Table of Contents:
1. Introduction
2. Importance of Financial Statement Analysis
3. Key Types of Financial Statements
4. Methods of Analysis
5. A case study that demonstrates financial analysis
6. Common Financial Ratios
7. Conclusion
Introduction
The act of analysing a company's financial reports to gain insight into its performance, profitability, and financial strength is known as financial statement analysis. The data in these reports includes information about revenue, expenses, assets, liabilities, and cash flow. Understanding a business's condition requires all of these things, which aid investors, lenders, and business managers in making informed decisions.
In order to make informed decisions, it is important to analyse financial statements, whether you are a business owner, student, or investor.
Importance of Financial Statement Analysis
The analysis of financial statements serves a number of essential purposes:
- To estimate how profitable it is.
- To measure the effectiveness of operations
- To comprehend the foundations of financial stability
- For the purpose of comparing performance over time
- To verify how much money is being sourced and how much money is being repaid by the business
The purpose of this analysis is to measure the performance of a company and to identify areas for improvement.
Key Types of Financial Statements
Here are the three core financial statements used for analysis:
A. Balance Sheet
A balance sheet is a financial statement that shows a company's assets, liabilities, and owner's equity. It shows the company's financial transactions and financial position on a specific date.
Formula:
Assets = Liabilities + Equity
B. Profit and Loss Statement (Income Statement)
The profit and loss statement shows the company's revenues, expenses, and profit or loss during a specific period. It helps to understand how much money the business has made or lost.
Formula:
Net profit = Total revenue - Total expenses
C. Cash flow statement
The cash flow statement shows how much cash comes in and goes out of the business during a specific period. This statement is divided into operating, investing, and financing activities, which helps to know the company's actual cash position.
Methods of Analysis
There are many ways to analyse financial statements. The most common of which are given below:
1. Horizontal analysis
Compares financial data over two or more time periods.
Example: Revenue in 2024 versus revenue in 2025.
2. Vertical analysis
Here, each item is expressed as a percentage of the base item.
Example: The percentage of revenue that goes toward operating expenses.
3. Ratio analysis
The simplicity of large amounts of financial data can be achieved by using ratios.
These metrics include net profit margin and return on assets, among others.
case study that demonstrates financial analysis
The situation of ABC Private Limited, a retail company, is something we need to take into consideration.
Profit & Loss Statement (FY 2024–25)
Particulars Amount (₹)
Revenue (Sales) 8,000,000
Cost of Goods Sold (COGS) 5,000,000
Gross Profit 3,000,000
Operating Expenses 1,500,000
Net Profit Before Tax 1,500,000
Step-by-Step Analysis
Formula: (Gross Profit / Revenue) × 100
= (30,00,000 / 80,00,000) × 100 = 37.5%
Formula: (Net Profit / Revenue) × 100
= (15,00,000 / 80,00,000) × 100 = 18.75%
Interpretation:
The company retains ₹18.75 out of every ₹100 earned, which indicates good profitability.
A gross margin of 37.5% shows efficient cost control over purchases.
Common Financial Ratios
Financial ratios make it easy to evaluate certain aspects of a business:
This measures a company's ability to pay its short-term debts.
The current ratio is calculated by subtracting current assets from current liabilities.
The quick ratio is calculated by multiplying (Current Assets - Inventory) by Current Liabilities.
The ratio indicates the extent to which a company generates profits.
Net Profit Margin = Net Profit / Sales
Return on Assets (ROA) = Net Profit / Total Assets
They check long-term financial stability.
Debt to Equity Ratio = Total Debt / Total Equity
Interest Coverage Ratio = EBIT / Interest Expense
Used to evaluate how efficiently a company uses its assets.
Inventory Turnover = COGS / Average Inventory
Receivables Turnover = Net Credit Sales / Average Receivables
Conclusion
Understanding a company's financial status can be achieved through financial statement analysis, which is a powerful tool. By separating the income statement, balance sheet, and cash flow, it is possible to identify strengths, weaknesses, and areas for improvement.
Reviewing your own business, studying finance, or checking a company before investing is crucial, and knowing how to read and analyse financial statements is a vital skill.
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