Objectives of Financial Statement Analysis: Types, Advantages & More

Financial statement analysis can be important because it allows us to understand how a company is doing financially regarding its financial health, operational efficiency, and future vision. It can help determine whether a company is doing bad or good. This is based on tier-three analyses or balance sheets, income statements and cash flow statements, which provide a vivid financial view of the business. In this article, we’ll talk about financial statement analysis, its main goals, its importance, and how one should do it.

What is Financial Statement Analysis?

Financial analysis of performance deals with the probability associated with a firm’s financial situation and efficiency; it is possible to predict further company performance. For this analysis, you will look at two such analyses: a balance sheet, income statement, cash flow statement, asset, liability, shareholder’s equity, revenues, costs, and cash operating activities. Managers, shareholders and other stakeholders use financial statement analysis to assist in decision-making and action that will enhance the areas of profit, liquidities, solvency and operational efficiency. These methods are horizontal, vertical, ratio, common size absolute, and percentage trend analysis, which are used to quickly analyse where the company currently stands and predict trends.

• Analysing Financial Health

A balance sheet analysis of a company’s assets, liabilities and equity is used to assess a company’s ability to weather economic fluctuations and pay off short-term obligations.

• Evaluating Profitability

Analyse the statement of a company to determine how efficiently a company is generating profit. Cost management and profitability insights can be acquired through the main metrics, such as gross and net profit margins.

• Predicting Future Performance

When fitted with historical data, identify trends and forecast future financial performance. Trend analysis also helps predict potential future earnings and growth.

• Efficient Allocations of Resources

Financial ratios are used to identify areas for better utilisation. That ensures that funding is directed into the space where it’s most profitable and strategic, pushing up profitability.

• Finding ways to Identify Operational Efficiency

How good a company is at generating revenue with its allocated resources? Ratios like inventory turnover and asset utilisation help reform and improve processes.

• Assessing Risk Exposure

Measure a company’s capacity to control financial risk by analysing debt level, liquidity ratios, and cash flow movement. It allows for effective financial stability decisions; the earlier you can make those decisions, the better for you.

• Investment Opportunities Evaluation

Your concept is to analyse investors’ financial health and growth prospects to make informed investment decisions. To assess potential returns and risks, compare ratios to industry benchmarks.

• Supporting Strategic Planning

The company can use financial statement analysis to develop long-term strategies that help match its long-term plans with its finances and goals to achieve sustained growth.

• Ensuring Regulatory Compliance

Ensures financial statements align with accounting standards & regulations to keep stakeholders well-informed, reliable, and honest.

• Stakeholder Communication Enhancement

If you want to provide data-based insights to communicate how the company’s financial position and performance to stakeholders, it would help build trust and reinforce management’s credibility.

Also Read: Understanding the Importance of Financial Statements

Types of Financial Statement Analysis

• Horizontal Analysis

The horizontal analysis analyses the financial data covering several periods. This allows for identifying trends and changes in key financial metrics such as revenue and expenses over time.

• Vertical Analysis

Vertical analysis expresses each line item on a financial statement as a base item for the same period. This method indicates the importance of several components relative to others.

• Ratio Analysis

Financial ratios are calculated by ratio analysis, and particular items on the financial statements are compared. The three main ratios check a company’s financial health, liquidity, leverage, and profitability.

• Common Size Analysis

In common size analysis, a common base of each line item on a financial statement is shown as its share or percentage of the whole, typically revenue or assets. Therefore, comparing financial statements in different companies and periods is easy.

• Trend Analysis

We look at the financial data trajectory in trend analysis over several periods. This allows you to identify those patterns and changes in patterns to help you predict future financial performance.

• Industry Comparative Analysis

This type of analysis uses financial information from a company and benchmarks it against industry averages. It helps to see how the company performs compared to its competitors and its strengths and weaknesses.

• Qualitative Analysis

With qualitative analysis, quantitative data are supplemented with non-financial factors like management quality, market trends and industry dynamics. The reason is this approach will give a more holistic view of how a company is performing.

• Credit Analysis

Credit analysis evaluates a company’s ability to satisfy its debt obligations. This analysis is about betting based on cash flow, debt levels and financial stability to determine the company’s creditworthiness.

• Valuation Analysis

Valuation analysis identifies a firm’s stock or assets’ intrinsic or fundamental value. Investors who wish to buy or sell securities must have access to it.

• Scenario Analysis

Scenario analysis studies the result of different assumptions and various external factors. It gets the companies accustomed to different scenarios and their ramifications on economic performance.

Also Read: Types of Financial Statements

Advantages of Financial Statement Analysis

Improved Decision Making

Financial statement analysis is a general view of the company’s financial position by which management, investors and creditors can make informed decisions. This can be used successfully to make resource allocation decisions or evaluate investment potential based on strategic choices.

Identifies Financial Health

The business’s financial statements can be reviewed to see if the business is profitable, liquid, viable, and solvent. It helps them know how much they spend, what they spend, and what they need to do to shore up the weaknesses in their financial profile.

Trend Identification

Financial statement analysis can determine trends over time. Financial data is compared to a business’s performance to establish positive and negative patterns and forecast future performance.

Cost Management

When you look at financial statements, you can realise that you can reduce or minimise costs. This means better operations and more profits.

Enhanced Risk Management

Testing debt levels, cash flow trends and even liquidity ratios helps businesses discover potential risks to their long-term stability and fend them off ahead of time.

Benchmarking

Your study can compare a company’s financial performance against industry standards or competitors to gauge their strengths and weaknesses. It will help a business know its position in the market and where it can improve.

Investor Confidence

When financial statement analysis is present, financial statement analysis is present. Investors will be more likely to fund you if you put up financial reports that are clear and easy to understand.

Regulatory Compliance

This analysis regulates the application of accounting standards and regulations of financial statements. Moreover, compliance ensures credibility and is safe from any legal problems.

Strategic Planning

Financial statement analysis can aid strategic planning by providing information about financial performance to allow a business to match strategies to its financial capabilities and long-term goals.

Financial Forecasting is supported

Historical data and financial trends help businesses better understand what will happen in the future and what is needed to grow, expand, move relief forces, etc.

Also Read: Understanding the Core Objectives of Financial Statements

Real-World Applications of Financial Statement Analysis

• Investment Decision-Making

Financial statement analysis assists investment strategies by allowing you to recognise profitable opportunities. Think of a company that desires to expand. Then, the financial statement should be examined to understand how much revenue is increasing, how profitable its margins are, and how the cash flow is in these potential markets.

• Risk assessment under Credit Analysis

Financial institutions use financial statement analysis to determine a borrower’s creditworthiness. Liquidity ratios, debt level, and cash flow trends become interesting to lenders as they can determine how much a company can repay a loan.

Conclusion

Stakeholders can use financial statement analysis to determine how well a company is financially profitable and its prospects. A wide range of such methods, viz. horizontal and vertical ratio analysis, provide clear insights to help you make informed decisions. Financial statement analysis is a business world issue, and it must be clear whether you are a manager, an investor, or a creditor to understand the problems of the business world. Being updated on your finances is a must when you are a working professional, and if finance is your bread and butter then you must learn about finances. To help you with that Hero Vired has brought you this Certificate Program in Financial Analysis, Valuation, & Risk Management With EdX.