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• Financial Statement Analysis
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Types of Financial Statements

Financial performance.

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• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Financial Statement Analysis: How It’s Done, by Statement Type

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

What Is Financial Statement Analysis?

Financial statement analysis is the process of analyzing a company’s financial statements for decision-making purposes. External stakeholders use it to understand the overall health of an organization and to evaluate financial performance and business value. Internal constituents use it as a monitoring tool for managing the finances.

Key Takeaways

• Financial statement analysis is used by internal and external stakeholders to evaluate business performance and value.
• Financial accounting calls for all companies to create a balance sheet, income statement, and cash flow statement, which form the basis for financial statement analysis.
• Horizontal, vertical, and ratio analysis are three techniques that analysts use when analyzing financial statements.

Jiaqi Zhou / Investopedia

How to Analyze Financial Statements

The financial statements of a company record important financial data on every aspect of a business’s activities. As such, they can be evaluated on the basis of past, current, and projected performance.

In general, financial statements are centered around generally accepted accounting principles (GAAP) in the United States. These principles require a company to create and maintain three main financial statements: the balance sheet, the income statement, and the cash flow statement. Public companies have stricter standards for financial statement reporting. Public companies must follow GAAP, which requires accrual accounting. Private companies have greater flexibility in their financial statement preparation and have the option to use either accrual or cash accounting.

Several techniques are commonly used as part of financial statement analysis. Three of the most important techniques are horizontal analysis , vertical analysis , and ratio analysis . Horizontal analysis compares data horizontally, by analyzing values of line items across two or more years. Vertical analysis looks at the vertical effects that line items have on other parts of the business and the business’s proportions. Ratio analysis uses important ratio metrics to calculate statistical relationships.

Companies use the balance sheet, income statement, and cash flow statement to manage the operations of their business and to provide transparency to their stakeholders. All three statements are interconnected and create different views of a company’s activities and performance.

Balance Sheet

The balance sheet is a report of a company’s financial worth in terms of book value. It is broken into three parts to include a company’s assets ,  liabilities , and  shareholder equity . Short-term assets such as cash and accounts receivable can tell a lot about a company’s operational efficiency; liabilities include the company’s expense arrangements and the debt capital it is paying off; and shareholder equity includes details on equity capital investments and retained earnings from periodic net income. The balance sheet must balance assets and liabilities to equal shareholder equity. This figure is considered a company’s book value and serves as an important performance metric that increases or decreases with the financial activities of a company.

Income Statement

The income statement breaks down the revenue that a company earns against the expenses involved in its business to provide a bottom line, meaning the net profit or loss. The income statement is broken into three parts that help to analyze business efficiency at three different points. It begins with revenue and the direct costs associated with revenue to identify gross profit . It then moves to operating profit , which subtracts indirect expenses like marketing costs, general costs, and depreciation. Finally, after deducting interest and taxes, the net income is reached.

Basic analysis of the income statement usually involves the calculation of gross profit margin, operating profit margin, and net profit margin, which each divide profit by revenue. Profit margin helps to show where company costs are low or high at different points of the operations.

Cash Flow Statement

The cash flow statement provides an overview of the company’s cash flows from operating activities, investing activities, and financing activities. Net income is carried over to the cash flow statement, where it is included as the top line item for operating activities. Like its title, investing activities include cash flows involved with firm-wide investments. The financing activities section includes cash flow from both debt and equity financing. The bottom line shows how much cash a company has available.

Free Cash Flow and Other Valuation Statements

Companies and analysts also use free cash flow statements and other valuation statements to analyze the value of a company . Free cash flow statements arrive at a net present value by discounting the free cash flow that a company is estimated to generate over time. Private companies may keep a valuation statement as they progress toward potentially going public.

Financial statements are maintained by companies daily and used internally for business management. In general, both internal and external stakeholders use the same corporate finance methodologies for maintaining business activities and evaluating overall financial performance .

When doing comprehensive financial statement analysis, analysts typically use multiple years of data to facilitate horizontal analysis. Each financial statement is also analyzed with vertical analysis to understand how different categories of the statement are influencing results. Finally, ratio analysis can be used to isolate some performance metrics in each statement and bring together data points across statements collectively.

Below is a breakdown of some of the most common ratio metrics:

• Balance sheet : This includes asset turnover, quick ratio, receivables turnover, days to sales, debt to assets, and debt to equity.
• Income statement : This includes gross profit margin, operating profit margin, net profit margin, tax ratio efficiency, and interest coverage.
• Cash flow : This includes cash and earnings before interest, taxes, depreciation, and amortization (EBITDA) . These metrics may be shown on a per-share basis.
• Comprehensive : This includes return on assets (ROA) and return on equity (ROE) , along with DuPont analysis .

What are the advantages of financial statement analysis?

The main point of financial statement analysis is to evaluate a company’s performance or value through a company’s balance sheet, income statement, or statement of cash flows. By using a number of techniques, such as horizontal, vertical, or ratio analysis, investors may develop a more nuanced picture of a company’s financial profile.

What are the different types of financial statement analysis?

Most often, analysts will use three main techniques for analyzing a company’s financial statements.

First, horizontal analysis involves comparing historical data. Usually, the purpose of horizontal analysis is to detect growth trends across different time periods.

Second, vertical analysis compares items on a financial statement in relation to each other. For instance, an expense item could be expressed as a percentage of company sales.

Finally, ratio analysis, a central part of fundamental equity analysis, compares line-item data. Price-to-earnings (P/E) ratios, earnings per share, or dividend yield are examples of ratio analysis.

What is an example of financial statement analysis?

An analyst may first look at a number of ratios on a company’s income statement to determine how efficiently it generates profits and shareholder value. For instance, gross profit margin will show the difference between revenues and the cost of goods sold. If the company has a higher gross profit margin than its competitors, this may indicate a positive sign for the company. At the same time, the analyst may observe that the gross profit margin has been increasing over nine fiscal periods, applying a horizontal analysis to the company’s operating trends.

Congressional Research Service. “ Cash Versus Accrual Basis of Accounting: An Introduction ,” Page 3 (Page 7 of PDF).

Internal Revenue Service. “ Publication 538 (01/2022), Accounting Periods and Methods: Methods You Can Use. ”

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A | Financial Statement Analysis

Financial statement analysis.

Financial statement analysis reviews financial information found on financial statements to make informed decisions about the business. The income statement, statement of retained earnings, balance sheet, and statement of cash flows, among other financial information, can be analyzed. The information obtained from this analysis can benefit decision-making for internal and external stakeholders and can give a company valuable information on overall performance and specific areas for improvement. The analysis can help them with budgeting, deciding where to cut costs, how to increase revenues, and future capital investments opportunities.

When considering the outcomes from analysis, it is important for a company to understand that data produced needs to be compared to others within industry and close competitors. The company should also consider their past experience and how it corresponds to current and future performance expectations. Three common analysis tools are used for decision-making; horizontal analysis, vertical analysis, and financial ratios.

For our discussion of financial statement analysis, we will use Banyan Goods. Banyan Goods is a merchandising company that sells a variety of products. The image below shows the comparative income statements and balance sheets for the past two years.

Keep in mind that the comparative income statements and balance sheets for Banyan Goods are simplified for our calculations and do not fully represent all the accounts a company could maintain. Let’s begin our analysis discussion by looking at horizontal analysis.

Horizontal Analysis

Horizontal analysis (also known as trend analysis) looks at trends over time on various financial statement line items. A company will look at one period (usually a year) and compare it to another period. For example, a company may compare sales from their current year to sales from the prior year. The trending of items on these financial statements can give a company valuable information on overall performance and specific areas for improvement. It is most valuable to do horizontal analysis for information over multiple periods to see how change is occurring for each line item. If multiple periods are not used, it can be difficult to identify a trend. The year being used for comparison purposes is called the base year (usually the prior period). The year of comparison for horizontal analysis is analyzed for dollar and percent changes against the base year.

The dollar change is found by taking the dollar amount in the base year and subtracting that from the year of analysis.

Using Banyan Goods as our example, if Banyan wanted to compare net sales in the current year (year of analysis) of $120,000 to the prior year (base year) of $100,000, the dollar change would be as follows:

The percentage change is found by taking the dollar change, dividing by the base year amount, and then multiplying by 100.

Let’s compute the percentage change for Banyan Goods’ net sales.

This means Banyan Goods saw an increase of $20,000 in net sales in the current year as compared to the prior year, which was a 20% increase. The same dollar change and percentage change calculations would be used for the income statement line items as well as the balance sheet line items. The image below shows the complete horizontal analysis of the income statement and balance sheet for Banyan Goods.

Depending on their expectations, Banyan Goods could make decisions to alter operations to produce expected outcomes. For example, Banyan saw a 50% accounts receivable increase from the prior year to the current year. If they were only expecting a 20% increase, they may need to explore this line item further to determine what caused this difference and how to correct it going forward. It could possibly be that they are extending credit more readily than anticipated or not collecting as rapidly on outstanding accounts receivable. The company will need to further examine this difference before deciding on a course of action. Another method of analysis Banyan might consider before making a decision is vertical analysis.

Vertical Analysis

Vertical analysis shows a comparison of a line item within a statement to another line item within that same statement. For example, a company may compare cash to total assets in the current year. This allows a company to see what percentage of cash (the comparison line item) makes up total assets (the other line item) during the period. This is different from horizontal analysis, which compares across years. Vertical analysis compares line items within a statement in the current year. This can help a business to know how much of one item is contributing to overall operations. For example, a company may want to know how much inventory contributes to total assets. They can then use this information to make business decisions such as preparing the budget, cutting costs, increasing revenues, or capital investments.

The company will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup. These percentages are considered common-size because they make businesses within industry comparable by taking out fluctuations for size. It is typical for an income statement to use net sales (or sales) as the comparison line item. This means net sales will be set at 100% and all other line items within the income statement will represent a percentage of net sales.

On the balance sheet, a company will typically look at two areas: (1) total assets, and (2) total liabilities and stockholders’ equity. Total assets will be set at 100% and all assets will represent a percentage of total assets. Total liabilities and stockholders’ equity will also be set at 100% and all line items within liabilities and equity will be represented as a percentage of total liabilities and stockholders’ equity. The line item set at 100% is considered the base amount and the comparison line item is considered the comparison amount. The formula to determine the common-size percentage is:

For example, if Banyan Goods set total assets as the base amount and wanted to see what percentage of total assets were made up of cash in the current year, the following calculation would occur.

Cash in the current year is $110,000 and total assets equal $250,000, giving a common-size percentage of 44%. If the company had an expected cash balance of 40% of total assets, they would be exceeding expectations. This may not be enough of a difference to make a change, but if they notice this deviates from industry standards, they may need to make adjustments, such as reducing the amount of cash on hand to reinvest in the business. The image below shows the common-size calculations on the comparative income statements and comparative balance sheets for Banyan Goods.

Even though vertical analysis is a statement comparison within the same year, Banyan can use information from the prior year’s vertical analysis to make sure the business is operating as expected. For example, unearned revenues increased from the prior year to the current year and made up a larger portion of total liabilities and stockholders’ equity. This could be due to many factors, and Banyan Goods will need to examine this further to see why this change has occurred. Let’s turn to financial statement analysis using financial ratios.

Overview of Financial Ratios

Financial ratios help both internal and external users of information make informed decisions about a company. A stakeholder could be looking to invest, become a supplier, make a loan, or alter internal operations, among other things, based in part on the outcomes of ratio analysis. The information resulting from ratio analysis can be used to examine trends in performance, establish benchmarks for success, set budget expectations, and compare industry competitors. There are four main categories of ratios: liquidity, solvency, efficiency, and profitability. Note that while there are more ideal outcomes for some ratios, the industry in which the business operates can change the influence each of these outcomes has over stakeholder decisions. (You will learn more about ratios, industry standards, and ratio interpretation in advanced accounting courses.)

Liquidity Ratios

Liquidity ratios show the ability of the company to pay short-term obligations if they came due immediately with assets that can be quickly converted to cash. This is done by comparing current assets to current liabilities. Lenders, for example, may consider the outcomes of liquidity ratios when deciding whether to extend a loan to a company. A company would like to be liquid enough to manage any currently due obligations but not too liquid where they may not be effectively investing in growth opportunities. Three common liquidity measurements are working capital, current ratio, and quick ratio.

Working Capital

Working capital measures the financial health of an organization in the short-term by finding the difference between current assets and current liabilities. A company will need enough current assets to cover current liabilities; otherwise, they may not be able to continue operations in the future. Before a lender extends credit, they will review the working capital of the company to see if the company can meet their obligations. A larger difference signals that a company can cover their short-term debts and a lender may be more willing to extend the loan. On the other hand, too large of a difference may indicate that the company may not be correctly using their assets to grow the business. The formula for working capital is:

Using Banyan Goods, working capital is computed as follows for the current year:

In this case, current assets were $200,000, and current liabilities were $100,000. Current assets were far greater than current liabilities for Banyan Goods and they would easily be able to cover short-term debt.

The dollar value of the difference for working capital is limited given company size and scope. It is most useful to convert this information to a ratio to determine the company’s current financial health. This ratio is the current ratio.

Current Ratio

Working capital expressed as a ratio is the current ratio. The current ratio considers the amount of current assets available to cover current liabilities. The higher the current ratio, the more likely the company can cover its short-term debt. The formula for current ratio is:

The current ratio in the current year for Banyan Goods is:

A 2:1 ratio means the company has twice as many current assets as current liabilities; typically, this would be plenty to cover obligations. This may be an acceptable ratio for Banyan Goods, but if it is too high, they may want to consider using those assets in a different way to grow the company.

Quick Ratio

The quick ratio, also known as the acid-test ratio, is similar to the current ratio except current assets are more narrowly defined as the most liquid assets, which exclude inventory and prepaid expenses. The conversion of inventory and prepaid expenses to cash can sometimes take more time than the liquidation of other current assets. A company will want to know what they have on hand and can use quickly if an immediate obligation is due. The formula for the quick ratio is:

The quick ratio for Banyan Goods in the current year is:

A 1.6:1 ratio means the company has enough quick assets to cover current liabilities.

Another category of financial measurement uses solvency ratios.

Solvency Ratios

Solvency implies that a company can meet its long-term obligations and will likely stay in business in the future. To stay in business the company must generate more revenue than debt in the long-term. Meeting long-term obligations includes the ability to pay any interest incurred on long-term debt. Two main solvency ratios are the debt-to-equity ratio and the times interest earned ratio.

Debt to Equity Ratio

The debt-to-equity ratio shows the relationship between debt and equity as it relates to business financing. A company can take out loans, issue stock, and retain earnings to be used in future periods to keep operations running. It is less risky and less costly to use equity sources for financing as compared to debt resources. This is mainly due to interest expense repayment that a loan carries as opposed to equity, which does not have this requirement. Therefore, a company wants to know how much debt and equity contribute to its financing. Ideally, a company would prefer more equity than debt financing. The formula for the debt to equity ratio is:

The information needed to compute the debt-to-equity ratio for Banyan Goods in the current year can be found on the balance sheet.

This means that for every $1 of equity contributed toward financing, $1.50 is contributed from lenders. This would be a concern for Banyan Goods. This could be a red flag for potential investors that the company could be trending toward insolvency. Banyan Goods might want to get the ratio below 1:1 to improve their long-term business viability.

Times Interest Earned Ratio

Time interest earned measures the company’s ability to pay interest expense on long-term debt incurred. This ability to pay is determined by the available earnings before interest and taxes (EBIT) are deducted. These earnings are considered the operating income. Lenders will pay attention to this ratio before extending credit. The more times over a company can cover interest, the more likely a lender will extend long-term credit. The formula for times interest earned is:

The information needed to compute times interest earned for Banyan Goods in the current year can be found on the income statement.

The $43,000 is the operating income, representing earnings before interest and taxes. The 21.5 times outcome suggests that Banyan Goods can easily repay interest on an outstanding loan and creditors would have little risk that Banyan Goods would be unable to pay.

Another category of financial measurement uses efficiency ratios.

Efficiency Ratios

Efficiency shows how well a company uses and manages their assets. Areas of importance with efficiency are management of sales, accounts receivable, and inventory. A company that is efficient typically will be able to generate revenues quickly using the assets it acquires. Let’s examine four efficiency ratios: accounts receivable turnover, total asset turnover, inventory turnover, and days’ sales in inventory.

Accounts Receivable Turnover

Accounts receivable turnover measures how many times in a period (usually a year) a company will collect cash from accounts receivable. A higher number of times could mean cash is collected more quickly and that credit customers are of high quality. A higher number is usually preferable because the cash collected can be reinvested in the business at a quicker rate. A lower number of times could mean cash is collected slowly on these accounts and customers may not be properly qualified to accept the debt. The formula for accounts receivable turnover is:

Many companies do not split credit and cash sales, in which case net sales would be used to compute accounts receivable turnover. Average accounts receivable is found by dividing the sum of beginning and ending accounts receivable balances found on the balance sheet. The beginning accounts receivable balance in the current year is taken from the ending accounts receivable balance in the prior year.

When computing the accounts receivable turnover for Banyan Goods, let’s assume net credit sales make up $100,000 of the $120,000 of the net sales found on the income statement in the current year.

An accounts receivable turnover of four times per year may be low for Banyan Goods. Given this outcome, they may want to consider stricter credit lending practices to make sure credit customers are of a higher quality. They may also need to be more aggressive with collecting any outstanding accounts.

Total Asset Turnover

Total asset turnover measures the ability of a company to use their assets to generate revenues. A company would like to use as few assets as possible to generate the most net sales. Therefore, a higher total asset turnover means the company is using their assets very efficiently to produce net sales. The formula for total asset turnover is:

Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year.

Banyan Goods’ total asset turnover is:

The outcome of 0.53 means that for every $1 of assets, $0.53 of net sales are generated. Over time, Banyan Goods would like to see this turnover ratio increase.

Inventory Turnover

Inventory turnover measures how many times during the year a company has sold and replaced inventory. This can tell a company how well inventory is managed. A higher ratio is preferable; however, an extremely high turnover may mean that the company does not have enough inventory available to meet demand. A low turnover may mean the company has too much supply of inventory on hand. The formula for inventory turnover is:

Cost of goods sold for the current year is found on the income statement. Average inventory is found by dividing the sum of beginning and ending inventory balances found on the balance sheet. The beginning inventory balance in the current year is taken from the ending inventory balance in the prior year.

Banyan Goods’ inventory turnover is:

1.6 times is a very low turnover rate for Banyan Goods. This may mean the company is maintaining too high an inventory supply to meet a low demand from customers. They may want to decrease their on-hand inventory to free up more liquid assets to use in other ways.

Days’ Sales in Inventory

Days’ sales in inventory expresses the number of days it takes a company to turn inventory into sales. This assumes that no new purchase of inventory occurred within that time period. The fewer the number of days, the more quickly the company can sell its inventory. The higher the number of days, the longer it takes to sell its inventory. The formula for days’ sales in inventory is:

Banyan Goods’ days’ sales in inventory is:

243 days is a long time to sell inventory. While industry dictates what is an acceptable number of days to sell inventory, 243 days is unsustainable long-term. Banyan Goods will need to better manage their inventory and sales strategies to move inventory more quickly.

The last category of financial measurement examines profitability ratios.

Profitability Ratios

Profitability considers how well a company produces returns given their operational performance. The company needs to leverage its operations to increase profit. To assist with profit goal attainment, company revenues need to outweigh expenses. Let’s consider three profitability measurements and ratios: profit margin, return on total assets, and return on equity.

Profit Margin

Profit margin represents how much of sales revenue has translated into income. This ratio shows how much of each $1 of sales is returned as profit. The larger the ratio figure (the closer it gets to 1), the more of each sales dollar is returned as profit. The portion of the sales dollar not returned as profit goes toward expenses. The formula for profit margin is:

For Banyan Goods, the profit margin in the current year is:

This means that for every dollar of sales, $0.29 returns as profit. If Banyan Goods thinks this is too low, the company would try and find ways to reduce expenses and increase sales.

Return on Total Assets

The return on total assets measures the company’s ability to use its assets successfully to generate a profit. The higher the return (ratio outcome), the more profit is created from asset use. Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year. The formula for return on total assets is:

For Banyan Goods, the return on total assets for the current year is:

The higher the figure, the better the company is using its assets to create a profit. Industry standards can dictate what is an acceptable return.

Return on Equity

Return on equity measures the company’s ability to use its invested capital to generate income. The invested capital comes from stockholders investments in the company’s stock and its retained earnings and is leveraged to create profit. The higher the return, the better the company is doing at using its investments to yield a profit. The formula for return on equity is:

Average stockholders’ equity is found by dividing the sum of beginning and ending stockholders’ equity balances found on the balance sheet. The beginning stockholders’ equity balance in the current year is taken from the ending stockholders’ equity balance in the prior year. Keep in mind that the net income is calculated after preferred dividends have been paid.

For Banyan Goods, we will use the net income figure and assume no preferred dividends have been paid. The return on equity for the current year is:

The higher the figure, the better the company is using its investments to create a profit. Industry standards can dictate what is an acceptable return.

Advantages and Disadvantages of Financial Statement Analysis

There are several advantages and disadvantages to financial statement analysis. Financial statement analysis can show trends over time, which can be helpful in making future business decisions. Converting information to percentages or ratios eliminates some of the disparity between competitor sizes and operating abilities, making it easier for stakeholders to make informed decisions. It can assist with understanding the makeup of current operations within the business, and which shifts need to occur internally to increase productivity.

A stakeholder needs to keep in mind that past performance does not always dictate future performance. Attention must be given to possible economic influences that could skew the numbers being analyzed, such as inflation or a recession. Additionally, the way a company reports information within accounts may change over time. For example, where and when certain transactions are recorded may shift, which may not be readily evident in the financial statements.

A company that wants to budget properly, control costs, increase revenues, and make long-term expenditure decisions may want to use financial statement analysis to guide future operations. As long as the company understands the limitations of the information provided, financial statement analysis is a good tool to predict growth and company financial strength.

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Evaluating Corporate Financial Performance pp 131–212 Cite as

Financial Statement Analysis

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A primary approach to evaluating and comparing financial performance of enterprises is a ratio analysis , which deals with a set of metrics that are typically computed on the basis of inputs extracted from primary financial statements (discussed in Chapter 1 ) and notes to them (discussed in Chapter 2 ). As will be demonstrated in the following sections, most of those accounting ratios are calculated in a very simple way, as a quotient of just two numbers.

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Home » Explanations » Financial statement analysis » What is financial statement analysis?

What is financial statement analysis?

Definition and explanation, techniques of financial statement analysis.

• Limitations

Financial statement analysis is a function that involves the evaluation of reported financial statements of an entity, to aid stakeholders and users of those statements in their decision making. It seeks to establish relationships between various financial parameters so as to gain a better understanding of the entity’s financial health and performance. Financial statement analysis benefits both internal stakeholders (like management and existing shareholders) as well as external stakeholders (like potential investors, lenders and suppliers).

Financial statements typically include income statement , cash and fund flow statements and balance sheet . They record detailed financial transactions of the entity for a specific time period and thus reveal both financial performance and financial position of its business. A further analysis of these financial statements facilitates stakeholders with a lot of information which works as a key in their decision making process.

On the part of management, financial statement analysis reveals and identify areas of the organization that call for corrective actions, from investors’ perspective, it is a tool for gauging financial outlook and deciding upon the viability of their investment in the entity, and for vendors and suppliers, it helps dig into the entity’s creditworthiness and guides them in deciding whether or not they should consider providing goods and/or services to the entity on credit.

While there are several techniques of financial statement analysis, the three most widely used techniques are briefly discussed below:

1. Horizontal analysis

Horizontal analysis involves evaluation of financial statements on a historical basis. Under this technique, financial data is compared across time periods. For example, the progression of sales is evaluated over the years to evaluate the sales growth rate of the entity.

Horizontal analysis uses a base period and one or more comparison periods. The result of this analysis is generally expressed as a percentage with reference to the specified base period. The formula used to calculate percentages in a horizontal analysis is given below:

To understand the practical working of horizontal analysis, click here .

Benefits of horizontal analysis technique:

This technique of financial statement analysis offers the following advantages:

• Horizontal analysis helps identify and analyze trends and patterns in entity’s financial performance.
• By analyzing the progression of various financial parameters over the years, it helps in identifying areas of the strengths and weaknesses in the entity’s financial operations. For example, management can analyze the growth in entity’s profitability in relation to the growth in sales revenue over the years which may reveal actions needed to be taken towards cost control.
• This analysis provides a basis for estimating the entity’s future performance as well as assists in setting benchmarks or standards for forthcoming years.

Drawbacks of horizontal analysis technique:

Horizontal analysis technique also suffers from certain drawbacks; such as:

• It only compares relative financial performance without considering performance in absolute terms.
• Under this type of analysis, a change in classification of reported accounts can lead to misleading results.
• It can be manipulated to indicate desired but misleading results; for example, a comparison of line items amongst different quarters of the same year can lead to significantly different results when compared to the same quarter of different years.

2. Vertical analysis

As the name suggests, vertical analysis involves the assessment of various line items of a financial statement as a percentage of a specific base line item. For example, various expenses on an income statement are expressed as a percentage of sales and the share of each type of asset is expressed as a percentage of total assets. The percentages under a vertical analysis are derived by the following formula:

To understand the practical working of vertical analysis, click here .

Benefits of vertical analysis technique:

• It is an easy representation of relationship between various line items of the financial statement.
• It helps understand the relative share of each line item. For example, if direct material is a significant percentage of sales in relation to say, direct labor , the management can understand its impact on profitability and can thus focus a greater attention towards any possibility of reducing or controlling it.
• Since a vertical analysis converts absolute numbers to percentage terms, It can be employed for inter-firm comparison with other entities within the industry by equating companies of different scales.
• It helps in identifying trends to aid comparison over time periods.

Drawbacks of vertical analysis technique:

• It requires a standard benchmark percentage defined for the analysis to be meaningful and to actually assist in decision making. For example, a company may know that its marketing expenses are 10% of its sales; however without a defined standard percentage, it may not be able to decide on the reasonableness of this derived percentage.
• Need for consistency in base – for an appropriate comparison from year to year or company to company, the base used for comparison must be the same.

3. Ratio analysis

Ratio analysis involves evaluating relationship between various line items of financial statements like income statement and balance sheet. This is done by calculating various financial ratios and comparing them with some set standards. On the basis of this comparison, management can take corrective steps and other stakeholders can make informed decisions according to their specific situations.

The ratios that are derived to perform a financial statement analysis are typically categorized as follows:

• Liquidity ratios: measure an entity’s ability to service its near-term debts as well as to meet its near-term fund requirements. A typical set of liquidity ratios includes current ratio , quick or liquid ratio, absolute liquid ratio , and current cash debt coverage ratio etc.
• Solvency ratios: measure the long-term stability of a business entity by evaluating its ability to meet its fund requirements over a long period of time. These typically include debt to equity ratio , fixed assets to equity ratio , current assets to equity ratio , and capital gearing ratio etc.
• Profitability ratios: measure the ability of a commercial entity to generate profits for its stockholders or owners. These ratios can include gross and net profit ratio , P/E ratio, EPS ratio , and return on capital employed ratio etc.
• Activity ratios: measure the efficiency of a business entity to utilize or convert its assets into sales revenue or liquid funds. These ratios can include inventory turnover ratio , receivables turnover ratio , and fixed assets turnover ratio etc.

Benefits of ratios analysis technique:

• Ratios analysis indicates an entity’s financial health as well as its operational efficiency through various parameters (e.g., liquidity and solvency) which other analysis techniques may not address.
• This analysis indicates the entity’s current position and any necessary remedial actions that it needs to take. It, thus, helps management in financial activity planning of the entity.
• Ratios analysis provides a standard for inter-firm comparison.

Drawbacks of ratios analysis technique:

• Ratios analysis can give erroneous results if there is a difference in accounting presentation of different entities compared or different periods considered in the analysis.
• Its results are often limited to quantitative analysis only, and not qualitative analysis. For example, balance sheet may exhibit a healthy current ratio but will not reveal the level of obsolescence present in the inventory considered in the calculation.

Purpose of financial statement analysis

Financial statement analysis has considerable utility for all stakeholders of an entity. Some of its salient purposes are mentioned below:

• The primary purpose: The primary purpose of performing a financial statement analysis is to dig into financial health as well as operational efficiency of the entity through its various analysis techniques.
• Aids industry comparison: It helps stakeholders gauge where the entity’s financial performance stands as compared to its peers in the industry. This is possible even when other entities operate at materially different scales.
• Aids historical comparison: It helps identify trends in financial performance as well as understand the financial progression of the entity over the years.
• Forecasting and budgeting: The interpretation of financial statement analysis can help management take budgeting decisions. Stakeholders can also estimate and project future performance based on results of financial analysis.
• Basis for decision making: The ultimate goal of the analysis is to provide stakeholders with a means to evaluate financial performance giving them a basis for comprehensive decision making.

Limitations of financial statement analysis

While financial statement analysis is an important and useful exercise, it does suffer from certain limitations. These can include:

• High dependency on accuracy of financial statements: A financial statement analysis can be inaccurate and in fact can even be manipulated if the base financial statements are inaccurate.
• Change in accounting policies: Any change in accounting methodology or presentation can result in erroneous results, hampering the efficacy of inter-period or inter-firm comparison.
• Focus on quantitative analysis: While exercising a financial statement analysis, the primary focus is on quantitative data. The non-monetary and qualitative aspects that impact financial performance are often side-lined under.
• Only a tool not a solution: The analysis of financial statements is only a means to an end. The actual success of the analysis requires expert analysts to meaningfully interpret, analyze and then take appropriate and timely decisions about the matters involved.

All in all, financial statement analysis is an extremely vital function as it has utility for both internal and external stakeholders. Generally, a large part of this financial analysis is presented in annual reports along with the reported financial statements. This is done so that the information is easily accessible by all stakeholders. However, a leader is only as good as his team; thus for financial statement analysis to be meaningful, the financial statements themselves must be accurate and the interpretations applied must be meaningful.

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How to Write a Financial Analysis Paper

It takes a lot of time, studying, and calculation skills to know how to write a financial analysis paper perfectly. Finance is a narrow discipline that connects economics and mathematics, making applied business the discipline you need to master if you want to work in finance. However, you need to start somewhere, so learning about different types of financial papers and what to focus on in them is the first step on your way to graduate successfully.

One of the most difficult stages is learning how to write a financial analysis research paper. If you master this skill, you will be able to complete any other type of assignment because this one includes all the different activities you need to do and present in a single work. Furthermore, we will give you some tips on what to focus on in every element of your finance homework to avoid major revisions and score high on grades.

How to write a financial statement analysis paper

Collecting numerical data and completing financial statements is a necessary part of the work on your paper in accounting. To analyze data and work with it, you need to gather it first, and this is when you need to make sure you have or can compose the financial statement of a company. A financial statement includes a cash flow statement, an income statement, a balance sheet, and an equity statement. Collecting them is only the beginning, as further on, you should take the information you need from them.

• A cash flow statement demonstrates the sources the company obtains its money from and the ways it spends it.
• An income statement is a summary of the company’s revenues, the money it spends, and profitability statistics.
• A balance sheet is a document with information on the company’s asset allocations, shareholders, and liabilities.
• An equity statement , in turn, is the current data on the dynamics in the equity each stakeholder has in the company.

Depending on your particular assignment, you may not need all of them in your financial statement, but it is important you know where to look for every aspect of it. Anyway, CopyCrafter can clarify it if it looks too difficult for you, and even help with finance homework if needed, by the means of our expert paper writing service .

How to write an executive summary paper

An executive summary is something like an introduction to your financial analysis paper, in which you introduce the company, the problem you are working on, the methods you use to conduct the analysis, and the conclusion you eventually arrive at. Thus, it may serve as a substitution for reading the whole paper for people who do not want to check figures. For that reason, you need to work a lot on your executive summary, as it must reflect the quality of your work and it must represent your knowledge, understanding, and skills.

Make sure your executive summary is concise and easy to read yet contains only essential and relevant information. To create a comprehensive executive summary, you should include the company’s mission, history, performance, and profit. Then, finish it off with the conclusion your analysis arrives at, and invite the reader to read the whole thing.

How to write an industry analysis paper

Whether it is a small business or a huge corporation, the company you are writing about exists and functions in a certain ecology, which is its connection to the outside world—namely the market and the industry in this case. So, this part of the paper draws on the environment in which the company operates. The main aim of the industry analysis is to determine whether the company is a powerful competitor in this field and whether investing in this company will eventually bring any profit.

For that reason, you will need to include the information on the behavior of the company in its industry, which includes the report of the company’s financial health, the comparison of it with companies with the same specifications, its share of the target market, and the possible development or decay of the company. It is important to remember that industry analysis is not about promoting investment in the company but drawing a realistic picture of the pros and cons of digits. It must give the possible investor information to use while making a weighted decision.

How to write a paper on financial ratios

Another thing you should include in your financial analysis paper is the part in which you dwell on the different financial ratios of the company you have chosen. The ratios must provide information on the company’s debt load, liquidity, and efficiency. To measure these, you need to spend some time observing the last activity of the company in the market. Here is what you should pay attention to:

• To figure out the debt load ratio, you need to compare the total debt of the company to the total of its equity.
• To figure out the liquidity ratio, compare the company’s current ratio to its current liability.
• The return ratio is the relation between the profits that the company makes compared to the equity of its shareholders.
• To calculate the ratio of price to earnings, you need to divide the actual market price per share by the earnings after taxation per share.

Every ratio will give you an idea of the profitability of the company, its potential, and the shareholder opportunities, although it needs some calculations.

Types of financial analysis

There are several pathways you may choose in your financial analysis paper. Usually, the choice will depend on the peculiarities of your assignment. So, here are all of them for you to choose the optimal one. They differ in the initial point of the analysis and the direction you can take in it. Consequently, your conclusion will also depend on the analysis direction of your choice.

• The horizontal analysis aims to compare consecutive activity reports of a company throughout a certain period of time. It is horizontal because the reports are supposed to be linear. So, if you want to study the dynamics of a company, choose this type.
• Vertical analysis is used mostly for filling out a balance sheet. It is an analysis of expenses and income that is measured by percentage in the chain and stock sales.
• In a short-term analysis, you need to review the working capital in detail, which includes the turnover rate calculation, inventory, and payable accounts of a company. This analysis helps to figure out whether there is any difference in the long-term average turnover rate, which may be alarming for business.
• Multi-company comparison is focused on the ratio component of businesses. You need to calculate the ratios mentioned before in different companies and base your comparison on the digits you get.
• To conduct an industry comparison, you need to work with ratios as well. However, the difference between it and multi-company comparison is that here you need to focus on the average results in the whole industry compared to the performance by these criteria of a certain company.

Evidently, all these tips may seem too abstract in theory. However, when you know what company you are going to analyze, everything will fall in place. Depending on the aim of your analysis, take the starting point based on the analysis type, and make sure to include all the components which should be there. Finally, present it in a brief, comprehensive, and intelligible executive summary.

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Term Paper on Financial Statement analysis

The general objective of this report is to analysis Financial Statement analysis of Beximco Pharmaceuticals Limited. Other objectives are know the financial condition and to know the financial position the pharmaceutical section. Report also focus on to guess its future condition and to know about its past condition of this company. Report also use of cash flows analysis to evaluate the financial health of an enterprise.

Introduction

Beximcon pharma is a Leading pharmaceutical company base is Dhaka, Bangladesh. It is a member of the “Beximco group” the largest private section industrial conglomerate in Bangladesh. Their strategic strengths include strong recognition of their brands. They stated their operation in 1980. manufacturing product under the licenses of Bayer Ag of Germany and Upjohn Inc of USA and now have grown to be come nation, some of the heading pharmaceutical companies. Supplying more than 10% of county’s total medicine need today “Beximco pharma” manufactures and markets its own branded gene ricers for almost all deceases from AIDS to cancer. They market their bonds though their own professional sales and marketing terms in African, South Asian, and other markets. They also supply their products to owned hospitals and institution in many countries.

Financial Statement Analyses is a special art of going in depth to the financial Statement by the people who have expertise to do so. Without this it helps investors and creditors to improve their economic decisions. We will examine the impact of the differential application of accounting methods and estimates on financial statements with particular emphasis on the effect of accounting choices on reported earning, stockholder equity, cash flow and various measures of corporate performance (including but not limited to financial ratios). We will also stress the use of cash flows analysis to evaluate the financial health of an enterprise.

Background of the repot

Beximco pharma is a leading company based in Dhaka, and is acclaimed for its outstanding product quality, world class manufacturing facility product development capabilities and outstanding professional service. Without this Beximco pharma has long enjoyed the equation of being a leader in setting the trends in Bangladesh pharmaceutical industry. 25 years have passes since we started out own operation. In the last 25 years they lead the domestic pharmaceutical market in several dimensions.

In 25 years of operating in healthcare business, the true and reliability on their products has emerged as one of our core competencies. Today, the mane “Baximco pharma” has become synonymous with true and reliability. Quality is their relentless passion.

• To know the financial condition.
• To know the financial position the pharmaceutical section.
• To guess its future condition.
• To know about its past condition

Different types of Ratios and there objectives :

Short-term liquidity Ratios:

Short- term liquidity ratios are the measurement of a firm’s ability to meet its short-term obligation. Two ratios are typically used to measure short-term liquidity 1) current ratio and 2) quick ratio. Both focus on the relationship between current assets and current liabilities. The quick ratio is the moiré conservative measure of liquidity.

Current Ratio:

Current ratio is an assessment of a firm’s short-term liquidity. It is computed by dividing current assets by current liabilities.

Quick Ratio:

Quick ratio is a conservative assessment of a firm’s short-term liquidity.

It is computed by dividing quick assets (cash, receivables, and marketable securities) by current liabilities.

Debt- Management Ratios:

Debt- management ratios are the measurements of a firm’s ability to meet obligations involving debt. In general debt management’s ratio measures either (1) the excess of earnings over interest or (2) the proportion of debt in the business liabilities and equity.

Times-Interest-earned Ratio:

It is the measurements of the excess of income available for interest payment over the amount of interest payments. The equation used to calculate this ratio is: (net income+ interest+ taxes)/ interest.

Debt to Equity Ratio:

This is the measurements of the proportion of capital provided by creditors relative to that provided by stock holders. It is computed by dividing total debt by total equity.

Operating Ratios:

Operating ratio (efficiency ratio) are measures of how intensely a business uses its assets. The principal operating ratio is measure of turnover, the average length of time required for assets to be consumed or replaced.

Accounts Receivable turnover Ratio:

It is the measurement of the number of times account receivable is turned over each year. It is computed by dividing net credit sales by average account receivable.

Inventory turnover Ratio:

Inventory turnover ratio is the measurement of the number of times inventory is turned over each year. The equation used for computation is cost of good sold/ average inventory.

Assets turnover Ratio:

The ratio is used to measure the intensity with which business assets arused to produce sales revenue. It is computed by dividing net sales by the average total assets.

Profitability Ratios:

Profitability ratios are the measurement of (1) the contribution of the elements of operations of profit or (2) the relationship of profit to total investment and investment by stockholders.

Goss margin Ratios:

It is the measurement of the proportion of each sales taka that is available to pay other expenses and provide profit for owners. This ratio is computed by dividing gross margin by net sales.

Operating income Ratio:

It is the measurement of the profitability of business operations in relation to its sales. It is compared by dividing operating income by net sales.

Net income Ratio:

This ratio is the measurement of the proportion of each sales taka that is profit. The equation for computation the ratio is: net income / net sales.

Returns on assets Ratio:

Return on assets ratio is the measurement of the profit earned by a firm through the use of all its capital, or the total investment by both creditor and owners. The equation for computation of this ratio is:( net income+ interest)/ average total assets

Returns on Equity Ratio:

This ratio is the measurement of the profit earned by a firm through the use of capital supplied by stockholders. The equation for computation is: net income/ average equity.

CURRENT RATIO :

CURRENT RATIO= CURRENT ASSETS/CURRENT Liabilities

NOTE: Here the assets of 31 December, 2006 are 1.78. so, we can say that the situation of assess and liabilities of 31 December 2006 is better than assets and liabilities 31 December 2005 and 2004.in this ratio we see that the company has 1.78 in current assets to cover each 1.00 in current liabilities.

QUICK RATIOS:

  QUICK Ratio= (CURRENT ASSETS-Inventories)/Current liabilities

NOTE: Here 31 December, 2006 quick ratio is 1.19.we can say that 31t December 2006 quick ratio is better than previous years. In this situation we can say that the company has 1.19 sales of inventory to pay the bills.

Cash flow liquidity

  Cash flow liquidity = (Cash + market securities + CFO)/Current liabilities

Note: It explaining the improvement in the cash flow liquidity ratio and stronger short-term solvency.

Leverage ratio: Debit financing and coverage

Debt Ratio:

Debt Ratio = Total liabilities/Total Assets

NOTE: The debt ratio indicates how borrowing has financed much of the firm’s assets lower the ratio means lower amounts of borrowing. In year 2006 the ratio is lower than previous years.

Debt to equity ratio:

Debt to equity ratio = Total liabilities/Share holders equity

NOTE: Debt to ratio is decreasing year 2006. But it is increases in 2005 not good for the company. Because the higher degree of debt the greater is the degree of risk. There have a chance bankruptcy

Times-Interest – Earned Ratio:

Times-Interest – Earned Ratio = (Net income+ interest + taxes)/ Interest expense

Note: Times –interest – earned ratio has increase in the year 2005 but it decreases in 2006. So the company is now in a stable position.

Activity ratios: assets liquidity, assets management efficiency

average collection period:

Average collection period= Accounts receivable/Average daily sales

Note: This ratio determines how rapidly the firm’s credit accounts are being collected. In 2006 average collection period is 16 days. Which is less than 2005 & 2004. This means that in this years management was more efficient form previous years.

Accounts receivable turnover ratio:

Accounts receivable turnover ratio: Net sales/ Accounts receivable

  Note: This circumstances we see that, account receivable turnover is decrease than previous years. So we can say that is quite good for the company.

Inventory turnover ratios:

Inventory turnover ratio= Cost of good sold/ Inventory

  Note: this ratio show that how fast the inventory is converted into finished goods that are sold. In 2006 the ratio is lower than 2005.it is good for the company.

Total Asset turnovers Ratio:

  Asset turnovers Ratio = Sales/Total Asset

Note: In2006 TATO ratio is very poor through out the year 2005.since the ratio is showing decreased in 2006, it reveals the fact that the firm could not use its asset efficiently to generate sales. This is because a large portion of assets is involving the current assets, which are not productive.

Profitability ratios

Gross margin ratios:

Gross margin ratio= Gross margin/Net sales

Note: This ratio indicates the efficiency of operation of how products are priced. In 2006 gross margin ratio is increased than previous years. It is good for the company.

Operating income ratios:

Operating income ratios=    Operating income/Net sales

  Note: Operating income ratio is increasing in per year. So we can say that the company earned enough profit to cover operating cost. It is good for the company.

Net income ratios:

Net income ratio=    Net income/Net sales

Note: Net income ratio is decrease on the last year. In this ratio the company earned 0.25 profits from 1 dollar sales in 31 December, 2006. It is not good for the company. They have to improve the condition.

Return on assets ratio:

Return on assets ratio= Net income/Total Asset

Note: this ratio reflects the rate of return on firm’s total investment after interest and taxes. In year 2006 the percentage of ROA is lower than previous years. This mean year 2006 the return of firm’s total investment after interest and taxes is very insignificant.

Cash return on assets

Cash return on assets ratio= Cash flow operating activities / Total assets

Note: The cash return on assets of the decreasing respectively 2004, 2005, and 2006. It is negative activity of the company. Cash generating ability of assets decreases year after year. It is not good for future investment. Because, cash will be required for the future investment

Conclusion:

The financial statement analyses of the beximco pharmaceutical ltd. The financial statement consists of the mixture of steps and prices that interrelate and affect each other. No one part of thee analysis should be interpreted in isolation. Short –term liquidity impacts profitability, profitability began with sale which relates to the liquidity of assets. The efficiency of assets management influences the cost and Availability of credit which shapes the capital structure. Every aspect of a cost Availability of a company’s financial statement condition performance and outlook affects the share price.

Recommendation:

• To remove some positive side which can be affective for the organization?
• If the average collection period decreasing day by day. The sale of the firm may be decreases.
• The current ratio is increasing which is a positive side of the firm it means the firm is capable to face its all liabilities.

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Financial Statement Analysis Term Paper:

Financial statement analysis (or financial analysis) is the process of understanding the risk and profitability of a firm through analysis of reported financial information, particularly annual and quarterly reports. Financial analysis is very important for every employer, because he has to observe the financial condition of his firm all the time to be able to improve the problematic situation fast and rescue his business. The process is based in the analysis of the errors, financial acts and reports. Evidently, a businessman who plans to develop his business has to take risks, and if these risks are not controlled, it can lead to the bankrupting of the firm. So, in order to keep the business under the constant control, an employer has to analyze the financial situation of the firm regularly and on the basis of the results make appropriate decisions.

A successful term paper on financial statement analysis should present the necessity of the constant analysis, the ways of the analysis, the methods, which are useful for the control of the finance and introduce some new effective methods what will make the paper valuable and informative. A good term paper should be perfectly composed and contain rich methodology section and a wide list of the used literary sources. It should present wise conclusions, which reflect you are able to think constructively, soberly and critically.

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Students who have to write a term paper will surely have troubles with it, because the topic is complicated and it is quite difficult to find enough data on it. No wonder, in order to complete a successful paper students rely on the Internet and read numerous free examples of term papers on financial statement analysis on a range of websites. On one hand, samples are extremely helpful for students, because they present a good picture of term paper writing, the composition of the paper, the manner of presentation of data. On the other hand, examples are sometimes harmful when they are of poor quality and prepared by an amateur. So, reading a free ample of a term paper on financial statement analysis try to realize and value its quality.

The most reasonable way to complete a good term paper is to read much about the topic. Use only reliable literary sources, like books, encyclopedias, articles of the famous scholars in newspapers, magazines and scientific journals. A good term paper is not a simple description of the topic but its interpretation. That means, you may use the facts and cases from the real life and illustrate the impact of financial statement analysis on the success of the business. Having analyzed data and borrowed the experience of the free examples from the web, you will be able to complete a great term paper and improve your academic progress.

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