A | Financial Statement Analysis

Financial statement analysis.

Financial statement analysis reviews financial information found on financial statements to make informed decisions about the business. The income statement, statement of retained earnings, balance sheet, and statement of cash flows, among other financial information, can be analyzed. The information obtained from this analysis can benefit decision-making for internal and external stakeholders and can give a company valuable information on overall performance and specific areas for improvement. The analysis can help them with budgeting, deciding where to cut costs, how to increase revenues, and future capital investments opportunities.

When considering the outcomes from analysis, it is important for a company to understand that data produced needs to be compared to others within industry and close competitors. The company should also consider their past experience and how it corresponds to current and future performance expectations. Three common analysis tools are used for decision-making; horizontal analysis, vertical analysis, and financial ratios.

For our discussion of financial statement analysis, we will use Banyan Goods. Banyan Goods is a merchandising company that sells a variety of products. The image below shows the comparative income statements and balance sheets for the past two years.

Keep in mind that the comparative income statements and balance sheets for Banyan Goods are simplified for our calculations and do not fully represent all the accounts a company could maintain. Let’s begin our analysis discussion by looking at horizontal analysis.

Horizontal Analysis

Horizontal analysis (also known as trend analysis) looks at trends over time on various financial statement line items. A company will look at one period (usually a year) and compare it to another period. For example, a company may compare sales from their current year to sales from the prior year. The trending of items on these financial statements can give a company valuable information on overall performance and specific areas for improvement. It is most valuable to do horizontal analysis for information over multiple periods to see how change is occurring for each line item. If multiple periods are not used, it can be difficult to identify a trend. The year being used for comparison purposes is called the base year (usually the prior period). The year of comparison for horizontal analysis is analyzed for dollar and percent changes against the base year.

The dollar change is found by taking the dollar amount in the base year and subtracting that from the year of analysis.

Using Banyan Goods as our example, if Banyan wanted to compare net sales in the current year (year of analysis) of $120,000 to the prior year (base year) of $100,000, the dollar change would be as follows:

The percentage change is found by taking the dollar change, dividing by the base year amount, and then multiplying by 100.

Let’s compute the percentage change for Banyan Goods’ net sales.

This means Banyan Goods saw an increase of $20,000 in net sales in the current year as compared to the prior year, which was a 20% increase. The same dollar change and percentage change calculations would be used for the income statement line items as well as the balance sheet line items. The image below shows the complete horizontal analysis of the income statement and balance sheet for Banyan Goods.

Depending on their expectations, Banyan Goods could make decisions to alter operations to produce expected outcomes. For example, Banyan saw a 50% accounts receivable increase from the prior year to the current year. If they were only expecting a 20% increase, they may need to explore this line item further to determine what caused this difference and how to correct it going forward. It could possibly be that they are extending credit more readily than anticipated or not collecting as rapidly on outstanding accounts receivable. The company will need to further examine this difference before deciding on a course of action. Another method of analysis Banyan might consider before making a decision is vertical analysis.

Vertical Analysis

Vertical analysis shows a comparison of a line item within a statement to another line item within that same statement. For example, a company may compare cash to total assets in the current year. This allows a company to see what percentage of cash (the comparison line item) makes up total assets (the other line item) during the period. This is different from horizontal analysis, which compares across years. Vertical analysis compares line items within a statement in the current year. This can help a business to know how much of one item is contributing to overall operations. For example, a company may want to know how much inventory contributes to total assets. They can then use this information to make business decisions such as preparing the budget, cutting costs, increasing revenues, or capital investments.

The company will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup. These percentages are considered common-size because they make businesses within industry comparable by taking out fluctuations for size. It is typical for an income statement to use net sales (or sales) as the comparison line item. This means net sales will be set at 100% and all other line items within the income statement will represent a percentage of net sales.

On the balance sheet, a company will typically look at two areas: (1) total assets, and (2) total liabilities and stockholders’ equity. Total assets will be set at 100% and all assets will represent a percentage of total assets. Total liabilities and stockholders’ equity will also be set at 100% and all line items within liabilities and equity will be represented as a percentage of total liabilities and stockholders’ equity. The line item set at 100% is considered the base amount and the comparison line item is considered the comparison amount. The formula to determine the common-size percentage is:

For example, if Banyan Goods set total assets as the base amount and wanted to see what percentage of total assets were made up of cash in the current year, the following calculation would occur.

Cash in the current year is $110,000 and total assets equal $250,000, giving a common-size percentage of 44%. If the company had an expected cash balance of 40% of total assets, they would be exceeding expectations. This may not be enough of a difference to make a change, but if they notice this deviates from industry standards, they may need to make adjustments, such as reducing the amount of cash on hand to reinvest in the business. The image below shows the common-size calculations on the comparative income statements and comparative balance sheets for Banyan Goods.

Even though vertical analysis is a statement comparison within the same year, Banyan can use information from the prior year’s vertical analysis to make sure the business is operating as expected. For example, unearned revenues increased from the prior year to the current year and made up a larger portion of total liabilities and stockholders’ equity. This could be due to many factors, and Banyan Goods will need to examine this further to see why this change has occurred. Let’s turn to financial statement analysis using financial ratios.

Overview of Financial Ratios

Financial ratios help both internal and external users of information make informed decisions about a company. A stakeholder could be looking to invest, become a supplier, make a loan, or alter internal operations, among other things, based in part on the outcomes of ratio analysis. The information resulting from ratio analysis can be used to examine trends in performance, establish benchmarks for success, set budget expectations, and compare industry competitors. There are four main categories of ratios: liquidity, solvency, efficiency, and profitability. Note that while there are more ideal outcomes for some ratios, the industry in which the business operates can change the influence each of these outcomes has over stakeholder decisions. (You will learn more about ratios, industry standards, and ratio interpretation in advanced accounting courses.)

Liquidity Ratios

Liquidity ratios show the ability of the company to pay short-term obligations if they came due immediately with assets that can be quickly converted to cash. This is done by comparing current assets to current liabilities. Lenders, for example, may consider the outcomes of liquidity ratios when deciding whether to extend a loan to a company. A company would like to be liquid enough to manage any currently due obligations but not too liquid where they may not be effectively investing in growth opportunities. Three common liquidity measurements are working capital, current ratio, and quick ratio.

Working Capital

Working capital measures the financial health of an organization in the short-term by finding the difference between current assets and current liabilities. A company will need enough current assets to cover current liabilities; otherwise, they may not be able to continue operations in the future. Before a lender extends credit, they will review the working capital of the company to see if the company can meet their obligations. A larger difference signals that a company can cover their short-term debts and a lender may be more willing to extend the loan. On the other hand, too large of a difference may indicate that the company may not be correctly using their assets to grow the business. The formula for working capital is:

Using Banyan Goods, working capital is computed as follows for the current year:

In this case, current assets were $200,000, and current liabilities were $100,000. Current assets were far greater than current liabilities for Banyan Goods and they would easily be able to cover short-term debt.

The dollar value of the difference for working capital is limited given company size and scope. It is most useful to convert this information to a ratio to determine the company’s current financial health. This ratio is the current ratio.

Current Ratio

Working capital expressed as a ratio is the current ratio. The current ratio considers the amount of current assets available to cover current liabilities. The higher the current ratio, the more likely the company can cover its short-term debt. The formula for current ratio is:

The current ratio in the current year for Banyan Goods is:

A 2:1 ratio means the company has twice as many current assets as current liabilities; typically, this would be plenty to cover obligations. This may be an acceptable ratio for Banyan Goods, but if it is too high, they may want to consider using those assets in a different way to grow the company.

Quick Ratio

The quick ratio, also known as the acid-test ratio, is similar to the current ratio except current assets are more narrowly defined as the most liquid assets, which exclude inventory and prepaid expenses. The conversion of inventory and prepaid expenses to cash can sometimes take more time than the liquidation of other current assets. A company will want to know what they have on hand and can use quickly if an immediate obligation is due. The formula for the quick ratio is:

The quick ratio for Banyan Goods in the current year is:

A 1.6:1 ratio means the company has enough quick assets to cover current liabilities.

Another category of financial measurement uses solvency ratios.

Solvency Ratios

Solvency implies that a company can meet its long-term obligations and will likely stay in business in the future. To stay in business the company must generate more revenue than debt in the long-term. Meeting long-term obligations includes the ability to pay any interest incurred on long-term debt. Two main solvency ratios are the debt-to-equity ratio and the times interest earned ratio.

Debt to Equity Ratio

The debt-to-equity ratio shows the relationship between debt and equity as it relates to business financing. A company can take out loans, issue stock, and retain earnings to be used in future periods to keep operations running. It is less risky and less costly to use equity sources for financing as compared to debt resources. This is mainly due to interest expense repayment that a loan carries as opposed to equity, which does not have this requirement. Therefore, a company wants to know how much debt and equity contribute to its financing. Ideally, a company would prefer more equity than debt financing. The formula for the debt to equity ratio is:

The information needed to compute the debt-to-equity ratio for Banyan Goods in the current year can be found on the balance sheet.

This means that for every $1 of equity contributed toward financing, $1.50 is contributed from lenders. This would be a concern for Banyan Goods. This could be a red flag for potential investors that the company could be trending toward insolvency. Banyan Goods might want to get the ratio below 1:1 to improve their long-term business viability.

Times Interest Earned Ratio

Time interest earned measures the company’s ability to pay interest expense on long-term debt incurred. This ability to pay is determined by the available earnings before interest and taxes (EBIT) are deducted. These earnings are considered the operating income. Lenders will pay attention to this ratio before extending credit. The more times over a company can cover interest, the more likely a lender will extend long-term credit. The formula for times interest earned is:

The information needed to compute times interest earned for Banyan Goods in the current year can be found on the income statement.

The $43,000 is the operating income, representing earnings before interest and taxes. The 21.5 times outcome suggests that Banyan Goods can easily repay interest on an outstanding loan and creditors would have little risk that Banyan Goods would be unable to pay.

Another category of financial measurement uses efficiency ratios.

Efficiency Ratios

Efficiency shows how well a company uses and manages their assets. Areas of importance with efficiency are management of sales, accounts receivable, and inventory. A company that is efficient typically will be able to generate revenues quickly using the assets it acquires. Let’s examine four efficiency ratios: accounts receivable turnover, total asset turnover, inventory turnover, and days’ sales in inventory.

Accounts Receivable Turnover

Accounts receivable turnover measures how many times in a period (usually a year) a company will collect cash from accounts receivable. A higher number of times could mean cash is collected more quickly and that credit customers are of high quality. A higher number is usually preferable because the cash collected can be reinvested in the business at a quicker rate. A lower number of times could mean cash is collected slowly on these accounts and customers may not be properly qualified to accept the debt. The formula for accounts receivable turnover is:

Many companies do not split credit and cash sales, in which case net sales would be used to compute accounts receivable turnover. Average accounts receivable is found by dividing the sum of beginning and ending accounts receivable balances found on the balance sheet. The beginning accounts receivable balance in the current year is taken from the ending accounts receivable balance in the prior year.

When computing the accounts receivable turnover for Banyan Goods, let’s assume net credit sales make up $100,000 of the $120,000 of the net sales found on the income statement in the current year.

An accounts receivable turnover of four times per year may be low for Banyan Goods. Given this outcome, they may want to consider stricter credit lending practices to make sure credit customers are of a higher quality. They may also need to be more aggressive with collecting any outstanding accounts.

Total Asset Turnover

Total asset turnover measures the ability of a company to use their assets to generate revenues. A company would like to use as few assets as possible to generate the most net sales. Therefore, a higher total asset turnover means the company is using their assets very efficiently to produce net sales. The formula for total asset turnover is:

Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year.

Banyan Goods’ total asset turnover is:

The outcome of 0.53 means that for every $1 of assets, $0.53 of net sales are generated. Over time, Banyan Goods would like to see this turnover ratio increase.

Inventory Turnover

Inventory turnover measures how many times during the year a company has sold and replaced inventory. This can tell a company how well inventory is managed. A higher ratio is preferable; however, an extremely high turnover may mean that the company does not have enough inventory available to meet demand. A low turnover may mean the company has too much supply of inventory on hand. The formula for inventory turnover is:

Cost of goods sold for the current year is found on the income statement. Average inventory is found by dividing the sum of beginning and ending inventory balances found on the balance sheet. The beginning inventory balance in the current year is taken from the ending inventory balance in the prior year.

Banyan Goods’ inventory turnover is:

1.6 times is a very low turnover rate for Banyan Goods. This may mean the company is maintaining too high an inventory supply to meet a low demand from customers. They may want to decrease their on-hand inventory to free up more liquid assets to use in other ways.

Days’ Sales in Inventory

Days’ sales in inventory expresses the number of days it takes a company to turn inventory into sales. This assumes that no new purchase of inventory occurred within that time period. The fewer the number of days, the more quickly the company can sell its inventory. The higher the number of days, the longer it takes to sell its inventory. The formula for days’ sales in inventory is:

Banyan Goods’ days’ sales in inventory is:

243 days is a long time to sell inventory. While industry dictates what is an acceptable number of days to sell inventory, 243 days is unsustainable long-term. Banyan Goods will need to better manage their inventory and sales strategies to move inventory more quickly.

The last category of financial measurement examines profitability ratios.

Profitability Ratios

Profitability considers how well a company produces returns given their operational performance. The company needs to leverage its operations to increase profit. To assist with profit goal attainment, company revenues need to outweigh expenses. Let’s consider three profitability measurements and ratios: profit margin, return on total assets, and return on equity.

Profit Margin

Profit margin represents how much of sales revenue has translated into income. This ratio shows how much of each $1 of sales is returned as profit. The larger the ratio figure (the closer it gets to 1), the more of each sales dollar is returned as profit. The portion of the sales dollar not returned as profit goes toward expenses. The formula for profit margin is:

For Banyan Goods, the profit margin in the current year is:

This means that for every dollar of sales, $0.29 returns as profit. If Banyan Goods thinks this is too low, the company would try and find ways to reduce expenses and increase sales.

Return on Total Assets

The return on total assets measures the company’s ability to use its assets successfully to generate a profit. The higher the return (ratio outcome), the more profit is created from asset use. Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year. The formula for return on total assets is:

For Banyan Goods, the return on total assets for the current year is:

The higher the figure, the better the company is using its assets to create a profit. Industry standards can dictate what is an acceptable return.

Return on Equity

Return on equity measures the company’s ability to use its invested capital to generate income. The invested capital comes from stockholders investments in the company’s stock and its retained earnings and is leveraged to create profit. The higher the return, the better the company is doing at using its investments to yield a profit. The formula for return on equity is:

Average stockholders’ equity is found by dividing the sum of beginning and ending stockholders’ equity balances found on the balance sheet. The beginning stockholders’ equity balance in the current year is taken from the ending stockholders’ equity balance in the prior year. Keep in mind that the net income is calculated after preferred dividends have been paid.

For Banyan Goods, we will use the net income figure and assume no preferred dividends have been paid. The return on equity for the current year is:

The higher the figure, the better the company is using its investments to create a profit. Industry standards can dictate what is an acceptable return.

Advantages and Disadvantages of Financial Statement Analysis

There are several advantages and disadvantages to financial statement analysis. Financial statement analysis can show trends over time, which can be helpful in making future business decisions. Converting information to percentages or ratios eliminates some of the disparity between competitor sizes and operating abilities, making it easier for stakeholders to make informed decisions. It can assist with understanding the makeup of current operations within the business, and which shifts need to occur internally to increase productivity.

A stakeholder needs to keep in mind that past performance does not always dictate future performance. Attention must be given to possible economic influences that could skew the numbers being analyzed, such as inflation or a recession. Additionally, the way a company reports information within accounts may change over time. For example, where and when certain transactions are recorded may shift, which may not be readily evident in the financial statements.

A company that wants to budget properly, control costs, increase revenues, and make long-term expenditure decisions may want to use financial statement analysis to guide future operations. As long as the company understands the limitations of the information provided, financial statement analysis is a good tool to predict growth and company financial strength.

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7.3: Financial Statement Analysis

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At this point, you have learned quite a bit about financial accounting. This includes the process of analyzing a wide variety of transactions, recording them in the journal, maintaining running account balances, and summarizing theinformation in the financial statements.

Businesses publish financial statements to communicate information about their operating performance and economic health. The income statement shows the profitability of a business by presenting its revenue and expenses for a period of time and summarizes its profitability in one final result: net income. The retained earnings statement reports all of the profit that a business has accumulated since it began operations. The balance sheet is a comprehensive summary report that lists a business’s assets, liabilities, owner investments, and accumulated profit. Examples of basic financial statements appear below.

Once the financial statements are available, the next step is to analyze them to gleen useful information about a corporation’s performance over time and its current financial health. These insights help business managers and investors make decisions about future courses of action. Areas of weakness may be identified and followed up with appropriate measures for improvement. Elements of strength should be reinforced and continued.

Much of this financial statement analysis is accomplished using ratios that reveal how one amount relates to another. One or more amounts are divided by other amount(s), yielding a decimal or percentage amount. However, no ratio is particularly meaningful by itself; it needs to be compared to something else, such as desired or expected results, previous results, other companies’ results, or industry standards. This comparison lets you know where you stand in terms of whether you are doing better, worse, or the same as what you have expected or hoped for.

Screen Shot 2020-06-17 at 7.19.54 PM.png

ANNUAL CHECK-UP

Many people visit a doctor annually for a check-up to evaluate their overall health. This often involves a physician looking, listening, poking, prodding, weighing, and conducting tests to assess the strength and wellness of multiple body parts and the status of vital signs and chemical levels.

The results may be positive in some areas and less so in others. One deficiency or ailment may impact the body as a whole. As weaknesses are uncovered, measures such as medication, procedures, exercise, diet changes, etc. may be prescribed to assist with recovery.

For example, if high cholesterol levels and excessive weight are discovered, lifestyle changes and medication may be recommended. At the following year’s visit, subsequent testing will reveal the progress made over time in these areas as well as other diagnostic results on that particular date. The goal is to continuously address deficiencies for improvement and to maintain positive outcomes on an ongoing basis.

A similar process is used for determining the operational and financial health of a corporation. The financial statements represent the current condition of an organization as a whole for a period of time. Probing, testing, and spot-checking efforts are conducted on a number of its parts to verify areas of strength and to pinpoint weaknesses. Action plans for improvement may then be prescribed to address substandard line items going forward.

7.3.1 Horizontal analysis

Important information can result from looking at changes in the same financial statement over time, both in terms of dollar amounts and percentage differences. Comparative financial statements place two years (or more) of the same statement side by side. A horizontal analysis involves noting the increases and decreases both in the amount and in the percentage of each line item. The earlier year is typically used as the base year for calculating increases or decreases in amounts.

Screen Shot 2020-06-17 at 7.23.32 PM.png

A horizontal analysis of a firm’s 2018 and 2019 income statements appears to the left. The first two columns show income statement amounts for two consecutive years. The amount and percentage differences for each line are listed in the final two columns, respectively.

The presentation of the changes from year to year for each line item can be analyzed to see where positive progress is occuring over time, such as increases in revenue and profit and decreases in cost. Conversely, less favorable readings may be isolated using this approach and investigated further.

In this sample comparative income statement, sales increased 20.0% from one year to the next, yet gross profit and income from operations increased quite a bit more at 33.3% and 60.0%, respectively. However, the final net incomeamount increased only 7.4%. Changes between the income from operations and net income lines can be reviewed to identify the reasons for the relatively lower increase in net income.

Likewise, the following is a horizontal analysis of a firm’s 2018 and 2019 balance sheets. Again, the amount and percentage differences for each line are listed in the final two columns, respectively.

Screen Shot 2020-06-17 at 7.28.27 PM.png

The horizontal analysis to the left uses a firm’s 2018 and 2019 balance sheets. Again, the amount and percentage differences for each line are listed in the final two columns, respectively.

The increase of $344,000 in total assets represents a 9.5% change in the positive direction. Total liabilities increased by 10.0%, or $116,000, from year to year. The change in total stockholders’ equity of $228,000 is a 9.3% increase. There seems to be a relatively consistent overall increase throughout the key totals on the balance sheet.

7.3.2 Vertical Analysis

A vertical analysis may also be conducted to each financial statement to report the percentage of each line item to a total amount.

On the comparative income statement, the amount of each line item is divided by the sales number, which is the largest value.

Screen Shot 2020-06-17 at 7.39.48 PM.png

On the comparative balance sheet, the amount of each line item is divided by the total assets amount, which is the largest value (and which equals total liabilities and stockholders’ equity.)

Screen Shot 2020-06-17 at 7.41.54 PM.png

On both financial statements, percentages are presented for two consecutive years so that the percent changes over time may be evaluated.

7.3.3 Common-size Statements

The use of percentages converts a company’s dollar amounts on its financial statements into values that can be compared to other companies whose dollar amounts may be different.

Common-size statements include only the percentages that appear in either a horizontal or vertical analysis. They often are used to compare one company to another or to compare a company to other standards, such as industry averages.

The following compares the performance of two companies using a vertical analysis on their income statements for 2019.

Screen Shot 2020-06-17 at 7.45.42 PM.png

7.3.4 Ratio Analysis

Horizontal and vertical analyses present data about each line item on the financial statements in a uniform way across the board. Additional insight about a corporation’s financial performance and health can be revealed by calculating targeted ratios that use specific amounts that relate to one another. Again, as stated earlier, no ratio is meaningful by itself; it needs to be compared to something, such as desired or expected results, previous results, other companies’ results, or industry standards.

There are a series of ratios that are commonly used by corporations. These will be classified as liquidity, solvency, profitability, and return on investment.

Liquidity analysis looks at a company’s available cash and its ability to quickly convert other current assets into cash to meet short-term operating needs such as paying expenses and debts as they become due. Cash is the most liquid asset; other current assets such as accounts receivable and inventory may also generate cash in the near future.

Creditors and investors often use liquidity ratios to gauge how well a business is performing. Since creditors are primarily concerned with a company’s ability to repay its debts, they want to see if there is enough cash and equivalents available to meet the current portions of debt.

Six liquidity ratios follow. The current and quick ratios evaluate a company’s ability to pay its current liabilities. Accounts receivable turnover and number of days’ sales in receivables look at the firm’s ability to collect its accounts receivable. Inventory turnover and number of days’ sales in inventory gauge how effectively a company manages its inventory.

CURRENT RATIO

What it measures: The ability of a firm to pay its current liabilities with its cash and/or other current assets that can be converted to cash within a relatively short period of time.

\(\ \text{Calculation:} \frac{\text { Current assets }}{\text { Current liabilities }}=\frac{911,000}{364,000}=2.5\)

Screen Shot 2020-06-17 at 7.50.02 PM.png

Interpretation : This company has 2.5 times more in current assets than it has in current liabilities. The premise is that current assets are liquid; that is, they can be converted to cash in a relatively short period of time to cover short-term debt. A current ratio is judged as satisfactory on a relative basis. If the company prefers to have a lot of debt and not use its own money, it may consider 2.5 to be too high – too little debt for the amount of assets it has. If a company is conservative in terms of debt and wants to have as little as possible, 2.5 may be considered low – too little asset value for the amount of liabilities it has. For an average tolerance for debt, a current ratio of 2.5 may be considered satisfactory. The point is that whether the current ratio is considered acceptable is subjective and will vary from company to company.

QUICK RATIO

What it measures: the ability of a firm to pay its current liabilities with its cash and other current assets that can be converted to cash within an extremely short period of time . Quick assets include cash, accounts receivable, and marketable securities but do not include inventory or prepaid items.

\(\ \text{Calculation:} \frac{\text { Quick assets }}{\text { Current liabilities }}=\frac{373,000+248,000+108,000}{364,000}=2.0\)

Screen Shot 2020-06-17 at 7.54.10 PM.png

Interpretation: This company has 2.0 times more in its highly liquid current assets, which include cash, marketable securities, and accounts receivable, than it has in current liabilities. The premise is these current assets are the most liquid and can be immediately converted to cash to cover short-term debt. Current assets such as inventory and prepaid items would take too long to sell to be considered quick assets. A quick ratio is judged as satisfactory on a relative basis. If the company prefers to have a lot of debt and not use its own money, it may consider 2.0 to be too high – too little debt for the amount of assets it has. If a company is conservative in terms of debt and wants to have as little as possible, 2.0 may be considered low – too little asset value for the amount of liabilities it has. For an average tolerance for debt, a current ratio of 2.0 may be considered satisfactory. The point is that whether the quick ratio is considered acceptable is subjective and will vary from company to company.

ACCOUNTS RECEIVABLE TURNOVER

What it measures: the number of times the entire amount of a firm’s accounts receivable, which is the monies owed to the company by its customers, is collected in a year.

\(\ \text{Calculation:} \frac{\text { Sales }}{\text { Average accounts receivable }}=\frac{994,000}{(108,000 + 91,000)/2}=10.0\)

Screen Shot 2020-06-17 at 8.03.53 PM.png

Interpretation: The higher the better. The more often customers pay off their invoices, the more cash available to the firm to pay bills and debts and less possibility that customers will never pay at all.

NUMBER OF DAYS’ SALES IN RECEIVABLES

What it measures: the number of days it typically takes for customers to pay on account.

\(\ \text{Calculation:} \frac{\text { Average accounts receivable }}{\text { Sales / } 365}=\frac{(108,000+91,000) / 2}{994,000 / 365}=36.5 days\)

The denominator of “Sales / 365” represents the dollar amount of sales per day in a 365-day year.

Screen Shot 2020-06-17 at 8.12.03 PM.png

Interpretation: The lower the better. The less time it takes customers to pay off their invoices, the more cash available to the firm to pay bills and debts and less possibility that customers will never pay at all.

INVENTORY TURNOVER

What it measures: the number of times the average amount of a firm’s inventory is sold in a year.

\(\ \text{Calculation:} \frac{\text { Cost of merchandise sold }}{\text { Average inventory }}=\frac{414,000}{(55,000 + 48,000)/2}=8.0\)

Screen Shot 2020-06-17 at 8.20.44 PM.png

Interpretation: The higher the better. The more often inventory is sold, the more cash generated by the firm to pay bills and debts. Inventory turnover is also a measure of a firm’s operational performance. If the company’s line of business is to sell merchandise, the more often it does so, the more operationally successful it is.

NUMBER OF DAYS’ SALES IN INVENTORY

What it measures: the number of days it typically takes for a typical batch of inventory to be sold.

\(\ \text{Calculation}: \frac{\text {Average inventory }}{\text { Cost of merchandise sold/365 }}=\frac{(55,000 + 48,000)/2}{(414,000/365)}=45.4 \text{ days}\)

The denominator of “Cost of merchandise sold / 365” represents the dollar amount of cost per day in a 365-day year.

Screen Shot 2020-06-17 at 8.28.36 PM.png

Interpretation: The lower the better. The less time it takes for the inventory in stock to be sold, the more cash available to the firm to pay bills and debts. There is also less of a need to pay storage, insurance, and other holding costs and less of a chance that inventory on hand will become outdated and less attractive to customers.

Solvency analysis evaluates a company’s future financial stability by looking at its ability to pay its long-term debts.

Both investors and creditors are interested in the solvency of a company. Investors want to make sure the company is in a strong financial position and can continue to grow, generate profits, distribute dividends, and provide a return on investment. Creditors are concerned with being repaid and look to see that a company can generate sufficient revenues to cover both short and long-term obligations.

Four solvency ratios follow.

RATIO OF LIABILITIES TO STOCKHOLDERS’ EQUITY

What it measures: the ability of a company to pay its creditors.

\(\ \text{Calculation}: \frac{\text {Total liabilities }}{\text { Total stockholders’ equity }}=\frac{1,275,000}{2,675,000}=5\)

Screen Shot 2020-06-18 at 9.24.14 AM.png

Interpretation: Favorable vs. unfavorable results are based on company’s level of tolerance for debt Assets are acquired either by investments from stockholders or through borrowing from other parties. Companies that are adverse to debt would prefer a lower ratio. Companies that prefer to use “other people’s money” to finance assets would favor a higher ratio. In this example, the company’s debt is about half of what its stockholders’ equity is. Approximately 1/3 of the assets are paid for through borrowing.

RATIO OF FIXED ASSETS TO LONG-TERM LIABILITIES

What it measures: the availability of investments in property, plant, and equipment that are financed by long-term debt and to generate earnings that may be used to pay off long-term debt.

\(\ \text{Calculation}: \frac{\text {Book value of fixed assets }}{\text { Long-term liabilities }}=\frac{1,093,000}{911,000}=1.2\)

Screen Shot 2020-06-18 at 9.33.41 AM.png

Interpretation: The higher the better. The more that has been invested in fixed assets, which are often financed by long- term debt, the more potential there is for a firm to perform well operationally and generate the cash it needs to make debt payments.

NUMBER OF TIMES INTEREST CHARGES ARE EARNED

What it measures: the ability to generate sufficient pre-tax income to pay interest charges on debt.

\(\ \text{Calculation}: \frac{\text {Income before income tax + interest expense }}{\text { Interest expense }}=\frac{314,000 + 55,000}{55,000}=6.7\)

Screen Shot 2020-06-18 at 9.43.51 AM.png

Since interest expense had been deducted in arriving at income before income tax on the income statement, it is added back in the calculation of the ratio.

Interpretation: The higher the better. The ratio looks at income that is available to pay interest expense after all other expenses have been covered by the sales that were generated. The number of times anything is earned is always more favorable when it is higher since it impacts the margin of safety and the ability to pay as earnings fluctuate, particulary if they decline.

NUMBER OF TIMES PREFERRED DIVIDENDS ARE EARNED

What it measures: the ability to generate sufficient net income to pay dividends to preferred stockholders

\(\ \text{Calculation}: \frac{\text {Net income }}{\text { Preferred dividends }}=\frac{248,000}{12,000}=20.7\)

Screen Shot 2020-06-18 at 10.07.05 AM.png

Interpretation: The higher the better. The ratio looks at net income that is available to pay preferred dividends, which are paid on an after-tax basis, and after all expenses have been covered by the sales that were generated. The number of times anything is earned is always more favorable when it is higher since it impacts the margin of safety and the ability to pay as earnings fluctuate.

Profitability analysis evaluates a corporation’s operational ability to generate revenues that exceed associated costs in a given period of time.

Profitability ratios may incorporate the concept of leverage , which is how effectively one financial element generates a progressively larger return on another element. Thes first five ratios that follow look at how well the assets, liabilities, or equities in the denominator of each ratio are able produce a relatively high value in the respective numerator. Ths final two ratios evaluate how well sales translate into gross profit and net income.

ASSET TURNOVER

What it measures: how effectively a company uses its assets to generate revenue.

\(\ \text{Calculation}: \frac{\text {Sales }}{\text { Average total assets (excluding long-term investments) }}=\frac{994,000}{(3,950,000 - 1,946,000 + 3,606,000 - 1,822,000)/2}=52.5 \)%

Long-term investments are not included in the calculation because they are not productivity assets used to generate sales to customers.

Screen Shot 2020-06-18 at 10.33.14 AM.png

Interpretation: The higher the better. The ratio looks at the value of most of a company’s assets and how well they are leveraged to produce sales. The goal of owning the assets is that they should generate revenue that ultimately results in cash flow and profit.

RETURN ON TOTAL ASSETS

What it measures: how effectively a company uses its assets to generate net income.

\(\ \text{Calculation}: \frac{\text {Net income + Interest expense }}{\text {Average total assets }}=\frac{248,000 + 55,000}{(3,950,000 + 3,606,000)/2}=8.0 \)%

Interest expense relates to financed assets, so it is added back to net income since how the assets are paid for should be irrelevant.

Screen Shot 2020-06-18 at 10.52.02 AM.png

Interpretation: The higher the better. The ratio looks at the value of a company’s assets and how well they are leveraged to produce net income. The goal of owning the assets is that they should generate cash flow and profit.

RETURN ON STOCKHOLDERS’ EQUITY

What it measures: how effectively a company uses the investment of its owners to generate net income.

\(\ \text{Calculation}: \frac{\text {Net income }}{\text { Average total stockholders’ equity }}=\frac{248,000}{(2,675,000 + 2,447,000)/2}= 9.7\)%

Screen Shot 2020-06-18 at 10.57.36 AM.png

Interpretation: The higher the better. The ratio looks at how well the investments of preferred and common stockholders are leveraged to produce net income. One goal of investing in a corporation is for stockholders to accumulate additional wealth as a result of the company making a profit.

RETURN ON COMMON STOCKHOLDERS’ EQUITY (ROE)

What it measures: how effectively a company uses the investment of its common stockholders to generate net income; overall performance of a business.

\(\ \text{Calculation}: \frac{\text {Net income - Preferred dividends }}{\text { Average common stockholders’ equity }}=\frac{248,000 - 12,000}{(83,000 + 2,426,000 + 83,000 + 2,198,000)/2}= 9.9\)%

Preferred dividends are removed from the net income amount since they are distributed prior to commonshareholders having any claim on company profits.

In this example, shareholders saw a 9.9% return on their investment. The result indicates that every dollar of common shareholder’s equity earned about $.10 this year.

Screen Shot 2020-06-18 at 11.10.37 AM.png

EARNINGS PER SHARE ON COMMON STOCK

What it measures: the dollar amount of net income associated with each share of common stock outstanding.

\(\ \text{Calculation}: \frac{\text {Net income - Preferred dividends }}{\text { Number of shares of common stock outstanding }}=\frac{248,000 - 12,000}{83,000/$10}= $28.43\)

Preferred dividends are removed from the net income amount since they are distributed prior to common shareholders having any claim on company profits.

The number of common shares outstanding is determined by dividing the common stock dollar amount by the par value per share given.

Screen Shot 2020-06-18 at 11.18.58 AM.png

Interpretation: The higher the better. The ratio is critical in reporting net income at a micro level – per share – rather than in total. A greater net income amount will result in a higher earnings per share given a fixed number of shares.

GROSS PROFIT PERCENTAGE

What it measures: how effectively a company generates gross profit from sales or controls cost of merchandise sold.

\(\ \text{Calculation}: \frac{\text {Gross profit }}{\text { Sales }}=\frac{580,000}{994,000}= 58.4\)%

Screen Shot 2020-06-18 at 11.24.40 AM.png

Interpretation: The higher the better. The ratio looks at the main cost of a merchandising business – what it pays for the items it sells. The lower the cost of merchandise sold, the higher the gross profit, which can then be used to pay operating expenses and to generate profit.

PROFIT MARGIN

What it measures: the amount of net income earned with each dollar of sales generated.

\(\ \text{Calculation}: \frac{\text {Net income }}{\text { Sales }}=\frac{248,000}{994,000}= 24.9\)%

Screen Shot 2020-06-18 at 11.32.52 AM.png

Interpretation: The higher the better. The ratio shows what percentage of sales are left over after all expenses are paid by the business.

Finally, a Dupont analysis breaks down three components of the return on equity ratio to explain how a company can increase its return for investors. It may be evaluated on a relative basis, comparing a company’s Dupont results with either another company’s results, with industry standards, or with expected or desired results.

DUPONT ANALYSIS

What it measures: a company’s ability to increase its return on equity by analyzing what is causing the current ROE.

Results indicate that Company A has a higher profit margin and greater financial leverage. Its weaker position on total asset turnover as compared to Company B is what brings down its ROE. The analysis of the components of ROE provides insight of areas to address for improvement.

Interpretation: Investors are not looking for large or small output numbers from this model. Investors want to analyze and pinpoint what is causing the current ROE to identify areas for improvement. This model breaks down the return on equity ratio to explain how companies can increase their return for investors.

Return-on-investment analysis looks at actual distributions of current earnings or expected future earnings.

DIVIDENDS PER SHARE ON COMMON STOCK

What it measures: the dollar amount of dividends associated with each share of common stock outstanding.

\(\ \text{Calculation}: \frac{\text {Common stock dividends }}{\text { Number of shares of common stock outstanding }}=\frac{8,000}{83,000/$10}= $0.96\)

Screen Shot 2020-06-18 at 12.11.08 PM.png

Interpretation: If stockholders desire maximum dividends payouts, then the higher the better. However, some stockholders prefer to receive minimal or no dividends since dividend payouts are taxable or because they prefer that their returns be reinvested. Then lower payouts would be better.

The ratio reports distributions of net income in the form of cash at a micro level – per share – rather than in total. A greater dividends per share amount will result from a higher net income amount given a fixed number of shares.

DIVIDENDS YIELD

What it measures: the rate of return to common stockholders from cash dividends.

Assume that the market price per share is $70.00.

\(\ \text{Calculation}: \frac{\text {Common dividends / Common shares outstanding }}{\text { Market price per share }}=\frac{$0.96}{$70.00}= 1.4\)%

Screen Shot 2020-06-18 at 12.17.57 PM.png

Interpretation: If stockholders desire maximum dividend payouts, then the higher the better. However, some stockholders prefer to receive minimal or no dividends since dividend payouts are taxable or because they prefer that their returns be reinvested. Then lower payouts would be better.

The ratio compares common stock distributions to the current market price. This conversion allows comparison between different companies and may be of particular interest to investors who wish to maximize dividend revenue.

PRICE EARNINGS RATIO

What it measures: the prospects of future earnings.

\(\ \text{Calculation}: \frac{\text {Market price per share }}{\text { Common stock earnings per share }}=\frac{$70.00}{$28.43}= 2.5\)

Recall that earnings per share is (Net income – Preferred stock dividends) / Number of shares of common stock.

Screen Shot 2020-06-18 at 12.28.37 PM.png

Interpretation: The higher the better. The more the market price exceeds earnings, the greater the prospect of value growth, particularly if this ratio increases over time.All the analytical measures discussed, taken individually and collectively, are used to evaluate a company’s operating performance and financial strength. They are particularly informative when compared over time to expected or desired standards. The ability to learn from the financial statements makes the processes of collecting, analyzing, summarizing, and reporting financial information all worthwhile.

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Financial Statement Analysis: The Basics for Non-Accountants

Financial Statement Analysis

  • 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.

“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.

Income Statement Example

  • 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.

Balance Sheet Example

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.

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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? Download our free Guide to Advancing Your Career with Essential Business Skills to learn how enhancing your business knowledge can help you make an impact on your organization and be competitive in the job market.

company financial statement analysis assignment

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Financial Statement Analysis

True Tamplin, BSc, CEPF®

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on June 08, 2023

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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.

company financial statement analysis assignment

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 .

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ACCT 370 Financial Statement Analysis

  • Course Description

This course examines the fundamental techniques of financial statement analysis and their application to strategic planning and decision making. The course covers the analysis and interpretation of financial information including the balance sheet, income statement, and statement of cash flows.

For information regarding prerequisites for this course, please refer to the  Academic Course Catalog .

Course Guide

View this course’s outcomes, policies, schedule, and more.*

Requires a student login to access.

*The information contained in our Course Guides is provided as a sample. Specific course curriculum and requirements for each course are provided by individual instructors each semester. Students should not use Course Guides to find and complete assignments, class prerequisites, or order books.

Understanding the keys to effective financial statement analysis will provide finance majors and other business and accounting students with a competitive advantage in the marketplace. A working knowledge of the tools used to evaluate and adjust the financial statements to enhance their economic content for meaningful financial analysis will enhance students’ strategic decision making capabilities. The processes and methods used to reconstruct the economic reality embedded in the financial statements including ratio analysis, prospective analysis, earnings prediction and equity valuation are emphasized in the course.

Course Assignment

Textbook readings and presentations.

No details available.

Course Requirements Checklist

After reading the Course Syllabus and Student Expectations , the student will complete the related checklist found in Course Overview.

Discussions (2)

Discussions are a collaborative learning experience. Therefore, the student will post a thread of 350 words in response to each of the provided prompts.  The thread must demonstrate course-related knowledge, and clearly respond to the discussion prompt.  In addition to the thread, the student is required to reply to two other students’ threads.  Each reply must be at least 150 words. 

Connect SmartBook (Read & Interact) Assignments (20)

The student will complete 20 SmartBook assignments (Read & Interact) using Connect. These assignments involve reading the assigned chapter, and answering questions regarding the concepts covered in the assigned readings.

Connect Quizzes (4)

There will be 4 quizzes in this course completed in Connect. Each quiz will be based on the textbook readings and contain problems and/or multiple-choice questions.

Excel Project Assignments (3 Parts)

The student will complete a 3 part project in Microsoft Excel that focuses on financial statement analysis of a selected company. The selected company must be traded on a recognized stock exchange, such as the New York Stock Exchange, or NASDAQ.  The course instructor must approve each student’s company selection.  The project will be submitted in the following parts throughout the course:

Historical Financial Statement Analysis Assignment : Company Information, Historical Balance Sheets, Income Statements, and Statements of Cash Flow for Company, and Historical Ratios

Competitor Analysis Assignment : Historical Balance Sheets, Income Statements, and Statements of Cash Flow for 2-3 Competitors, and Competitor Ratios

Projecting Financial Statements Assignment : Horizontal and Vertical Analysis and Projected Financial Statements

Financial Analysis Presentation Assignment

The student will prepare a 10–12 minute presentation using Kaltura Capture software (provided by the University). This narrated PowerPoint presentation will address the financial analysis completed for the company that was selected for the Excel Project.  The student’s presentation should be supported by market research and the student’s own quantitative analysis.  The presentation should contain APA style citations to at least 8 reputable professional, scholarly, or trade publications, which should include the textbook and Bible.

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What Is Financial Analysis?

Understanding financial analysis, corporate financial analysis, investment financial analysis, types of financial analysis, horizontal vs. vertical analysis.

  • Example of Financial Analysis
  • Financial Analysis FAQs

The Bottom Line

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

Financial Analysis: Definition, Importance, Types, and Examples

company financial statement analysis assignment

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

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 conclusion.

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: 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 understand the market sentiment behind price trends by looking for patterns and trends 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, then seeing how every other component on a financial statement compares to that benchmark. Most often, net sales is used as the benchmark. A company would then compare cost of goods sold, gross profit, operating profit, or net income as a percentage to this benchmark. Companies can then track how the percent changes over time.

Examples of Financial Analysis

In the nine-month period ending Sept. 30, 2022, Amazon.com reported a net loss of $3 billion. This was a substantial decline from one year ago where the company reported net income of over $19 billion.

Financial analysis shows some interesting facets of the company's earnings per share (shown above. On one hand, the company's EPS through the first three quarters was -$0.29; compared to the prior year, Amazon earned $1.88 per share. This dramatic difference was not present looking only at the third quarter of 2022 compared to 2021. Though EPS did decline from one year to the next, the company's EPS for each third quarter was comparable ($0.31 per share vs. $0.28 per share).

Analysts can also use the information above to perform corporate financial analysis. For example, consider Amazon's operating profit margins below.

  • 2022: $9,511 / $364,779 = 2.6%
  • 2021: $21,419 / $332,410 = 6.4%

From Q3 2021 to Q3 2022, the company experienced a decline in operating margin, allowing for financial analysis to reveal that the company simply earns less 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 .

Last, 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.

Amazon. " Amazon.com Announces Third Quarter Results ."

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A Guide to Writing Effective Assignments on Financial Statement Analysis

Jacob Thompson

The ability to analyze financial statements is a key competency for finance professionals because it allows them to evaluate the financial health of an organization and make wise decisions. Writing an essay on this subject helps you to better understand it while also honing your analytical skills. An extensive tutorial on how to write a financial statement analysis assignment is provided in this blog post. We will go over every important detail, from comprehending the fundamental ideas to conducting an exhaustive analysis. The goals of financial statement analysis, such as assessing profitability, liquidity, and solvency, will be covered in detail. We'll examine various methods and tools, including ratio analysis, common-size analysis, and trend analysis, that can be used to efficiently interpret financial statements. We will also describe the assignment writing process in detail, including how to define the assignment's scope, conduct research, and organize the content. You can demonstrate your mastery of this important area of finance by producing a high-quality assignment on financial statement analysis by adhering to our professional advice and tips.

A Comprehensive Guide: How to Write an Assignment on Financial Statement Analysis

Understanding Financial Statement Analysis

It's essential to build a solid foundation in this subject before starting to write a financial statement analysis assignment. It is essential to have a thorough understanding of financial statement analysis before diving into the assignment's complexity. You will receive a brief introduction to this field as well as the key ideas that underpin it in this section. You can complete the assignment more successfully if you have a solid understanding of financial statement analysis. The main financial statements involved (balance sheet, income statement, and cash flow statement), as well as the tools and techniques typically used in analyzing these statements, will all be covered in this section. By understanding these basic ideas, you will lay a solid foundation for the subsequent steps involved in writing your financial statement analysis assignment.

Introduction to Financial Statement Analysis

In order to evaluate a company's financial performance and health, financial statement analysis entails looking at its financial statements. The balance sheet, income statement, and cash flow statement are the three main financial statements that are analyzed. These statements give important details about the assets, liabilities, revenue, costs, and cash flows of a company. You can gain a thorough understanding of a company's financial situation, profitability, and cash flow management by examining these statements. Investors, creditors, and other stakeholders can assess a company's financial performance and potential risks with the help of financial statement analysis .

Objectives of Financial Statement Analysis

The evaluation of a company's profitability, liquidity, solvency, and operational effectiveness are the goals of financial statement analysis. Financial statement analysis allows you to evaluate a company's capacity for profit generation, short-term debt management, long-term financial commitment fulfillment, and operational efficiency enhancement. You can spot trends, strengths, and weaknesses in a company's financial performance by looking at its financial statements. Making informed investment decisions, determining creditworthiness, and gauging a company's general financial health are all made easier thanks to the insights provided by this analysis.

Tools and Techniques for Financial Statement Analysis

In financial statement analysis, a variety of tools and techniques are frequently employed. These consist of comparative analysis, trend analysis, ratio analysis, and common-size analysis. Calculating and interpreting different financial ratios, such as liquidity ratios, profitability ratios, and solvency ratios, are all part of ratio analysis. In order to make comparisons easier, common-size analysis involves expressing financial statement line items as a percentage of a base figure. In order to spot patterns and changes over time, trend analysis looks at financial data over a number of time periods. The comparative analysis involves evaluating a company's financial performance against that of companies in a similar industry or against rival businesses. These methods and tools facilitate benchmarking, support decision-making, and offer insightful information about a company's financial performance.

Writing an Assignment on Financial Statement Analysis

It is now time to investigate how to write an assignment on this topic after gaining a basic understanding of financial statement analysis. This section acts as a step-by-step manual, arming you with the resources you need to create a thoroughly organized assignment. You will discover how to efficiently organize your assignment by referring to the provided instructions, ensuring that your arguments are coherent and clear. You will learn how to clearly define the parameters of your assignment, conduct exhaustive background research, and organize your work logically. The section will also go over crucial elements like using the right tools and techniques to analyze financial statements, interpreting the findings, and coming to meaningful conclusions. With the help of this thorough manual, you will be equipped to produce a superb assignment on financial statement analysis that will demonstrate your expertise and analytical abilities in this area.

Define the Scope of Your Assignment

Setting a clear definition of your project's parameters is crucial before you start writing your financial statement analysis assignment. Think about whether you need to concentrate on a particular business, sector, or financial statement. You can focus your research and keep a clear, cogent focus throughout your assignment by defining the scope. By defining the scope, you can determine the parameters of your analysis and make sure that you focus on the pertinent facets of financial statement analysis that are in line with the goals of your assignment.

Conduct Background Research

It is essential to conduct in-depth background research to compile pertinent data before beginning the writing process. Make use of reliable resources like financial journals, scholarly works, industry reports, and dependable online databases. Make sure the data you compile is accurate, trustworthy, and supports your analysis. You can learn important information about the selected company, market trends, financial regulations, and other elements that could affect the financial statement analysis by conducting thorough research. You will have the background knowledge from this research to critically analyze and decipher the financial data you come across in your assignment. To reference your sources correctly and to uphold academic integrity throughout your work, always provide accurate documentation.

Structure Your Assignment

Clarity, coherence, and effective communication of your financial statement analysis depend on a well-structured assignment. To arrange your assignment and present your findings in a clear and thorough way, think about using the following format:

  • Introduction: Get things going with an interesting introduction that gives a quick rundown of financial statement analysis and its importance in gauging a company's financial well-being. Give a clear description of the assignment's goals.
  • Methodology: Describe the equipment and procedures you'll use to analyze financial statements. Give an explanation of the thinking behind your chosen techniques and argue for their applicability to the goals of your assignment.
  • Company Profile : Describe the business you've chosen for analysis and give any pertinent background information. Include any pertinent information that aids in contextualizing the financial statement analysis, such as information about the sector, company size, business model, and industry.
  • Financial Statements Analysis: Examine the financial statements of the company using a variety of methods and tools. Divide the analysis into sections such as operational efficiency analysis, profitability analysis, liquidity analysis, and solvency analysis. To improve clarity and visual appeal, present your findings using the appropriate charts, graphs, and tables.
  • Interpretation of Results: Give an explanation of your analysis' conclusions and insights into the business's financial health. Highlight important patterns, attributes, shortcomings, and potential areas for development. Provide pertinent information and references to back up your interpretations.
  • Conclusion: List your main findings and inferences from the financial statement analysis. Point out how your analysis affects the company's finances and potential future prospects. On the basis of your analysis, make suggestions that focus on problem areas or suggest potential solutions.

Analyzing Financial Statements

Take into account the following actions to properly analyze financial statements:

  • Review the Balance Sheet: The company's balance sheet, which gives a quick overview of its assets, liabilities, and shareholders' equity, should be examined first. Calculate pertinent ratios, such as liquidity ratios (such as current ratio, quick ratio), leverage ratios (such as debt-to-equity ratio, interest coverage ratio), and efficiency ratios (such as asset turnover ratio, inventory turnover ratio), as well as the composition and quality of the company's assets.
  • Analyze the Income Statement: Review the income statement of the business to learn more about its sales, costs, and general profitability. Calculate important ratios like the gross profit margin, operating margin, and net profit margin. Analyse trends in revenue. You can use this analysis to determine the company's capacity for profit-making and to pinpoint potential areas for cost- or revenue-revenue optimization.
  • Examine the Cash Flow Statement: Examine the cash flows from operating, investing, and financing activities for the company as shown on the cash flow statement. Examine the business's capacity to generate cash from its core operations, as well as its choices regarding investments and financing. The management of the company's cash flow, its capacity to finance operations and investments, and its overall financial flexibility will all be analyzed.
  • Compare with Industry Benchmarks: You can learn more about a company's financial performance by comparing its financial ratios to those of similar businesses in the same industry. Establish industry norms for different financial ratios, then evaluate how the company's ratios compare. You can use this comparison to evaluate the company's competitive position in the market, understand its relative performance, and spot any areas of strength or weakness.

Writing a financial statement analysis assignment requires a combination of research, analytical skill, and effective communication. Following the detailed instructions in this blog post will enable you to efficiently structure your assignment and conduct a thorough analysis of financial statements to draw out insightful conclusions. Your findings must be presented logically and coherently, supported by pertinent data and industry standards. You will develop a solid understanding of financial statement analysis through practice and application, which will improve your capacity to assess a company's financial health. You will improve your ability to interpret complex financial data, spot trends, and reach well-informed conclusions as you keep honing your abilities. You have the chance to hone your skills and establish your comprehension of this crucial facet of financial analysis by writing an assignment on financial statement analysis.

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Analysis of Financial Statement Formal Assignment Report

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