Chapter 4 Financial Statement Analysis What is Financial Statement Analysis? FSA is the process of identifying financial strengths & weaknesses of the firm by properly establishing relationship b/n[.]
Chapter Financial Statement Analysis What is Financial Statement Analysis? FSA is the process of identifying financial strengths & weaknesses of the firm by properly establishing relationship b/n the items of the balance sheet & the income statement There are various techniques used to analyze financial statements, such as comparative statements, schedule of changes in working capital, common size percentages, funds analysis, trend analysis, & ratios analysis Financial statements are prepared to meet external reporting obligations & also for decision making purposes But the information provided in the financial statements is not an end in itself as no meaningful conclusions can be drawn from these statements alone However, the information provided in the financial statements is of immense use in making decisions through FSA Sources of FSA An annual report of a company usually contains: A Financial statements B Notes to the financial statements C A summary of accounting methods used D Management discussions E An auditor’s report F Comparative financial data for to 10 years All these documents can be the source of financial statement analysis Tools/Techniques of FSA Following are the most commonly used tools and techniques for FSA: Horizontal and Vertical Analysis Ratio Analysis Horizontal and Vertical Analysis Horizontal (Trend) Analysis Comparison of two or more year's financial data is known as HA, or trend analysis HA is facilitated by showing changes between years in both value (dolla/birr) and percentage form Horizontal analysis of financial statements can also be carried out by computing trend percentages Trend percentage states several years' financial data in terms of a base year The base year equals 100%, with all other years stated in some percentage of this base Therefore, the changes in financial statements from a base year to the subsequent years are expressed as a trend percentage to show the extent & direction of changes Horizontal Analysis-Example Sales Expenses Net income 2005 $41,500 40,000 1,500 2004 $37,850 36,900 950 Increase/(Decrease) Amount Percent $3,650 9.6% 3,100 8.4% 550 57.9% Horizontal Analysis-Example Sales 2005 $41,500 2004 $37,850 Difference $3,650 3,650 ÷ 37,850 = 0.0964, or 9.6% Trend Percentages - Example …are computed by selecting a base year whose amounts are set equal to 100% The amounts of each following year are expressed as a percentage of the base amount Trend % = Any year ÷ Base year