5 Common Techniques Of Financial Statement Analysis

The financial statement analysis is important for an organisation as it reviews the financial data presented in the financial statement in order to make an informed decision. The comparative financial statement, balance sheet, bank account statements and statements of cash flow are financial statements that are the subject of this type of analysis.

This article will discuss the most important tools (horizontal, vertical and ratio analysis) and methods such as comparative statements, funds flow statements, trend analysis, cash volume profit analysis, and cash flow analysis to perform the financial statement analysis.

What Are The Three Basic Tools For Financial Statement Analysis?

Finance statement analysis is a process of analysing an organisation’s financial statement. This analysis helps an organisation in making important decisions. Stakeholders use this analysis for estimating the business value and financial status of a firm before considering long-term contracts. Similarly, within a firm, it is helpful in monitoring and managing finance.

It forces a company to create a balance sheet, cash flow and income statement. Thus, financial statement analysis is mandatory for internal and external stakeholders to analyse an organisation’s performance. Moreover, for performing the financial statement analysis, three basic tools, namely horizontal analysis, vertical analysis and ratio analysis, are common. 

Horizontal Analysis

Horizontal analysis is the method of comparison of financial data. It includes the analysis of revenue and expense accounts to observe trends at different time periods. Horizontal analysis in financial statement analysis is mostly represented in the form of a percentage. For example, if a company compares its 2021 revenue with last 2020’s statistics, it will be considered a horizontal analysis. Both increasing and decreasing trends of the items in the financial statements provide valuable information for making important decisions and investment plans. The formula for performing horizontal analysis is as follows:

Percentage Change= ((Dollar Change)/(Base Year Amount))×100

Where, Dollar Change=Year of Analysis Amount-Base Year Amount

Here, the base year is the year chosen to compare with. To make this analysis more concise, you can hire the best finance writers of dissertation writing services UK.

Vertical Analysis 

Common size analysis (another name for vertical analysis) is the tool for financial statement analysis that expresses each line item as a percentage of the common base, which is always equal to 100. In other words, the vertical analysis is the comparison between items enlisted in one line with the items enlisted in another within the same finance statement. If a company compares its total cash generated with its total assists in the current year, then it will be an example of vertical analysis.

It is different from the horizontal analysis, which compares different financial statement items across different years. It examines how many individual items contribute to the overall health of a company. The formula for performing the vertical analysis is as follows:

Common size percentage= ((Comparison Amount)/(Base Amount))  ×100

The base amount is the item that we consider 100%, while the comparison amount is the financial data of each line item that contributes to the overall health of a company that we want to explore. 

Ratio Analysis

Ratio analysis aims to develop a meaningful relationship between items like profit and loss in the balance sheet. In short, it expresses the relationships between more than two accounts by dividing one number into another to get a percentage or proportion. This tool for financial statement analysis is equally important for both internal and external parties’ decision-making processes. It highlights the solvency, profitability, capital gearing and solvency.

What Are The Five Methods Of Financial Statement Analysis?

There are many methods of financial statement analysis, but the following session will provide a brief description of only the five most important ones;

Comparative Statement 

It compares different items like profit, loss, and balance sheets for two or more periods. Comparative statements are those statements that contain financial information from different periods of an organisation. Comparative financial statements are a popular method to present a quick eye view of the financial condition of a firm. They mostly contain tables having years based data regarding different items of a financial statement. Thus, a comparative financial statement is an important technique for financial statement analysis.   

Fund Flow Statement

Without a fund flow statement, the financial statement analysis cannot be performed. This is because it depicts the total sources and application of funds for a given time period. In this method, the main task is to measure the changes in an organisation’s financial conditions from the beginning to the end of a period.    

Cost Volume Profit Analysis

This method of financial statement analysis explains the relationship between cost, sale and profit. The cost in this method may be fixed as well as variable. Moreover, the relationship between the variable costs and fixed sales always remains constant. Cost volume profit analysis enables management to make better profit planning decisions.  

Cash Flow Analysis

It is another important financial statement analysis method. This method monitors the trends in cash transferred and bank balance details to review the financial health of a firm. In other words, instead of working capital, it measures the cash movement. Generally, we perform cash flow by measuring the notion or actual cash flows.   

Trend Analysis

Trend analysis compares the ratios of different items across different years. It is the best way to find whether the trends of a company are upward or downward. It is based on the principle that what happened in the past can predict what will happen in the future. It is simply a mathematical method that uses historical trends to forecast future outcomes. The comparison between trends of different organisations and comparison between the trends of an organisation at different periods both are the subjects of trend analysis in finance management. Most of the students feel lots of problems in the comparison and hence hire best assignment writing services.

Bottom Lines:

Financial statement analysis is an integral part of financial management that allows companies to make informed decisions. The three main tools for analysing financial statements include horizontal, vertical and ratio analysis. In horizontal analysis, we compare the financial statements of a firm across different periods, while vertical analysis is the comparison between different finance items within the same finance statement.

Similarly, the ratio is the division of different finance items to see the trends in the form of a percentage. Besides, comparative statements, funds flow statements, trend analysis, cash volume profit analysis and cash flow analysis are only a few methods. At the same time, you can also use average analysis, statement of changes in working capital, comparative income statement, common size statement and comparative balance sheet for this type of analysis.

By JonathanNaylor

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