The financial statement is the report providing information about a company’s performance, financial position to a broad range of users in making economic decisions. The role of financial statement analysis depends on users’ perspectives. Analysts use financial statement data to make investment, credit decisions. In the meantime, managers within a company may want the information to make operating and financing decisions. However, management may rely on internal financial details that are prepared in a different format and unavailable to external users.
A primary set financial statements include a statement of financial position (balance sheet), a statement of comprehensive income (income statement) and a statement of cash flows. In addition, footnotes to the financial statements are mandatory as an integral part of a complete set of financial statements.
The balance sheet presents a company’s current financial position by telling how much resources a company controls (assets), how much it owes (liabilities) at a specific time. And shareholders’ equity is the excess of assets over liabilities. In other words, the relationship among those three parts of the balance sheet can be expressed in the fundamental accounting equation:
Assets = Liabilities + Shareholders’ Equity
The income statement presents information on the financial record of the company’s profitability. It shows how much revenue the other income a company generated and the expenses incurred to such a generation. The income statement is also known as a profit and loss (P&L) statement or a statement of operations. The basic equation underlying the income statement is:
Revenue + Other Income – Expenses = Net Income
Cash Flow Statement
The cash flow statement shows a record of the actual changes in cash. Recognized revenue doesn’t necessarily equate to cash inflow due to the accrual basis of accounting. A similar concept is applied to understand the expenses and cash outflow. Therefore, a cash flow statement is vital to evaluate a company’s liquidity, solvency, and financial flexibility. All cash flows are classified into three categories: operating, investing, and financing.
Financial Statement Analysis Framework
Step 1: List the objective and context.
Set the goal for the analysis, the format in which this information should be presented
Step 2: Collect data
Collect the company’s financial statements and other relevant insights of its industry and the economy.
Step 3: Process the data
Make adjustments to financial statements. Calculate ratios
Step 4: Analyze and interpret processed data
Analytical output relevant to the goal set in the first step
Step 5: Report the conclusions or recommendations
Prepare and publish a report
Step 6: Follow up
Repeat these steps periodically and make changes if necessary.