So you want careers in Finance? and want to learn Financial Statement Analysis.
Well, just like the other disciplines, you need to start with the basics.
This guide will help you build a good foundation before you study complex financial valuations or models.
To better help you out, we have an Excel file named “Excel Counterpart –Basic Finance”. This excel file, along with this guide, will help you navigate your way through the basics of Finance.
Suggested: Read more about Finance Basics
Let’s dive right in!
Importance of Financial Statement Analysis
Introduction to Financial Statement Analysis
One of the most important basic things you need to learn in Finance is how to accurately interpret the financial statements.
Most of the times, they are the sources of financial information you’ll use for different types of models or analysis.
Usually, there are only three financial statements that are being frequently used by financial analysts. They are the balance sheet, income statement and cash flows statement.
The three basic types of financial statement analysis:
1. Balance Sheet (Statement of Financial Position)
The Balance Sheet (or Statement of Financial Position for purposes of International Financial Reporting Standards) is the financial statement which presents a company’s assets, liabilities, and equity during the end of the financial reporting period.
Let’s examine the following sample balance sheet.
Financial Statement Analysis Example
First of all, take note of the title. The third line says “As of December 31, 20xx”. This denotes that the report is accurate only at a certain period in time, which is the end of the reporting period.
The balances at that point in time is a good representation of what transpired during the year.
For example, if Fixed Assets of 2015 balance sheet is $100,000 greater than its 2014 counterpart, then, it only means that the company made acquisitions during 2015.
As you can see from our example balance sheet, the amounts divide into three main groups namely:
Notice that there are even subgroups:
- Current Assets
- Non-current Assets
- Current Liabilities
- Non-current Liabilities
The balance sheet is usually presented by order of liquidity (meaning the ease of converting to cash). For example, in the Assets section, Cash is on the topmost part because it is the most liquid. Next are the receivables since they can easily be monetized through the collection.
The Non-current Assets are second to the Current Assets because they are hard to realize within a short period of time.
The Liabilities, on the other hand, are arranged according to maturity. Thus, all current liabilities are due within one year. All non-current liabilities are due after more than a year.
Here are some of the things you can find on a balance sheet:
- Current Assets –These are the assets which are Cash or are easily realizable into Cash. Also, all receivables which can be collected within one year are considered Current Assets. Receivables from customers are always considered collectible within a short period of time.
- Non-current Assets – generally speaking, these are the assets that are hard to convert into cash. Thus, these are Land, Buildings, Machinery, Furniture and Fixtures and the likes.
Long-term investments which have a maturity date, when already due within one year, are transferred from Non-current Assets to Current Assets.
- Current Liability – These are the liabilities that are expected to be paid within one year. Usually, these are the Trade Payables (i.e. Accounts Payable), Salaries Payable or Utilities Payable.
- Non-current Liability – These are the liabilities which are due after more than one year. Bonds Payable and Mortgage Payables are the usual entrants here. But, if they already are due within one year, they get a transfer to current liabilities.
- Equity – these are the ownership stake of stockholders. This is where you can see the amounts invested by Common Stockholders and Preferred Stockholders. You can also see the accumulated earnings of the company in the form of Retained Earnings.
2. Income Statement (Statement of Recognized Income and Expenses)
Income Statement (or Statement of Recognized Income and Expenses under International Financial Reporting Standards) is the financial statement which presents the income and expenses throughout the reporting year.
The title must show the company name and the label “Income Statement“ or “Statement of Recognized Income and Expenses”.
The third line is the date covered which says “For the Period Ending date”.Note that there is the keyword “Period”. It tells us that the figures were accumulated during that period only. This is unlike balance sheet wherein the figures may be accumulated from different accounting periods.
Objectives of Financial Statement Analysis
The contents of income statements may vary depending on the nature of the business. What’s important here is that the amounts should be properly labeled. The Net Income endow at the bottom of the statement.
3. Cash Flows Statement
Cash is king, as they say.
Perhaps it’s a statement of how important Cash is to every business. That importance gave rise to a statement focusing on cash only – cash flow statement.
The Cash Flow statement focus on presenting the various uses of Cash for the reporting period.
Financial Statement Analysis Ratios
Just like the income statement, the contents of a Cash Flow Statements cover the transactions throughout the reporting period.
For our example above, the business uses calendar period, thus, the coverage of its Cash Flow Statement is from January 1 to December 31.
The Cash Flow Statement divides into three parts:
- Cash Flow (Used) Provided by Operating Activities – these are the cash movements arising from the profit-generating activities of the company. Some experts term those as “usual transactions”.
- Cash Flow (Used) Provided by Investing Activities –these are the cash flows related to purchase or sale of long-term (non-current) investments such as fixed assets.
- Cash Flow (Used) Provided by Financing Activities – these portion covers the cash outflow or cash inflow to or from the owners of the business.
Notice in our sample Cash Flow Statement that the Cash Flow from Operating and Investing Activities is positive. It means that there are more Cash Inflows than Cash Outflows, thus, the Operating and Investing Activities of the business increased the Cash balance of the company.
Meanwhile, the financing activities reduced Cash by $25,000. Most of the cash outflows went to paying dividends and long-term notes payable.
I hope you liked the comprehensive guide to Financial Statements Analysis for Beginners. Let me know in the comments section how will you plan your strategy.