Financial Statement Analysis:

1. INVESTORS:
o Investment Decision Making
o Risk Assessment
o Return On Investment (ROI) Evaluation
o Portfolio Diversification
o Long-Term Investment Strategy
o Monitoring Investment Performance
Financial statement analysis involves careful selection of data from financial
2. CREDITORS:
statements for the primary purpose of forecasting the financial health of the company.
o Credit Risk Assessment
WHY FINANCIAL STATEMENT ANALYSIS IS IMPORTANT? o Setting Loan Terms
o Monitoring Borrower Performance
1. Assessing Financial Health: By analyzing financial statements, stakeholders can o Regulatory Compliance
evaluate a company's financial health, including its profitability, liquidity, o Decision Making
solvency, and efficiency in resource utilization. 3. MANAGEMENT:
2. Performance Evaluation: It allows comparison of a company's current o Performance Evaluation
performance with its past performance and with competitors in the industry. o Strategic Decision Making
3. Decision Making: Financial analysis provides valuable insights for decision- o Resource Allocation
making processes. o Budgeting and Planning
4. Forecasting: By analyzing historical financial data, analysts can make reasonable o Investor Relations
forecasts about future financial performance. 4. REGULATORS:
5. Communication: Financial statements serve as a means of communication o In Gitman's perspective, financial statement analysis holds
between a company and its stakeholders. significant importance to regulators, such as government agencies
6. Identifying Risks: It helps identify potential risks and vulnerabilities in a company's and regulatory bodies.
financial structure. 5. EMPLOYEES:
7. Compliance and Regulation: Financial statement analysis is often required to o Job Security
ensure compliance with accounting standards and regulatory requirements. o Investment in Employee Programs
o Performance Evaluation

o Employee Stock Ownership Plans (ESOPs) Financial Leverage:

o Corporate Culture and Stability
▪ Financial Leverage: ability of the business to maximize common
o Understanding Company Performance
o Transparency and Communication stockholders’ equity through prudent use of debt.
▪ The higher the debt ratio, the more financially leveraged the company is,
the higher the risk of insolvency, and the higher the return on shareholders
UNDERSTANDING THE CONTENT OF THE FINANCIAL REPORTS
equity. The risk-return-trade-off comes into play.
▪ The balance sheet contains the following information:

BALANCE SHEET

INVESTING ACTIVITIES FINANCING ACTIVITIES

Short-term investment Short-term debt

Non-current assets Long-term debt ▪ Risk of insolvency: uncertainty of not meeting future obligations as they
Owner’s equity mature due to the inadequacy of assets or due to the critical level of
assets that would be used in meeting future debts.

▪ The income statement contains the following information: ▪ Positive financial leverage: the return on common stockholders is higher

INCOME STATEMENT than its cost of capital

▪ Negative financial leverage: the return on common stockholder is lower
OPERATING ACTIVITIES
that its cost of capital.

Current Asset Px The investing side and asset portfolio analysis

Current Liabilities (x)
Net Working Capital x ▪ Investing: allocation of financing money over resources and opportunities
expected to generate optimum return to stockholders. Investing is shown
Financing side and Financial Leverage:
on the asset side of the balance sheet.
▪ Financing: amount of money raised from owners and creditors in order to
▪ Current assets are directly used for and, are accordingly, treated as
fund the investment and operating activities of the business.
investments in the operating activities of the business.
▪ Financing side of the balance sheet includes the following:
▪ The non-current assets represent the long-term commitment of the
Debt Px
business to carry on its long-term objectives.
Stockholders’ equity Px
▪ All asset accounts, current or non-current, represent investments or
Total Equity Px
resources allocated by management for a purpose and should therefore
▪ Total equity is the same as the total assets.
give a fair return. Analyzing the assets portfolio (or assets distribution, or
▪ Debt includes current and long-term liabilities. Current liabilities are used in
assets spread) of a firm would reveal a strong understanding on how
the normal operations of the business and are more reflective of the
management has created wealth using the investing approach.
operating activities
 ▪ It should be noted, that the investing strategy of the management has a
direct impact on the business operating results (i.e., income or loss). A
variation in the assets portfolio would also mean a variation in operating
results.
▪ In the accounting sense, the investing activities include those that pertain
to short-term investments.

METHODS OF FINANCIAL STATEMENT ANALYSIS:

Vertical Analysis:
Vertical analysis is a method of financial statement analysis in
which each line item is listed as a percentage of a base figure within
the statement.
Also referred as Common-Size Analysis

Van Horne, J. C., & Wachowicz, J. M. (2008, January 1). Fundamentals of

Horizontal Analysis
Horizontal analysis is a financial statement analysis technique
used to compare historical data, such as ratios or line items, over a
number of accounting periods. It can involve absolute comparisons
or percentage comparisons, where the numbers in each
succeeding period are expressed as a percentage of the amount in
the baseline year, with the baseline amount being listed as 100%. This
method is also known as base-year analysis.

https://www.wallstreetmojo.com/vertical-analysis-formula/

Balance Sheet
 Income Statement

Van Horne, J. C., & Wachowicz, J. M. (2008, January 1). Fundamentals of Financial Management

Ratio Analysis
Ratio analysis involves methods of calculating and interpreting financial
ratios to analyze and monitor the firm’s performance. The basic inputs to ratio
analysis are the firm’s income statement and balance sheet.
1. Liquidity Ratios
2. Activity Ratios
3. Profitability Ratios
4. Growth Ratios
5. Leverage Ratios