The analysis of financial statements can be conducted with the help of the following tools –
- Comparative Statements: As the name suggests, these statements help in comparing the data of two or more periods. It presents the figures of balance sheet and income statement relating to any two or more years alongside each other. However, it should be kept in mind that the statements to be compared should be prepared following the same principles of accounting otherwise comparison would not garner desired results. The analysis using comparative statements is also known as “horizontal analysis”. This helps in tracking the direction of financial performance.
- Common Size Statements: It is a statement wherein detail of each line item is communicated as a percentage of the value of a common item. It is utilised for vertical analysis, in which detail of each line item in the financial statement or the budget report is represented as a percentage of a base figure inside the statement. These statements help to break down and analyse different sized companies of the same industry. The analysis using common size statements is also known as “vertical analysis”. It facilitates intra and inter firm comparisons.
- Trend Analysis: It assesses a company’s financial statements over some undefined time frame. Periods might be estimated in months, quarters or even years depending upon the circumstances. The objective is to compute and examine the sum change and percent change from one period to the next. It gives an idea whether the business is going upwards or downwards. It is also called the “pyramid method”.
- Ratio Analysis: It helps in establishing a significant relationship between financial figures of a balance sheet and income statement. Different kinds of ratios assist in judging the profitability, solvency, liquidity and efficiency of the company.
- Cash Flow Analysis: It analyses the inflow and outflow of cash in an organisation. In simple words, it tracks the in and out movement of cash. The earning of receipts is shown as cash inflow and the expenses incurred are presented as cash outflow. It is a tool which measures the cash position of a company and verifies the closing balance of cash during a year.
The analysis of financial statements can be made through tools like ratio analysis, trend analysis, cash flow analysis, comparative and common size statements. This helps in assessing the overall financial position and performance of the company. And it also helps in judging the operational efficiency and effectiveness achieved over the years.