A systematic process of analyzing the financial information in financial statements to understand and make decisions regarding the operation of an enterprise.
Complex data given in the financial statements is broken into simple, valuable elements. Relationships are established between elements of the same statement or across different statements.
Tools and Techniques
Comparative Analysis
Evaluates and compares a company’s financial performance and position across multiple periods, typically consecutive years, to identify trends, changes, and patterns.
Amounts for 2 or more years are placed side by side along with the change in absolute and percentage terms.
- Intra company basis
Comparison within the same company across periods. - Inter company basis
Comparison against another company. - Industry averages
Comparison against industry benchmarks.
Vertical Analysis
Also known as common-size analysis, expresses each line item on a financial statement as a percentage of a common base within a single period.
- Statement of financial position
Total assets or total liabilities taken as 100, all other figures expressed as a percentage of it. - Statement of profit or loss
Net sales taken as 100, all other amounts expressed as a percentage of it.
Standardizing the data allows comparison of composition across items and facilitates identification of trends, anomalies, and areas of risk or improvement.
Process
- Gather financial statements
Balance sheet, income statement, cash flow statement. - Review the financial statements
Examine revenue, expenses, assets, liabilities, and equity, including notes and disclosures. - Perform horizontal analysis
Compare financial data across multiple periods to identify trends and changes. - Conduct vertical analysis
Express each line item as a percentage of a base figure to compare composition. - Calculate financial ratios
Compute liquidity, profitability, solvency, and efficiency ratios, compared against industry benchmarks and historical performance. - Interpret and analyze results
Identify strengths, weaknesses, opportunities, and threats in the financial position. - Conduct comparative analysis
Benchmark against industry peers or competitors. - Consider qualitative factors
Industry dynamics, market trends, management quality, competitive advantages, regulatory environment. - Draw conclusions and make recommendations
For management, investors, or other stakeholders. - Monitor and update analysis
An ongoing process, adjusted as circumstances change.