If you want to manage your money well for personal or for business, you will need to analyze your financial statement from time to time. This will not only help you to know the financial condition but will also help you to deal with your debts easily, effectively and more confidently.
However, this is not an easy task. There are lots of elements to consider and analyze with proper knowledge about the terms, the objectives and the consequences as well. In order to make sure that you manage your finance and your financial statements well, you will need to use proper tools and follow the right techniques for it. For this you will need to first know what it really means by financial statement analysis and its importance.
All the transactions are recorded in financial statements systematically and scientifically. This helps in better assessment of the results, the operation of the business as well as its current financial condition. A business organization will have specific elements in their financial statement such as:
- A profit and loss account
- A balance sheet
- A cash flow statement.
All these collectively form the financial statement that helps the business to know it profitability, solvency, liquidity, operational efficiency as well as growth potentiality.
About Financial Statements
Financial statements, personal or business, are typically the summary of the financial transactions and status. Based on these, banks and other money lenders will decide whether a person is eligible for a loan and if eligible then how much to offer and at what terms.
All financial statements show the end result of the company or a person regarding their accounting activities in the given period of time. Since the financial statements report the results of all past activities it is also called the historical records.
Financial statement includes:
- Income statement: This is the statement of earnings of an individual or trading profit and loss account for a company that helps in measuring the profitability for a given period.
- Statement of retained earnings: Also known as the profit and loss appropriation account this helps to judge the income retained between two balance sheets and the reasons for changes such as deduction of dividends or addition of net income in it, if any.
- Balance sheet: Typical for a business this lists the assets and liabilities of the company, equity of the stockholders and financial position on a particular date.
- Statement of cash flow: This indicates the incoming and outgoing cash determining the ability of the borrower to pay the bills when it is due. It includes investing, operating and financing activities’ cash flows.
The features of financial statements are:
- Everything is expressed in terms of money ignoring the qualitative aspects
- All these are always prepared for a specific period of time usually a year and
- These are historic in nature revealing only past and present performance and nothing about the futuristic approach.
The primary objectives of using financial statements are to:
- Provide financial information to internal and external users
- Provide information useful for decision making for the business
- Reveal profitability and solvency of the business
- Facilitate intra and inter company comparison of financial performance
- Show financial health
- Evaluate efficiency of money management.
The importance of such statement is to several people such as:
- Personal or company management
- Business owners
- Debtors
- Creditors and
- Employees.
Banks, financial institutions also need these statements while providing financial assistance or for calculation of tax revenue.
Tools or Techniques to Use
Financial statements help in making proper decisions when it comes to planning or promotion, research and development or even for arranging of funds. However, there are a few limitations of it as well such as it includes only quantitative and no qualitative info but the most significant one is that everything is on cost basis and the effects of inflation or changes in price level cannot be determined.
Therefore, you will need to use proper tools and techniques to get the current value. Some of these tools are:
- Comparative Statements: This focuses on comparing different items of the balance sheet and profit and loss account for two or more periods. However, separate comparative statements are made for each. According to the needs these can be comparative profit and loss account, comparative balance sheet, comparative statement of working capital, comparative cost of production statement, and more.
- Common Size Statements: This is another tool that provides a vertical presentation of the financial info. However, in this instead of the dollar value, only percentage is considered to make these statements where the total assets, liabilities or sales is considered to be 100 and everything else are compared with it as a percentage. For profit and loss Common Size Income Statement and for balance sheet Common Size Balance Sheet is prepared separately.
- Trend Analysis: Considering different periods, the ratios of dissimilar items are considered and compared for this analysis. This analysis gives an idea whether a business is moving upward or there is a downward trend. Often this analysis is called the Pyramid Method.
- Average Analysis: This is also another useful tool for analyzing comparative financial statements. The trend ratios are compared with the industry average and presented as curves on the graph paper. These pictures help in better, impressive and more comprehensive analysis and comparison.
- Fund Flow Analysis: This technique will help to deal with the application of funds as well as the detailed sources for a specific period. For that period such analysis helps to see and review the sources the funds are coming from and the ways in which they are used. Such analysis highlights the alterations needed in the financial structure.
- Ratio Analysis: This technique will help in building a more meaningful relationship between each individual items or group of items in the P/L account or balance sheet.
Lastly, the Cost Volume Profit Analysis helps to find the relation between fixed and variable cost, sales, and profit.
All these tools and techniques helps in better profit planning, highlight liquidity, and capital gearing.
Author Bio: Marina Thomas is a marketing and communication expert. She also serves as a content developer with many years of experience. She helps clients in long-term wealth plans. She has previously covered an extensive range of topics in her posts, including Money Saving, Budgeting, Crypto currency, Business debt consolidation, Business, and Start-ups.
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