Understanding Financial Statement Analysis: Methods & Tools (2024)

Financial statement analysis requires two things. First, you have to create the financial statements. Then, you have to analyze them and generate a report. To create financial statements the accountant has to make sense of huge piles of years of scattered and seemingly unrelated financial data. However, that process is bound to errors and hundreds of man-hours.

So, how do accountants analyze financial statements with zero error and within the shortest time possible? Well, they use smart methods and formulas to analyze the statements. Plus, various financial analysis tools automate much of the task reducing the hours and number of errors.

Whether you are going to analyze your financial data or hire someone to do it, it’s important to know how the process unfolds. It can help you put the results of financial analysis to their best use.

Business owners and potential investors need to analyze the financial data of a company to make plans and investment decisions.

This data comes from the cash flow, income, balance sheets, etc. Afterward, financial analysts use various methods to generate insights and make sense of this vast amount of data. Some of the top methods are:

Ratio Analysis

This method uses ratios to compare a company’s various financial data. It helps you understand how profitable and solvent the business is. For instance, Liquidity ratios can help someone understand the relationship between current assets and short-term debt. A good liquidity ratio will mean that you can easily pay off the debts with your current assets.

Meanwhile, the profitability ratio shows the relation between your sales/assets and the profit your business made. It gives you a clear understanding of how much profit you are making off the product you sell. Or, what kind of return you are getting on the company assets. Based on this information you can sell/keep an asset or continue/discontinue a product.

Horizontal Analysis

The comparison between a company’s sets of historical financial data is horizontal analysis. It gives you a well-defined picture of how the company’s performance has evolved with time. You can also use it to view the change in a company’s business activity within a time segment. Thus, it can help you investigate any suspicious activity.

During a horizontal analysis, you will set a reference point. This is the base year when your company has started seeing significant activities. The analyst can then compare the following years by calculating the absolute changes in the line items of the financial statements. You can apply this to income statements, cash flow statements, balance sheets, or any other financial statement.

Vertical Analysis

In this method, you will set a common base figure and express other items on the financial statement as its percentage. Suppose you are applying this method to an income statement. You can set the total income as the base. Then, express net income, gross profit, and operating costs as its percentage. The results can give you a clear idea of the profitability and cost structure of the operation.

Another example is the balance sheet. Here, the total assets can be the base figure. Meanwhile, current and noncurrent assets/liabilities will be its percentages. You can gain valuable insight into the liquidity and solvency of your business from this analysis. Similarly, the method can be applied to cash flow statements to better understand the source and utilization of cash in your company.

DuPont Analysis

The DuPont Analysis uses five or three components to understand ROE. Return on Equity or ROE tells you how much profit a business was able to make with the shareholder’s capital investment. DuPont analysis reveals the sources, drivers, and influencing factors of the ROE. it can either be a five-step or three-step model.

A five-step DuPont Analysis uses five components. These are the Gross and Operating profit margins, interest and tax burdens, and financial leverage.
Gross profit tells you how much profit the core business activities are bringing in. Meanwhile, the operating profit margin describes how the operating expenses impact profitability. Similarly, interest and tax burdens present the impact of the respective factors on your business profits. You can learn about your company’s degree of debt finance from financial leverage.

Datarails

The platform syncs your spreadsheets into a central, well-structured database. It is a full native Excel FP&A solution. Therefore, you don’t have to shift or adapt to a new system.

Datarails will consolidate the data into a single interface and help you visualize and make sense of it. You can use the Datarails Excel add-in to get real-time updates and easily export the workbooks.

Cube

This is another spreadsheet native platform. You can easily integrate Cube with your existing systems and create dashboards to collaborate with your team.

Plus, it’s a cloud-based system. So, it provides a secure backup for your valuable financial data. Cube also offers a smart alert system that notifies you of any anomaly in the data and pinpoints the source of it.

Microsoft Excel

It’s one of the most well-known and classic spreadsheet software. Microsoft Excel’s vast collection of built-in functions makes it a truly useful tool for the financial analyst.

You can perform statistical tests and regression analysis with Excel’s data analysis toolpak. Moreover, the user community of Microsoft Excel is huge and they are constantly offering tips and new add-ins.

Accountants use financial statements to gain a calculated and scientific understanding of a business operation. Otherwise, your business would rely on baseless speculations and gut instincts only. Some of the ways accountants use financial statements are:

• Do the Taxes: Financial statements help accountants calculate the taxable income from your business. You can also calculate the tax liability and plan your future operations accordingly. It also helps you to maintain a positive image in the eyes of the IRS, SEC, and similar organizations.
• Birds Eye View of Operations: A business that has been running for a while consists of too many moving parts to keep track of. Getting an exact picture of the cash, assets, and liabilities of your company can be quite difficult especially when they are scattered over vast business landscapes. Financial statements can consolidate this mess and provide a bird’s eye view of the operations.
• Getting Investors: The modern investor requires concrete proof of the profitability and prospect of your business. Financial statements are the only way to provide them with that proof. The statements show the cash situation, liability, assets, and trends in your business which helps the investors make an informed decision.

Your business is only as good as its financial analysis states. Investors and tax authorities know this. So, even if a business owner doesn’t need financial analysis to run his operations they will need it when dealing with potential investors or the tax man.

During such emergencies, your in-house team might not be enough to quickly sort through years of vast financial data. KDG can help you out here. Our accounting team can provide you with the best service within the shortest time. We will keep consistent communication during the project and value your input. Contact us for accounting services today.

References:

• https://www.investopedia.com/terms/r/ratioanalysis.asp
• https://www.accountingtools.com/articles/ratio-analysis.html
• https://www.investopedia.com/terms/h/horizontalanalysis.asp
• https://corporatefinanceinstitute.com/resources/accounting/horizontal-analysis/
• https://www.investopedia.com/terms/v/vertical_analysis.asp
• https://acterys.com/vertical-analysis-explained/
• https://www.investopedia.com/terms/d/dupontanalysis.asp
• https://en.wikipedia.org/wiki/DuPont_analysis
• https://www.datarails.com/cube-software-vs-datarails-comparison/
• https://www.datarails.com/cube-vs-datarails/