2019-07-25 11:35:42Finance and Accounting: Finance and AccountingEnglishFinancial statement analysis evaluates the financial information of a business using various techniques including common size analysis,...https://quickbooks.intuit.com/in/resources/in_qrc/uploads/2019/07/A-businessman-analyzing-financial-report-data-using-various-financial-statement-analysis-tools.jpghttps://quickbooks.intuit.com/in/resources/finance-and-accounting-finance-and-accounting/financial-statement-analysis/Financial Statement Analysis: The Ultimate Guide

Financial Statement Analysis: The Ultimate Guide

8 min read

Financial Statement Analysis Example

A study was conducted on Linde Group to analyze the financial position of the company. Thus, financial data for the period ranging between 2010 and 2014 was used to carry out the analysis.

Linde Group is a global leader in gases and engineering solutions. It has a rich legacy of innovation with a strong focus on technology. The group sells products from a wide range of industries including chemicals, petrochemicals and steel.

So, various tools and techniques were used to undertake such an analysis. These included common size analysis, cash flow analysis and ratio analysis. As per the analysis, the key findings for the given period were as follows:

Key Findings

  • Sales increased gradually from 2010 to 2013 although year 2014 saw drop in sales by 1.77%
  • Cost of Goods Sold (COGS) had a negative growth rate in 2014. But in 2012, COGS had a high growth rate of 10.83%. Though the sales decreased in 2012 as compared to 2011, thus leading to high inventory in 2012.
  • Profitability was at its peak for the company in the years 2010 and 2013 as Net Income was close to 18% and 20% respectively of total sales. However, Net Income was close to 12% and 15% of total sales in the remaining years which was lower than that of 2010 and 2011.
  • PE ratio increased from 2010 to 2012 but it declined in 2011 and 2013. However in 2014, PE ratio increased to 22 which indicated that the firm was growing and its market price was also increasing. Thus, it was positive news for the investors.
  • Market to book value ratio of Linde was declining from 2011 to 2013. However, the ratio increased for the year 2014 which means that the investors regained trust in the company.

Analysis

Thus, the above analysis requires the company to increase its sales by undertaking increased sales promotion. Furthermore, the management needs to control its operating expenses that were high in 2014 as compared to the previous years. Likewise, the company also needs to offer increased cash discounts to increase cash sales as the trade debtors of the company increased.

Thus, we can conclude that financial statement analysis of Linde Group evaluates the financial information given in the statements of accounts. Furthermore, it helps the management in taking key decisions with regards to the operations of the company. Therefore, here is a step-by-step guide to understand what is analysis of financial statements.

Meaning of Financial Statement Analysis

Financial Statement Analysis is a financial management tool that helps in evaluating the financial data given in the financial statements. This analysis helps business owners and other key stakeholders in understanding the financial position and operating performance of the business. Further, it helps each of the stakeholders in making credit, investment and other business decisions.

Also, this kind of analysis helps in studying the relationship between various components of the financial statements and their interpretation. Thus, this analysis helps in knowing the profitability and the operational efficiency of the business. This further assists in forecasting the future condition and performance of the company.

Tools of Financial Statement Analysis

The most commonly used tools for analyzing financial statements include:

1. Common Size Statement Analysis

Common size analysis is also termed as vertical analysis. It is a technique that is used to analyze and interpret the financial statements. This technique helps in assessing the financial statements by considering each line item as a percentage of the base amount for that period.

In case of the income statement, the base is taken as the net sales. Whereas in case of balance sheet, the amount of total assets is taken as the base. Then, each line item in the income statement is expressed as a percentage of total sales. While, each item in the balance sheet is appropriated as a percentage of total assets.

2. Comparative Statement Analysis

This technique determines the profitability and financial position of a business by comparing financial statements for two or more time periods. This technique is also termed as Horizontal Analysis. Typically, income statement and balance sheet are prepared in a comparative form to undertake such an analysis.

Furthermore, there is a provision attached with comparing the financial data showcased by such statements. This relates with making use of the same accounting principles for preparing each of the comparative statements. In case same accounting principles are not followed to prepare such statements, then the difference must be disclosed in the footnote below.

3. Ratio Analysis

Financial ratios showcase relationship between accounting items that form part of the financial statements. These are mathematical numbers that are expressed in terms of percentage, fraction, proportion or number of times.

Furthermore, it is important that two or more numbers extracted from financial statements for the calculation of ratios must be correlated. This is because financial statement items having no correlation if chosen for ratio analysis would be meaningless. These unrelated numbers would not give any information whatsoever about the company’s financial position and future performance.

Typically, ratios are classified based on the purpose for which such ratios are calculated. These include:

  • Liquidity Ratios
  • Solvency Ratios
  • Activity Ratios
  • Profitability Ratios

4. Cash Flow Analysis

The statement of Cash flows represents your entity’s cash inflows and outflows for a specified period. It also showcases the non-cash investing and financing activities of your business for the same period. This information is significant to the varied stakeholders of your business including lenders and suppliers. Thus, these stakeholders assess your business’ ability to generate cash and the needs of your enterprise to utilize those cash flows. And this is done on the basis of the cash flow data.

In order to showcase cash flows generated or used due to the different business activities, such activities are classified into three categories: (i) operating, (ii) investing and (iii) financial activities.

Cash Flow from Operating Activities

The primary revenue generating activities of your business refer to the operating activities. These are the main activities that involve production and sale of your goods and services.

Cash Flow From Investing Activities

Investing activities refer to the acquisition and disposal of long-term assets as well as investments not considered as cash equivalents. These include purchase and sale of long term assets or fixed assets such as plant and machinery, land building etc.

Cash Flow From Financing Activities

Financing activities refer to the capital or long-term funds of your business.These are the outcome of changes in the proportion and structure in the owner’s capital and borrowings of your business. The elements of cash flow from financing activities include:

  • inflows from additional borrowing and equity financing and
  • outflows for repayment of debt, dividend payments and equity repurchases.

Now, the Cash flows from operating, investing and financing activities should be reported by using either direct method or indirect method.

Direct Method

Under the direct method, all the major categories of cash receipts and cash payments of your business are reported. These receipts and payments are segregated into different heads. Such heads include cash flows from:

  • Operating Activities
  • Investing Activities
  • Financing Activities

Indirect Method

The reporting of investing and financing activities under both direct and indirect method is exactly same. However, reporting of cash flows generated from operating activity is quite different under the indirect method.

Under this method, the ascertaining of cash flows generated from operating activities begins with a company’s net profit or loss. This is so because the income statements includes certain non-cash items like depreciation and non-operating items like interest paid. Therefore, it becomes necessary to adjust the amount of net profit or loss for all such non-cash, non-operating items.

5. Trend Analysis

Trend Analysis is a type of analysis that indicates the direction of changes occurring in the line items of the financial statements. It involves calculating percentage change occurring in each of the line items of the financial statements in a given year compared to the same line items in the base year.

Thus, Trend Analysis as tool analyzes the financial statements by calculating the trends of a series of information. Whereas tools like comparative statements and common size statements also showcase percentage changes but they determine such changes bit differently.

In case of comparative statements, each line item of the current year’s income statement and balance sheet is compared with itself in the previous year. This is done to know the changes in each of the line items. Likewise, common-size statements analyze the changes in the line items as compared to the base item. That is sales in case of income statement and total assets or liabilities in case of balance sheet.

Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.

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