significant potential for high impact in the field. A Feature Paper should be a substantial original Article that involves several techniques or approaches, provides an outlook for future research directions and describes possible research applications.

Feature papers are submitted upon individual invitation or recommendation by the scientific editors and must receive positive feedback from the reviewers.

Editor’s Choice articles are based on recommendations by the scientific editors of MDPI journals from around the world. Editors select a small number of articles recently published in the journal that they believe will be particularly interesting to readers, or important in the respective research area. The aim is to provide a snapshot of some of the most exciting work published in the various research areas of the journal.

Original Submission Date Received: .

• Active Journals
• Find a Journal
• Proceedings Series
• For Authors
• For Reviewers
• For Editors
• For Librarians
• For Publishers
• For Societies
• For Conference Organizers
• Open Access Policy
• Institutional Open Access Program
• Special Issues Guidelines
• Editorial Process
• Research and Publication Ethics
• Article Processing Charges
• Testimonials
• Preprints.org
• SciProfiles
• Encyclopedia

Article Menu

• Subscribe SciFeed
• Recommended Articles
• Google Scholar
• on Google Scholar
• Table of Contents

Find support for a specific problem in the support section of our website.

Please let us know what you think of our products and services.

Visit our dedicated information section to learn more about MDPI.

JSmol Viewer

Financial and esg analysis of the beer sector pre- and post-covid-19 in italy and spain, 1. introduction, 2. literature review, 3.1. financial ratios, 3.2. web communication of non-financial environmental, social, and governance indicators, 5. discussion, 6. conclusions, author contributions, institutional review board statement, informed consent statement, data availability statement, conflicts of interest.

• Amat Salas, O. Caso práctico de utilización de ratios para la detección de fraudes contables. Téc. Contab. Financ. 2020 , 33 , 98–105. [ Google Scholar ]
• Cowen, S.S.; Hoffer, J.A. Usefulness of financial ratios in a single industry. J. Bus. Res. 1982 , 10 , 103–118. [ Google Scholar ] [ CrossRef ]
• Deakin, E.B. Distributions of financial accounting ratios: Some empirical evidence. Account. Rev. 1976 , 51 , 90–96. Available online: https://www.jstor.org/stable/245375 (accessed on 20 July 2024).
• Ezzamel, M.; Mar-Molinero, C. The distributional properties of financial ratios in UK manufacturing companies. J. Bus. Financ. Account. 1990 , 17 , 1–29. [ Google Scholar ] [ CrossRef ]
• Frecka, T.J.; Hopwood, W.S. The effects of outliers on the cross-sectional distributional properties of financial ratios. Account. Rev. 1983 , 58 , 115–128. [ Google Scholar ]
• Lev, B.; Sunder, S. Methodological issues in the use of financial ratios. J. Account. Econ. 1979 , 1 , 187–210. [ Google Scholar ] [ CrossRef ]
• Linares-Mustarós, S.; Farreras-Noguer, M.A.; Arimany-Serrat, N.; Coenders, G. New financial ratios based on the compositional data methodology. Axioms 2022 , 11 , 694. [ Google Scholar ] [ CrossRef ]
• Martikainen, T.; Perttunen, J.; Yli-Olli, P.; Gunasekaran, A. Financial ratio distribution irregularities: Implications for ratio classification. Eur. J. Oper. Res. 1995 , 80 , 34–44. [ Google Scholar ] [ CrossRef ]
• Mcleay, S.; Omar, A. The sensitivity of prediction models to the non-normality of bounded and unbounded financial ratios. Br. Account. Rev. 2000 , 32 , 213–230. [ Google Scholar ] [ CrossRef ]
• Watson, C.J. Multivariate distributional properties, outliers, and transformation of financial ratios. Account. Rev. 1990 , 65 , 682–695. Available online: https://www.jstor.org/stable/247957 (accessed on 20 July 2024).
• Aitchison, J. The Statistical Analysis of Compositional Data. Monographs on Statistics and Applied Probability ; Chapman and Hall: London, UK, 1986. [ Google Scholar ]
• Egozcue, J.J.; Pawlowsky-Glahn, V. Compositional data: The sample space and its structure. TEST 2019 , 28 , 599–638. [ Google Scholar ] [ CrossRef ]
• Greenacre, M. Compositional data analysis. Annu. Rev. Stat. Its Appl. 2021 , 8 , 271–299. [ Google Scholar ] [ CrossRef ]
• Pawlowsky-Glahn, V.; Egozcue, J.J.; Tolosana-Delgado, R. Modeling and Analysis of Compositional Data ; Wiley: Chichester, UK, 2015. [ Google Scholar ]
• Coenders, G.; Ferrer-Rosell, B. Compositional data analysis in tourism. Review and future directions. Tour. Anal. 2020 , 25 , 153–168. [ Google Scholar ] [ CrossRef ]
• Martinez-Garcia, A.; Horrach-Rosselló, P.; Mulet-Forteza, C. Mapping the intellectual and conceptual structure of research on CoDa in the “Social Sciences” scientific domain. A bibliometric overview. J. Geochem. Explor. 2023 , 252 , 107273. [ Google Scholar ] [ CrossRef ]
• Arimany-Serrat, N.; Farreras-Noguer, M.À.; Coenders, G. New developments in financial statement analysis. Liquidity in the winery sector. Accounting 2022 , 8 , 355–366. [ Google Scholar ] [ CrossRef ]
• Arimany-Serrat, N.; Farreras-Noguer, M.À.; Coenders, G. Financial resilience of Spanish wineries during the COVID-19 lockdown. Int. J. Wine Bus. Res. 2023 , 35 , 346–364. [ Google Scholar ] [ CrossRef ]
• Carreras-Simó, M.; Coenders, G. Principal component analysis of financial statements. A compositional approach. Rev. Mét. Cuantit. Econ. Empres. 2020 , 29 , 18–37. [ Google Scholar ] [ CrossRef ]
• Carreras Simó, M.; Coenders, G. The relationship between asset and capital structure: A compositional approach with panel vector autoregressive models. Quant. Financ. Econ. 2021 , 5 , 571–590. [ Google Scholar ] [ CrossRef ]
• Coenders, G. Application aux ratios financiers. In Données de Composition ; Gégout-Petit, A., Bertrand, F., Thomas-Agnan, C., Eds.; Société Française de Statistique/Éditions TECHNIP: Paris, France, 2024. [ Google Scholar ]
• Creixans-Tenas, J.; Coenders, G.; Arimany-Serrat, N. Corporate social responsibility and financial profile of Spanish private hospitals. Heliyon 2019 , 5 , e02623. [ Google Scholar ] [ CrossRef ]
• Jofre-Campuzano, P.; Coenders, G. Compositional classification of financial statement profiles: The weighted case. J. Risk Finan. Manag. 2022 , 15 , 546. [ Google Scholar ] [ CrossRef ]
• Linares-Mustarós, S.; Coenders, G.; Vives-Mestres, M. Financial performance and distress profiles. From classification according to financial ratios to compositional classification. Adv. Account. 2018 , 40 , 1–10. [ Google Scholar ] [ CrossRef ]
• Saus-Sala, E.; Farreras-Noguer, M.À.; Arimany-Serrat, N.; Coenders, G. Compositional DuPont analysis. A visual tool for strategic financial performance assessment. In Advances in Compositional Data Analysis ; Filzmoser, P., Hron, K., Martín-Fernández, J.A., Palarea-Albaladejo, J., Eds.; Springer: Cham, Switzerland, 2021; pp. 189–206. [ Google Scholar ]
• Saus-Sala, E.; Farreras-Noguer, M.À.; Arimany-Serrat, N.; Coenders, G. Analysis of rural tourism companies in Catalonia and Galicia: Profitability and solvency 2014—2018. Cuad. Del C. 2023 , 25 , 33–54. [ Google Scholar ]
• Saus Sala, E.; Farreras Noguer, M.À.; Arimany Serrat, N.; Coenders, G. Financial analysis of rural tourism in Catalonia and Galicia pre- and post COVID-19. Int. J. Tour. Res. 2024 , 26 , e2698. [ Google Scholar ] [ CrossRef ]
• Arimany-Serrat, N.; Coenders, G. Biodiversity and accounting: Compositional methodology in the accounting statement analysis of the beekeeping industry. Agric. Resour. Econ. 2025 , 1–25. [ Google Scholar ]
• Danson, M.; Galloway, L.; Cabras, I.; Beatty, T. Microbrewing and entrepreneurship: The origins, development and integration of real ale breweries in the UK. Int. J. Entrep. Innov. 2015 , 16 , 135–144. [ Google Scholar ] [ CrossRef ]
• Esposti, R.; Fastigi, M.; Viganò, E. Italian craft beer revolution: Do spatial factors matter? J. Small Bus. Enterp. Dev. 2017 , 24 , 503–527. [ Google Scholar ] [ CrossRef ]
• Cabras, I.; Higgins, D. Beer, brewing, and business history. Bus. Hist. 2016 , 58 , 609–624. [ Google Scholar ] [ CrossRef ]
• Carroll, G.R. Concentration and specialization: Dynamics of niche width in populations of organizations. Am. J. Sociol. 1985 , 90 , 1262–1283. [ Google Scholar ] [ CrossRef ]
• Alfaro, M. Beer leaders against craft brewers: Will Goliath end up defeating David in the US? Appl. Econ. 2022 , 54 , 554–567. [ Google Scholar ] [ CrossRef ]
• Tremblay, V.J.; Iwasaki, N.; Tremblay, C.H. The dynamics of industry concentration for US micro and macro brewers. Rev. Ind. Organ. 2005 , 26 , 307–324. [ Google Scholar ] [ CrossRef ]
• Garavaglia, C.; Swinnen, J. Economics of the craft beer revolution: A comparative international perspective. In Economic Perspectives on Craft Beer. A Revolution in the Global Beer Industry ; Garavaglia, C., Swinnen, J., Eds.; Palgrave Macmillan: Cham, Switzerland, 2018; pp. 3–51. [ Google Scholar ] [ CrossRef ]
• Gao, D.; Zhou, X.; Wan, J. Unlocking sustainability potential: The impact of green finance reform on corporate ESG performance. Corp. Soc. Responsib. Environ. Manag. 2024 , 1–16. [ Google Scholar ] [ CrossRef ]
• Tan, L.; Gao, D.; Liu, X. Can Environmental Information Disclosure Improve Energy Efficiency in Manufacturing? Evidence from Chinese Enterprises. Energies 2024 , 17 , 2342. [ Google Scholar ] [ CrossRef ]
• Wesson, T.; Figueiredo, J.N. The importance of focus to market: A study of microbrewery performance. J. Bus. Ventur. 2001 , 16 , 377–403. [ Google Scholar ] [ CrossRef ]
• Weiss, B. Configuring the authentic value of real food: Farm-to-fork, snout-to-tail, and local food movements. Am. Ethnol. 2012 , 39 , 614–626. [ Google Scholar ] [ CrossRef ]
• Gatrell, J.; Reid, N.; Steiger, T.L. Branding spaces: Place, region, sustainability and the American craft beer industry. Appl. Geogr. 2018 , 90 , 360–370. [ Google Scholar ] [ CrossRef ]
• Duarte Alonso, A.; Bressan, A.; Sakellarios, N. A resource based approach in the context of the emerging craft brewing industry. Eur. Bus. Rev. 2016 , 28 , 560–582. [ Google Scholar ] [ CrossRef ]
• Garavaglia, C. The emergence of Italian craft breweries and the development of their local identity. In The Geography of Beer: Culture and Economics ; Hoalst-Pullen, N., Patterson, M., Eds.; Springer: Cham, Switzerland, 2020; pp. 135–147. [ Google Scholar ] [ CrossRef ]
• Hasman, J.; Hána, D.; Materna, K. Regional brands produced beyond the region: An analysis of beer brands from recently closed breweries in Europe. Morav. Geogr. Rep. 2021 , 29 , 168–183. [ Google Scholar ] [ CrossRef ]
• Schnell, S.M.; Reese, J.F. Microbreweries as tools of local identity. J. Cult. Geogr. 2003 , 21 , 45–69. [ Google Scholar ] [ CrossRef ]
• Swinnen, J. Beer consumption and trade in an era of economic growth and globalization. Choices 2017 , 32 , 1–6. [ Google Scholar ] [ CrossRef ]
• Wojtyra, B. How and why did craft breweries “revolutionise” the beer market? The case of Poland. Morav. Geogr. Rep. 2020 , 28 , 81–97. [ Google Scholar ] [ CrossRef ]
• Cabras, I. Beer on! The evolution of micro- and craft brewing in the UK. In Economic Perspectives on Craft Beer ; Garavaglia, C., Swinnen, J., Eds.; Palgrave Macmillan: Cham, Switzerland, 2018; pp. 373–396. [ Google Scholar ] [ CrossRef ]
• Garavaglia, C.; Borgoni, R. The local dimension of legitimation: An empirical analysis of firms’ entry in the Italian craft beer market. Reg. Stud. 2023 , 57 , 1909–1923. [ Google Scholar ] [ CrossRef ]
• Pitts, E.R.; Witrick, K. Brewery packaging in a post-COVID economy within the United States. Beverages 2021 , 7 , 14. [ Google Scholar ] [ CrossRef ]
• Yang, Y.; Liu, H.B.; Chen, X. COVID-19 and restaurant demand: Early effects of the pandemic and stay-at-home orders. Int. J. Contemp. Hosp. Manag. 2020 , 13 , 3809–3834. [ Google Scholar ] [ CrossRef ]
• Laguna, L.; Fiszman, S.; Puerta, P.; Chaya, C.; Tárrega, A. The impact of COVID-19 lockdown on food priorities. Results from a preliminary study using social media and an online survey with Spanish consumers. Food Qual. Prefer. 2020 , 86 , 104028. [ Google Scholar ] [ CrossRef ] [ PubMed ]
• Cabras, I.; Shakina, E.; Waehning, N.; Sohns, F.; Bosworth, G. Brewing at the time of COVID: The impact of the pandemic crisis on UK craft breweries and its implications for the sector and local economies. Reg. Stud. 2023 , 57 , 1937–1953. [ Google Scholar ] [ CrossRef ]
• Gordon-Wilson, S. An exploration of the substitutions of British pub consumers during the COVID-19 crisis. Int. J. Hosp. Manag. 2021 , 96 , 102998. [ Google Scholar ] [ CrossRef ]
• Nissen, C.T.N.; Bangerter, N.B.; Tran, L.; Bobke, M.T.; Awwad, M. Disinfectant shortage: A multicountry comparison of breweries and distilleries responses to the COVID-19 pandemic. In Proceedings of the 5th NA International Conference on Industrial Engineering and Operations Management, Detroit, MI, USA, 9–11 August 2020; Available online: http://www.ieomsociety.org/detroit2020/papers/77.pdf (accessed on 20 July 2024).
• Brewer, P.; Sebby, A.G. The effect of online restaurant menus on consumers’ purchase intentions during the COVID-19 pandemic. Int. J. Hosp. Manag. 2021 , 94 , 102777. [ Google Scholar ] [ CrossRef ]
• Enz, C.; Škodová-Parmová, D. Significance of digital communication channels for tourism providers in holiday regions. Deturope 2020 , 12 , 140–165. Available online: https://www.deturope.eu/contents/det/2020/02.pdf#page=141 (accessed on 20 July 2024). [ CrossRef ]
• Erhardt, N.; Martin-Rios, C.; Bolton, J.; Luth, M. Doing well by creating economic value through social values among craft beer breweries: A case study in responsible innovation and growth. Sustainability 2022 , 14 , 2826. [ Google Scholar ] [ CrossRef ]
• Jantyik, L.; Balogh, J.M.; Török, Á. What are the reasons behind the economic performance of the Hungarian beer industry? The case of the Hungarian microbreweries. Sustainability 2021 , 13 , 2829. [ Google Scholar ] [ CrossRef ]
• Zanotti, C.; Reyes, F.; Fernandez, B. Relationship between competitiveness and operational and financial performance of firms: An exploratory study on the European brewing industry. Intang. Cap. 2018 , 14 , 1–17. [ Google Scholar ] [ CrossRef ]
• Rossini, F.; Virga, G.; Loreti, P.; Iacuzzi, N.; Ruggeri, R.; Provenzano, M.E. Hops ( Humulus lupulus L.) as a novel multipurpose crop for the Mediterranean region of Europe: Challenges and opportunities of their cultivation. Agriculture 2021 , 11 , 484. [ Google Scholar ] [ CrossRef ]
• Bernetti, I.; Sottini, V.A.; Cipollaro, M.; Menghini, S. A survey on the performance of the Italian brewing companies. Ital. Rev. Agric. Econ. 2020 , 75 , 37–50. [ Google Scholar ] [ CrossRef ]
• Alvarez-Etxeberria, I.; Heras-Saizarbitoria, I.; Boiral, O. Academic research on sustainability reporting: A systematic review of the Spanish literature. Span. Account. Rev. 2023 , 26 , 59–78. [ Google Scholar ] [ CrossRef ]
• Hoalst-Pullen, N.; Patterson, M.; Mattord, R.; Vest, M. Sustainability trends in the regional craft beer industry. In The Geography of Beer: Regions, Environment, and Societies ; Patterson, M., Hoalst-Pullen, N., Eds.; Springer: Dordrecht, The Netherlands, 2014; pp. 109–116. [ Google Scholar ] [ CrossRef ]
• Sozen, E.; Rahman, I.; O’Neill, M. Craft breweries’ environmental proactivity: An upper echelons perspective. Int. J. Wine Bus. Res. 2022 , 34 , 237–256. [ Google Scholar ] [ CrossRef ]
• Ness, B. Beyond the pale (ale): An exploration of the sustainability priorities and innovative measures in the craft beer sector. Sustainability 2018 , 10 , 4108. [ Google Scholar ] [ CrossRef ]
• Stevens, S.S. On the theory of scales of measurement. Science 1946 , 103 , 677–680. [ Google Scholar ] [ CrossRef ]
• Thió-Henestrosa, S.; Martín-Fernández, J.A. Dealing with compositional data: The freeware CoDaPack. Math. Geol. 2005 , 37 , 773–793. [ Google Scholar ] [ CrossRef ]
• Dao, B.T.T.; Coenders, G.; Lai, P.H.; Dam, T.T.; Trinh, H.T. An empirical examination of financial performance and distress profiles during COVID-19: The case of fishery and food production firms in Vietnam. J. Financ. Report. Account. 2024; ahead-of-print . [ Google Scholar ] [ CrossRef ]
• Aitchison, J. Principal component analysis of compositional data. Biometrika 1983 , 70 , 57–65. [ Google Scholar ] [ CrossRef ]
• Kaufman, L.; Rousseeuw, P.J. Finding Groups in Data: An Introduction to Cluster Analysis ; Wiley: New York, NY, USA, 1990. [ Google Scholar ]
• Caliński, T.; Harabasz, J. A dendrite method for cluster analysis. Commun. Stat. Theory Methods 1974 , 3 , 1–27. [ Google Scholar ] [ CrossRef ]
• Coenders, G.; Arimany-Serrat, N. Accounting statement analysis at industry level. A gentle introduction to the compositional approach. arXiv 2023 , arXiv:2305.1684. [ Google Scholar ]

Click here to enlarge figure

	x	x	x /x	x /x
Company 1	27	27	1	1
Company 2	81	243	1/3	3
Company 3	9	3	3	1/3
Arithmetic average of the accounting figures	39	91
Geometric average of the accounting figures	27	27
Geometric average of ratios			1	1
Ratio between geometric averages			1	1
Arithmetic average of ratios			1.44444	1.44444
Ratio between arithmetic averages			0.42857	2.33333

	Spain			Italy
	2019	2020	2021	2019	2020	2021
x	0.2501	0.2241	0.1943	0.1485	0.2027	0.1978
x	0.1527	0.1470	0.1361	0.1697	0.1878	0.1950
x	0.1113	0.1057	0.0971	0.1164	0.1082	0.1229
x	0.2436	0.2500	0.2817	0.2805	0.2349	0.2404
x	0.2423	0.2732	0.2909	0.2849	0.2664	0.2439

	Spain			Italy
	2019	2020	2021	2019	2020	2021
s. t. Solvency	1.3716	1.3902	1.4022	1.4586	1.7351	1.5870
Current liabilities over assets	0.2764	0.2849	0.2937	0.3657	0.2772	0.3129
Margin	0.0053	−0.0929	−0.0326	−0.0159	−0.1344	−0.0146
Current-asset turnover	1.5947	1.7006	2.0698	1.6524	1.2508	1.2327
Turnover	0.6046	0.6736	0.8525	0.8814	0.6016	0.6120
ROA	0.0032	−0.0626	−0.0278	−0.0140	−0.0809	−0.0089
Asset structure	0.6209	0.6039	0.5881	0.4666	0.5191	0.5035

Cluster	1	2	3
n	99	102	84
s. t. Solvency	1.8026	2.0164	0.8996
Current liabilities over assets	0.1705	0.3238	0.5045
Margin	−0.0595	0.0435	−0.1578
Current-asset turnover	1.9095	1.6861	0.9125
Turnover	0.5869	1.1008	0.4141
ROA	−0.0349	0.0479	−0.0654
Asset structure	0.6926	0.3471	0.5462

	Italy	Spain
1. Energy consumption	14%	25%
2. Water consumption	7%	27%
3. Polluting emissions	6%	25%
4. Waste generation	7%	25%
5. Waste management	11%	30%
6. Waste reuse	13%	30%
7. Employees	3%	23%
8. Employee gender diversity	3%	18%
9. Employment stability	0%	3%
10. Absenteeism	1%	14%
11. Employee turnover	0%	10%
12. Net job creation	0%	7%
13. Seniority	0%	10%
14. Employee training	1%	18%
15. Customer payment cycles	0%	11%
16. Supplier payment cycles	0%	0%
17. Members of the board of directors	3%	14%
18. Independent board members	0%	0%
19. Board members with CSR responsibility	1%	3%
20. Executive commission	3%	14%
21. Audit committee	0%	0%
22. Board of directors’ appointments	1%	7%
23. Board of directors’ meetings	0%	7%
24. Remuneration of the board members	1%	0%
25. Gender diversity in the board members	0%	3%

The statements, opinions and data contained in all publications are solely those of the individual author(s) and contributor(s) and not of MDPI and/or the editor(s). MDPI and/or the editor(s) disclaim responsibility for any injury to people or property resulting from any ideas, methods, instructions or products referred to in the content.

Share and Cite

Arimany-Serrat, N.; Sgorla, A.F. Financial and ESG Analysis of the Beer Sector Pre- and Post-COVID-19 in Italy and Spain. Sustainability 2024 , 16 , 7412. https://doi.org/10.3390/su16177412

Arimany-Serrat N, Sgorla AF. Financial and ESG Analysis of the Beer Sector Pre- and Post-COVID-19 in Italy and Spain. Sustainability . 2024; 16(17):7412. https://doi.org/10.3390/su16177412

Arimany-Serrat, Núria, and Andrey Felipe Sgorla. 2024. "Financial and ESG Analysis of the Beer Sector Pre- and Post-COVID-19 in Italy and Spain" Sustainability 16, no. 17: 7412. https://doi.org/10.3390/su16177412

Article Metrics

Further information, mdpi initiatives, follow mdpi.

Subscribe to receive issue release notifications and newsletters from MDPI journals