Tools of financial statement analysis are a core part of every sector, be it finance or the study of something; without proper research, one cannot derive a conclusion. The same applies to financial markets; traders take into account several parameters before they invest.
These parameters are financial statement analysis, accounts, brand image, market holding, industry type, averages, etc. However, with this article, we’ll be focusing on one most significant analysis factor, the financial statement analysis.
Tools of financial statement analysis are many and could be used by traders to have clear market knowledge and understanding. So, let’s begin and know what all tools could be used for financial statement analysis.
Tools of Financial Statement Analysis
Financial statement analysis is done by the traders or companies in order to understand the health of the organisation. It is a procedure that involves going through the documents, having comparative financial statements, and evaluating them to have an essence of the industry and its operations.
Interested parties can refer to the financial statement analysis as a great tool for study. To support and help such investors and traders, we have mentioned the necessary tools of financial statements. These tools include:
- Ratio analysis
- Cash flow statement
- Trend analysis
- Income statement
- Comparative statements
- Common size statements
- Fund flow statement
- Cost volume profit analysis
- Average analysis
Here, we’ll be talking about each of these to have a detailed knowledge of the analysis of financial statements and manage market trading perfectly well. So, let’s begin with the analysis.
Ratio analysis is the main tool of financial statement analysis that characterizes the association of balance sheets and profit and loss statements. It is a quantitative analysis technique that establishes a relation between two or more items of financial statements over a period of time.
These items could be balance sheets, income statements, or cash flow statements which assist traders to analyse the operations of the firm and its financial performance in the market.
To have informed decisions that ensure profitability for the management, the factors of solvency, profitability, liquidity, and efficiency are vital.
The ratio analysis gives a comparative study of the listed aspects and helps users make decisions.
It has several kinds of ratios that could help users shape their investments; some of the most commonly used ratios are:
- Liquidity ratios
- Solvency ratio
- Coverage of cost or interest
- Component and turnover comparisons
Cash Flow Statement
Cash flow analysis is the examination of the cash movements in the company’s financial working. How much cash flow was there in the company gives a brief idea of the operations, profits, and loss, money flowed in and out of the company, and the financial position.
The cash that flows in of the concerned firm is called cash inflow or positive cash flow analysis. While the cash that flows out is called negative cash flow or cash outflow. Traders can have notional and actual cash flow statements.
The difference between inflow and outflow gives net cash flow analysis and is an important analytical tool for giving the reason for the change in cash.
Trend analysis is a technical tool for financial statements where ratios of different periods are taken and compared with the analysis. Users of the statement get an idea of the firm’s progress, whether it’s moving upwards or downwards.
The past workings of the company decide its future course of action and what will be its position. It uses historical data to analyze the future and thus is a mathematical technique. It has a proper period of analysis defined and accordingly helps in making decisions.
Thus, a meaningful tool for users of the financial statement and helps in having better market conclusions.
Income statements or profit and loss accounts are part of the financial statements that help in analyzing the revenue and expenses during a specified period. The statement analysis the profits and how these are transformed into net income for the company.
The purpose of the statement is to show the managers and investors whether the firm made money or not. It is different from the balance sheet as it shows price movement for a while, but the income statement is for a set duration.
The statements of a company for different periods of time are called comparative financial statements. Users of the statement analysis have to take into account various financial statement analyses to get a comparative statement analysis.
It may be in a table form or any other preferred by the company to have a comparative analysis of the various market items concerning the firm. Thus, a comparative view of different market parameters to depict the financial position and profitability.
The most vital part of the tools of financial statement analysis is a comparative balance sheet and the profit and loss account. Users can know the operating outcomes of the firm and help to understand the market trends.
It is also called horizontal analysis and usually is for the comparison of financial information for two or more periods.
Common Size Statements
Common size statements have a direct impact on the financial stability of a company. Analyzing financial statements are an essential tool of financial statement analysis and could give a picture of the company in the market.
The statement is also referred to as a common-size income statement as it covers income earned with financial statement data. It depicts each item as a percentage of the common item and allows the analysts to have financial and operational attributes for comparison.
It is a vertical analysis and takes total assets and liabilities or sales as 100 and compares the balance items to the total assets, total liabilities, and sales in percentage form. Common size statements include common-size balance sheets, common-size income statements, and common-size cash flow analysis.
Cover each of the mentioned parameters of the company and use the net sales of the company to get the results. These are used in the formula to get the percentage relation and have accurate data to invest in the company.
Fund Flow Statement
We have seen horizontal analysis and vertical analysis, but in this one, more analysis is added called fund flow analysis. Without a fund flow statement, users cannot use the financial statement analysis.
It is the tool of the financial statement analysis and shows the finance of the company being formulated. The statement is like a summary of the sources and utilization of the funds allocated.
The statement analysis gives a brief of the company’s financial health by evaluating the changes in working capital within the specified time period.
There are types of fund flow statements:
- Internal analysis
- External analysis
- Horizontal analysis
- Vertical analysis
Cost Volume Profit Analysis
Cost volume profit analysis is the financial statement that is used for analyzing the relationship of sales, cost, and profit. With these three things, users get an idea of the firm’s position in the market and actual movement.
The cost in this analysis is divided into two, fixed and variable costs. Sales and variable costs have a constant relationship that could assist users to get the costs and profit volume.
Cost analysis by the users guides them to manage their costs and have better profit planning.
Benchmarking is the procedure of comparing the actual gains with the targets set by the management team. Users can rely on this financial statement analysis as it takes best practices compared with the attempts to achieve the desired results.
It has the following steps to get it right:
- Selecting the area that needs optimization
- Identifying the trigger points to compare
- Have standards or industrial standards for benchmark
- Evaluate the performance with trigger points
- Analyse whether achieved or not
- Strive to have a better benchmark
The users can have ratio analysis, margin matrix, gross profit, financial position, financial data, net profit, current assets, current liabilities, interest expense, profit margin, and other absolute figures to set the benchmark.
The trend ratios of the company are always compared with the industry average and are important for business firms. These could be studies over charts or graphs to understand the curves and market trends followed.
This presentation of the data on the graphs gives a comprehensive view of the market growth of the firm. It’s an excellent tool for traders or users to have a brief picture of the company’s financial statement.
Tools of financial statement analysis are a good source of getting a comparative analysis of the company or business. Users can analyse the working, operating profit, cash equivalents, balance sheet items, and all other items impacting the company’s performance.
The article has considered all the significant aspects of the tool of financial statement analysis. These tools are highly essential to analyse the performance and growth of the company. We have taken ratios analysis, comparative statements, common-size statements, etc., to get financial analysis.
Users can take these tools mentioned and have better investment decisions made with the best brokers available in the market such as InvestBy. Happy Trading!