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Analyzing the financial statement of a company

Updated on 20 February 2021
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Bcom Exam Guide
7 min read 1 views
Updated on 20 February 2021

Financial statements of the company are defined as the statements which focus on the business activities and financial performance. These financial statements record how the company has performed over the years. These statements are generally audited by the government agencies, firms and accountants. These statements include Bank Reconciliation statements (BRS), Cash Flow Statements, Income Statements and many more. The financial condition of the firm is recorded in these statements.


Now, a reader must ponder on the fact; how to analyze the financial statement of the company? Financial statements are recorded by the accountants of the firm, generally by the CAs and CS. There are four ways in which the financial statements are analyzed.


Economic Characteristics


Identify the economic characteristics of the company i.e. how much profit the company is yielding per year. You have to keep an eye on the chain of activities going on in the company to understand the economic background of the company. Economic characteristics include various bank statements, loan statements and other financial statements of the company.


Strategy


You must identify the strategies and measures which have been undertaken by the company to maintain its shares and stocks (financial capital). Analyze the product quality, the profit margins and the uniqueness of the product. Company employs various financial strategists who take care of the company’s financial capital and help the company in yielding profits in the forthcoming years.


Current profitability


You can analyze the current profitability and the risks of the company by recording the financial statements. Here we can ask some questions like; how does the company finance the assets? and how the shareholders are profited from the firm? The answer is the same i.e. if the financial records of the company are flourishing then the company can finance the assets and the shareholders are also profited from the same. 


Forecasted Financial Records


An accountant makes assumptions about the financial records of the company which can help the company from getting into losses. These assumptions are about the shareholders, the assets and how will the company perform in the coming year along with investing in various things. These forecasted financial records help in saving the company from losses. 



Financial analysis of the company is important as it focuses on the company’s economic developments and future profits. There are various ways and types of financial analysis like vertical analysis, horizontal analysis, leverage analysis, growth rates and many more. These analyzing tools help the accountants in forecasting the future profits and threats of the company. 


Now there are several financial statement analysis examples which help us in understanding the financial condition of the company. One can analyze the financial statement of the company by focusing on aspects like profitability, liquidity ratios, leverages etc. Below is the figure which depicts some of the important ways in which the financial statement of the company is recorded. These are Liquidity Ratios, Solvency Ratios, Profitability Ratios and Turnover Ratios. 



The examples are as follows:


Liquidity Ratio:


It is the ability of the company to pay off its debts, loans and other obligations. There are two types of liquidity ratios:

  1. Current ratio – It measures the number of assets and liabilities which the company currently has. [Current Ratio Formula is: Current Assets/Current Liabilities]. For instance, if assets of two companies say, ABC and XYZ are 2,00,000 and 3,50,000 respectively and liabilities are 1,50,000 and 2,00,000 then the ratio will be 1.33:1.75.


  1. Quick Ratio – This ratio helps in analyzing the company’s paying ability to its loans and debts. [Quick Ratio Formula is: Current Assets – Current Liabilities]. For instance if the assets of two companies say, ABC and XYZ are 1,50,000 and 3,00,000 respectively and the liabilities are 1,50,000 and 2,00,000 then the ratio will come out to be 1:1.5.


Profitability Ratios:


The earning ability of the company is analyzed under this. The types of profitability ratios are:

  1. Net Profit Ratio – It measures the overall profits earned by the company. Net Profit Ratio formula is: Net Profit / Sales. For instance, the profit earned of the companies ABC and XYZ are 30,000 and 42,000 and the sales are 2,00,000 and 3,00,000 respectively, then the Net Profit Ratio will be 15% and 14%. 


  1. Return on Equity – This ratio analyses the returns from the equity shareholders. Return on Equity formula is: Net Profit / Shareholder’s Equity. For instance, the net profit earned of the companies ABC and XYZ are 30,000 and 42,000 and the equity is 2,00,000 and 3,00,000 respectively, then the Return on Equity will be 15% and 14%. 


Turnover Ratios:


It measures how the company has successfully used up it’s assets. The types of turnover ratios are:

  1. Inventory Turnover Ratio – It analyses how the inventory has been recorded and managed in the company. Inventory Turnover Ratio = Cost of Goods sold (COGS) / Avg. Inventory. For instance, the COGS and Avg. Inventory of both ABC and XYZ companies is 1,00,000 and 50,000 and 1,50,000 and 1,00,000 respectively so, the turnover ratio will be 2:1.50.


  1. Payable Turnover Ratios – This ratio measures the rate at which the company is able to make payments to its suppliers. Payable Turnover Ratio = Total purchases / Avg. Payables. If the ratio is high, it means that the company is paying off the bills quickly.


Solvency Ratios:


This ratio analyzes the number of assets the company owns in order to pay off its debts and loans. The types of Solvency Ratios are:


  1. Debt Equity Ratio – This ratio helps in analyzing the amount of equity undertaken by the company to pay off the obligations. Debt Equity Ratio = Total Debt / Total Equity. 


  1. Financial Leverage – It measures the assets available to the equity shareholders in the company. Financial Leverage = Total Assets / Equity. 

 

These are some of the analysis techniques and related examples which can be used to record the financial statements of the company. Now, let’s talk about the methods of financial statement analysis. These methods not only help in analyzing the financial statements but also help in analyzing the profitability of the company. The most important methods of financial analysis are:


Vertical Analysis:


This analysis establishes a co-relation among various items. This analysis gives the accountant a fair view of how the company has performed and what changes the company has to take on its part in order to overcome the incurred losses and debts.  


Horizontal Analysis:


The company’s progress is recorded under this analysis. For instance, if the annual profit earned is 30% – 40% then the horizontal analysis will show this profit in the annual balance sheet. This analysis helps in recording the profits and losses of the company per year. 


Trend Analysis:


This analysis records the increments of workers, the patterns and procedures undertaken by the company. The previous year serves as the base year for comparison and through this the trend is analyzed of the current year be it positive or negative. 


These are some of the methods of financial statement analysis. In addition to the above-mentioned methods, there are various financial statements analysis tools that help in having a fair understanding of the financial statements of the company. 


Comparative Statements:


These are the statements of profits and losses of previous years which are compared to the present year of the company. The previous year serves as the base year for comparison. Through such comparisons, the companies are able to analyze the profits earned and the losses incurred in that particular year. 


Fund Flow Analysis:


Fund Flow Analysis includes the funds of the company for the particular year. This analysis also involves the funds which have come from the external factors and also focuses on how these funds have been utilized.  


Cash Flow Analysis:


This analysis measures the movement of the cash from particular bank accounts. This analysis helps in recording the movement of the financial capital which the company utilizes in paying off the debts and loans. 


There are various methods of financial statement analysis and so are the various types of it. The financial statement of the company helps in analyzing the financial position of the company. If the financial position of the company is strong, the company yields profits. Moreover, it also helps in analyzing the shares and stocks of the company. Therefore, financial statement is the most important part of the company as it includes all the profits earned and losses incurred.

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