Financial statements are a set of reports that provide information about a company’s financial performance and position. The three main financial statements are the income statement, balance sheet, and cash flow statement.
The income statement, also known as the profit and loss statement, shows a company’s revenues and expenses over a specific period of time, and provides information about the company’s profitability.
The balance sheet shows a company’s assets, liabilities, and equity at a specific point in time, and provides information about the company’s financial position.
The cash flow statement shows the inflows and outflows of cash for a specific period of time and provides information about a company’s liquidity.
Financial statement analysis is the process of evaluating a company’s financial statements to gain insight into the company’s financial performance and position. This can be done by analyzing the relationships between different financial statement elements, such as analyzing a company’s profitability by looking at its income statement, or by comparing a company’s financial statements to those of similar companies in the same industry.
Overall, financial statement analysis is useful for investors, creditors, and company management to assess the financial stability and performance of a company.
Importance of Financial Statement
There are several reasons why financial statements are important:
- Decision making: Financial statements provide information that is crucial for making informed decisions. For example, investors use financial statements to determine whether to invest in a company, while creditors use them to decide whether to lend money to a company.
- Performance evaluation: Financial statements allow companies to evaluate their performance over a specific period of time. For example, by comparing the income statement of a company from one year to the next, management can determine whether the company has improved its profitability.
- Compliance: Financial statements are often required by laws and regulations. For example, publicly traded companies are required to file financial statements with the Securities and Exchange Commission (SEC) on a regular basis.
- Transparency: Financial statements provide transparency about a company’s financial position and performance. This is important for building and maintaining the trust of investors, creditors, and other stakeholders.
- Benchmarking: Financial statements allow companies to compare their performance to that of similar companies in the same industry. This can help management identify areas where the company is doing well, as well as areas where improvement is needed.
- Forecasting: Financial statements can be used to forecast future financial performance and position of a company.
Overall, financial statements play a vital role in providing information that is necessary for companies to operate effectively and make informed decisions.
Points of Financial Statement and Analysis
The points that are typically covered in a financial statement analysis include:
- Income statement: This shows a company’s revenues and expenses over a specific period of time and provides information about the company’s profitability. Analysis of the income statement will typically include looking at the company’s net income, gross profit margin, and operating income.
- Balance sheet: This shows a company’s assets, liabilities, and equity at a specific point in time, and provides information about the company’s financial position. Analysis of the balance sheet will typically include looking at the company’s liquidity, leverage, and working capital.
- Cash flow statement: This shows the inflows and outflows of cash for a specific period of time and provides information about a company’s liquidity. Analysis of the cash flow statement will typically include looking at the company’s cash flow from operating activities, investing activities, and financing activities.
- Ratios: Financial statement analysis often includes calculating financial ratios, such as the current ratio, quick ratio, and debt-to-equity ratio, to gain insight into a company’s financial performance and position.
- Trends: Analysis of financial statements also often includes looking at trends over time, such as changes in revenue or net income from one year to the next.
- Comparisons: Financial statement analysis may also include comparisons to industry averages or to the financial statements of similar companies.
- Forecasting: Financial statement analysis often includes forecasting future financial performance and position of a company, by analyzing historical financial data and trends.
- Other non-financial statement analysis: Other analysis that are not directly related to financial statements, such as market analysis, competitor analysis, and SWOT analysis can be used to gain a more comprehensive understanding of a company’s overall performance.
Overall, financial statement analysis provides a thorough and detailed understanding of a company’s financial performance and position, which is valuable for investors, creditors, and company management to make informed decisions.
