The Purpose of Analyzing Financial Statements

The term “Financial Statement Analysis” refers to what?

It’s the examination, appraisal, and interpretation of an organization’s financial statements. It is a process of establishing a link between the financial statements’ numerous components. Accounting records, such as income statements, balance sheets, and profit and loss statements, fall under this category. Financial statement analysis is used by analysts to get a comprehensive view of an organization’s financial situation and performance. All analyses are conducted in light of the industry and economic environment in which a firm operates. It helps to determine the strengths and flaws of an organization. Stakeholders, current and future investors, and regulators will all benefit from this information. Financial statement analysis has a wide range of purposes, as we’ll see in the next sections.

The data that organizations disclose financially may be deciphered with the aid of financial statement analysis. It helps to evaluate the quality and capability of the company’s profits by analyzing the company’s current and prospective earnings trends. They are able to detect and assess debt, repayment schedules, and related cash flow. The amount of interest that must be paid to repay the obligation is also made clear. It is also possible to get insight into the company’s overall financial picture by studying its revenue and expenditure statements as well as its dividend policy and a variety of other factors.

The Purpose of Analyzing Financial Statements

An evaluation of one’s ability to earn money

It is one of the primary goals of financial statement analysis to determine a company’s ability to produce money. In order to make an informed decision on a company’s financial health, customers may use this tool to analyze the company’s financial reports based on previous results. Furthermore, it provides a glimpse into the company’s future performance and earnings potential. There are several profitability measures that may be used to determine a company’s earning potential. Gross profit margin, net profit margin, and return on equity are a few examples.

Prospective investors may rest easy knowing that their money will pay the company’s cost of capital, fulfill its working capital needs, and create profits. There can be no survival, development, or appraisal of expansion potential if there are no profits.

Assessing the Management’s Effectiveness.

The goal of a financial statement analysis is to provide light on a company’s managerial performance. Analysts may determine how well or how badly management has done over time by doing a trend analysis or comparing year-to-year outcomes. An examination of auditing practices and the efficiency of internal control measures is provided. Financial statement analysis also aims to evaluate the company’s and its management’s operational effectiveness.

Patterns of Profitability Have Changed

The study of financial statements is critical when the company’s financial performance falls short of expectations and does not meet the standards expected. We’ll find out what happened to our earnings by conducting an investigation. Input costs may have increased, capital expenditures may have been unexpected, a natural catastrophe may have occurred, or some other tragedy may have occurred, for example. Don’t leap to conclusions, stakeholders, and other interested parties. Instead, they should thoroughly review the analysis report and attempt to determine the true cause of the company’s poor performance before making any significant financial choices.

Making Comparisons Among Different Companies

It is the goal of financial statement analysis to make it easier to compare one company to another. The financial and operational performance of two or more firms may be compared by analysts and other interested parties. In a few quarters, any corporation might have dismal outcomes. As a result, the study helps determine if the underperformance is short-term or long-term in nature. Even if an organization has a high degree of leverage and has excellent performance when compared to its competitors, it will still have a significant interest expense. It is the goal of the study to reveal such vital information and to assist stakeholders in deciding which of the options is the best overall.

Making and Keeping a Record of Decisions

Financial statement analysis has a primary goal of aiding in decision-making and control. Management sees financial statements as a type of report card for the company’s success over a period of time from their perspective. Making the appropriate choices for the company’s future relies on analysis. When things aren’t going as planned, they assist the company’s management take remedial action. Furthermore, when it comes to making critical judgments on mergers and acquisitions, it is essential to do a complete study.

Stakeholders’ Access to Information

The study of financial statements also strives to offer a foundation for essential government and statutory agency decision-making. Among the areas that are influenced by this study are licensing and controls, imposing price and profit caps, granting concessions and subsidies to the needy sectors, and so forth. Additionally, banks and other financial institutions benefit from the study when deciding whether or not to lend firm money.

The Right Path and a Focus on the Future

It is the goal of financial statement analysis to provide a firm with a sense of direction and lead it to success. Comparative statements, trend analysis, ratio analysis, and cash-flow analysis are some of the techniques used. These instruments aid management in properly evaluating and planning their financial outcomes. The analysis is dynamic and continually changing. It serves as a constant reminder to the company’s leaders of any deviations from the path they had envisioned. This helps the organization achieve its objectives and ensures its long-term viability.

Conclusion

Financial statement analysis has a wide range of aims. Management, as well as outsiders like creditors, lenders, investors, labor unions, and financial experts all, stand to gain from this plan of action. Management and business efficiency may be improved via the use of analysis. In addition, it provides insight into the company’s financial health and profit potential.

There are, however, a number of drawbacks to this kind of study. The financial statement serves as the starting point for financial statement analysis. A rosy image is painted by management by means of window dressing. In addition, the assertions fail to take inflation, price changes, and other non-monetary factors into account. Since the financial statement analysis has a chance to fail, it’s important to keep this in mind:

Read Also

The Different Types of Costing
Meaning, Formula, and Example of Equivalent Annual Cost
Fraudulent Bankruptcy – Meaning, Types, Civil and Criminal Bankruptcy Fraud
Stock Markets Across the Globe
Meaning, Formula, and Example of the Capital Recovery Factor

Leave a Comment