You know that financial statement analysis is one of the most important steps in decision-making for your business – here’s how to get the most from your analysis.
Financial analysis is a crucial procedure for any business. Though it is often a long, involved and detailed process, it tells the story of a business’s financial standing and helps business owners, executive teams, investors, and other stakeholders understand both the problems and the possibilities.
Financial statement analysis is useful for answering questions like:
- What are the business trends over the past few years?
- What is the debt to income ratio?
- In what business areas are profits and losses happening?
- Does the business have the financial ability to expand, hire more employees, or develop additional products?
- What areas need immediate attention to help balance the financial profile of the business?
- Is the business at risk? Is it profiting in accordance with projections?
The most important steps in analyzing a company’s financial statement.
Being able to successfully answer these questions annually can help businesses make better decisions about the direction of the organization into the next year and beyond. Here are 4 steps to conducting a thorough, accurate, and useful financial statement analysis.
1. Decide which method of financial statement analysis to use
There are two primary methods for analyzing financial statements. One is horizontal and vertical analysis, where horizontal analysis compares data sets across certain time periods, while vertical analysis reports costs and assets as a percentage of the entire financial statement. Horizontal analysis is useful for reviewing financial information over a set period (such as sales over the last 5 years), while vertical is useful for understanding different areas of business in comparison to each other (to help analyze marketing budget spend vs. sales budget spend, or how much money is spent on salaries vs. product development).
The second method is the ratio method. This can help you analyze dozens of areas of your business and compare them to overtime or even compare them other businesses in your industry. Some ratios businesses choose to examine include:
- Accounts payable ratio, which shows how quickly a business pays its suppliers
- Accounts receivable ratio, which measures how quickly a company collects payment
- Debt to equity ratio, which measures the amount of debt that is being used to fund operations
- Return on assets, which shows how much profit is generated based on a company’s combined assets (which can include product, personnel, working capital, and more)
What method you decide to use for your statement analysis will depend on what kind of business you have, how long the business has been in operation, and ultimately the goals for your financial statement analysis.
2. Gather all documents
A financial statement analysis includes many pieces, often from disparate areas of business. To be able to accurately assess the financial position of a company, you’ll need to audit records from different departments and possibly even other businesses, including:
- Sales records
- Annual budgets
- Profit and loss statement
- Supplier invoices and contracts
- Inventory records
- Supply chain bills
For the most part, accounting teams like accounts payable and accounts receivable, HR, executive leadership, procurement teams, and IT can help find and gather all the necessary data.
3. Process all the data
Once all the paperwork has been gathered, it needs to be evaluated. There are lots of programs that serve as useful tools of financial statement analysis and can help a business prepare and understand their data. Excel and Access databases can serve for small businesses, but as your business grows (and your data along with it), you’ll need a more robust solution that can not only handle the data but assist in presenting it.
Some of the leading comprehensive vendors are:
- AFP
- Adaptive Insights
- Sageworks
- Capterra
4. Analyze and report on findings
The goal of going this process is to ultimately create a financial statement analysis report. This should be based on the data that you gathered and compared and help guide business leadership in making decisions for the future of the business. One of the benefits of using a financial processing program like the ones listed above is that they are often able to highlight areas that need immediate attention or make recommendations based on the data.
Being able to prepare and understand a financial statement analysis is critical to the health of your business, as it can be a tool used to help shape your organization and be used to gain credit, capital, or record business compliance. Make sure you understand what’s involved in conducting your analysis accurately and effectively.
FAQs
Here are effective steps to analyse financial statements:
- Review objectives of the company. Reviewing the objectives of a company can help you understand its financial expectations. ...
- Select the method of analysis. ...
- Research industry standards. ...
- Prepare forecasted statements.
Financial statements can be divided into four categories: balance sheets, income statements, cash flow statements, and equity statements.
What are the four 4 major financial statements briefly describe each? ›
They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders' equity. Balance sheets show what a company owns and what it owes at a fixed point in time. Income statements show how much money a company made and spent over a period of time.
What are the 4 basic financial statements in order of preparation? ›
Financial statements are the way accountants report the performance and account balances of a company. The four financial statements (in order of preparation) are the income statement, statement of retained earnings (or statement of shareholders' equity), balance sheet, and statement of cash flows.
What are the 4 important types of financial statement? ›
There are four primary types of financial statements:
- Balance sheets.
- Income statements.
- Cash flow statements.
- Statements of shareholders' equity.
For-profit businesses use four primary types of financial statement: the balance sheet, the income statement, the statement of cash flow, and the statement of retained earnings.
Which of the four financial statements should be prepared first? ›
Income Statement
In accounting, we measure profitability for a period, such as a month or year, by comparing the revenues earned with the expenses incurred to produce these revenues. This is the first financial statement prepared as you will need the information from this statement for the remaining statements.
What are the 4 pieces of financial information contained in the income statement? ›
The income statement presents revenue, expenses, and net income. The components of the income statement include: revenue; cost of sales; sales, general, and administrative expenses; other operating expenses; non-operating income and expenses; gains and losses; non-recurring items; net income; and EPS.
How are the four financial statements connected? ›
The cash sales reported on the income statement are added to the balance sheet cash account. The credit sales are added to your accounts receivables. The balance of the retained earnings is included in the owner's equity section found on the balance sheet.
What are the four financial statements Quizlet? ›
On which of the four major financial statements (balance sheet, income statement, statement of cash flows, statement of retained earnings) would you find the following item?
In general, there are four categories of ratio analysis: profitability, liquidity, solvency, and valuation. Common ratios include the price-to-earnings (P/E) ratio, net profit margin, and debt-to-equity (D/E).
What are the 4 components of the financial statements? ›
The components of Financial Statements are the building blocks that together form the Financial Statements and help understand the business's financial health. And consists of an Income Statement, Balance Sheet, Cash Flow Statement, and Shareholders' Equity Statement.
What four statements are contained in most annual reports? ›
The four financial statements contained in most annual reports are: (1) balance sheet; (2) income statement; (3) cash flow statement; and (4) statements of shareholders' equity. The balance sheet provides an overview of company assets and liabilities. The income statement provides an overview of sales and expenses.
What is the process of financial management 4 steps? ›
For individuals and families, we focus on asset/liability matching, tax-efficiency, and cost-effective planning throughout the four key phases of financial management: accumulation, distribution, preservation, and legacy. Plan to budget, determine investments, set goals.
Which four analysis are done in analysis of financial statements? ›
Several techniques are commonly used as part of financial statement analysis. Three of the most important techniques are horizontal analysis, vertical analysis, and ratio analysis. Horizontal analysis compares data horizontally, by analyzing values of line items across two or more years.
How do the 4 financial statements flow together? ›
Finally, it is important to note that the income statement, statement of retained earnings, and balance sheet articulate. This means they “mesh together” in a self-balancing fashion. The income for the period ties into the statement of retained earnings, and the ending retained earnings ties into the balance sheet.
What are the 4 phases of ratio analysis? ›
In general, there are four categories of ratio analysis: profitability, liquidity, solvency, and valuation. Common ratios include the price-to-earnings (P/E) ratio, net profit margin, and debt-to-equity (D/E).
