Improve Your Financial Statement Analysis
Accounting and financial reporting systems have improved considerably in recent years. Useful data for benchmarking and industry comparisons is just a mouse click away. If properly analyzed, this improved financial data enables management to make better operating decisions. However, many companies have not improved the procedures used to analyze their interim and annual financial statements and reports.
Going Beyond the Basic Statements
The balance sheet and income statement are only the starting point for successful financial management. Applying other financial statement analysis methods is a necessary step in analyzing the success, failure and progress of your business. Improved financial statement analysis can help you:
- Locate and correct accounting errors.
- Identify areas for business improvement.
- Identify more problem areas and react to problems quickly.
- Better understand the interrelationship of accounts, which in turn will help you to devise better solutions to the problems identified.
- Identify business opportunities.
- Monitor success or failure of business initiatives.
Types of Financial Statement Analysis
Fluctuation analysis is the most basic form of financial statement analysis and simply involves review of changes in the balance sheet, income statement and other balances from period to period.
- In performing fluctuation analysis, both dollar and percentage changes should be analyzed.
- Reports should include columns that present such fluctuations, as this will improve the efficiency and the effectiveness of your analysis.
- It is important to understand the relationship among the different accounts and balances. These relationships can help to explain a significant fluctuation. They can also lead you to investigate why a balance did not change from year to year as expected based on changes in related balances.
Common size financial statements are statements showing percentages only rather than dollar amounts. These percentages are based on a key amount on the statement. For instance, a common size income statement generally expresses balances as a percentage of sales. The common size ratios provide a starting point. You can quickly get a feel for any unusual changes that have occurred, adjusted for the overall size of assets and the relative amount of sales.
Ratio analysis involves analyzing financial statements using key financial ratios. Ratios are not ends in themselves but provide insight into the operation of a business. They serve as “benchmarks” against which a company can evaluate itself and are only useful when:
- Compared with the same ratios, for the same company, from previous periods.
- Compared with some predetermined standard.
- Compared with the same ratios for other companies in the same industry.
- Compared with average ratios for the industry within which the company operates.
Does your company effectively use industry data in its financial analysis procedures? The purpose of an industry comparison is to look at a company’s performance in relationship to its competitors. By comparing a company to others, any differences in their operating efficiency will show up. Once a problem is identified, the company can take action to correct it. Industry comparisons can include a comparison of your company to the industry average or to selected guideline companies in your industry.
There are numerous sources of data that can be used in performing industry comparisons. Key sources include publications and trade organizations specific to your industry. In addition, there are organizations, such as the Risk Management Association (RMA), that publish industry statistics for virtually all industries. Filings for publicly traded companies are also an excellent source. And of course, the Internet can be used to obtain industry data from these and other sources.
Data that can be compared to industry benchmarks includes:
- Financial statement amounts, such as sales volume.
- Year-to-year fluctuations and trends, such as growth rate of sales.
- Common size financial statements.
Financial statement analysis is a necessary function in the effective management of a company. It is important to regularly evaluate the reports available for financial statement analysis and the procedures being performed. If your company is not effectively analyzing its internal financial reports and comparing operating results to others within the industry, then management does not have the necessary data for proper decision-making. This puts your company at a competitive disadvantage to other companies that are performing more effective financial statement analysis.