Financial Statement Analysis

Introduction to Financial Statement Analysis

Financial statement analysis can be referred as a process of understanding the risk and profitability of a company by analyzing reported financial info, especially annual and quarterly reports. Putting another way, financial statement analysis is a study about accounting ratios among various items included in the balance sheet. These ratios include asset utilization ratios, profitability ratios, leverage ratios, liquidity ratios, and valuation ratios. Moreover, financial statement analysis is a quantifying method for determining the past, current, and prospective performance of a company.

Advantages of financial statement analysis

The different advantages of financial statement analysis are listed below:

• The most important benefit if financial statement analysis is that it provides an idea to the investors about deciding on investing their funds in a particular company.
• Another advantage of financial statement analysis is that regulatory authorities like IASB can ensure the company following the required accounting standards.
• Financial statement analysis is helpful to the government agencies in analyzing the taxation owed to the firm.
• Above all, the company is able to analyze its own performance over a specific time period.

Limitations of financial statement analysis

In spite of financial statement analysis being a highly useful tool, it also features some limitations, including comparability of financial data and the need to look beyond ratios. Although comparisons between two companies can provide valuable clues about a company’s financial health, alas, the differences between companies’ accounting methods make it, sometimes, difficult to compare the data of the two.

Besides, many a times, sufficient data are on hand in the form of foot notes to the financial statements so as to restate data to a comparable basis. Or else, the analyst should remember the lack of data comparability before reaching any clear-cut conclusion. However, even with this limitation, comparisons between the key ratios of two companies along with industry averages often propose avenues for further investigation.

Summary

To summarize, financial statement analysis is concerned with analyzing the balance sheet and the income statement of a business to interpret the business and financial ratios of a business for financial representations, business evaluation, in addition to financial forecasting.

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