Analysis of financial statements is performed to measure and compare the performance of a business entity. Comparison can be made either with the company’s prior period performance or outside the company and see how the company has performed against its competitors in the industry.

Analysis of financial statements is one of the major tools used for decision making by all the companies’ stakeholders. It provides critical information and indicators about the company’s financial position and performance.

You can easily extract the following information from the analysis of financial statements.

• Gross and a net margin of the company and its analysis
• Debt to income ratio
• Easily determine the performance of all the departments
• Availability of cash for future projects and expansions
• Any other required information

Following are the steps which can be followed to develop an effective analysis of financial statements.

Step1: Gather Financial Statements

Gather all the financial reports for the period you want to compare. The following statements are normally required for financial analysis

• Balance sheet
• Profit & loss statement
• Cash flow statement
• Shareholders equity statements
• Sales records
• Inventory record

You can easily find all these reports in the company’s published financial statements.

Step 2: Select the method of analysis

You can easily analyze all or one of the financial statements by applying one of the two primary methods.

• Horizontal or Vertical analysis
• Ratio Analysis

1. Horizontal or Vertical Analysis

You can find different results by adopting horizontal or vertical analysis. The vertical analysis allows you to get the results of assets, revenue or expenses as the percentage of financial statements. For example, it is helpful while analyzing the marketing budget spent versus sales budget spent. And if you want a comparison between financial statements of different periods, then the horizontal analysis is the method for you. You can easily compare and analyze the financial information of 5 or more years by horizontal analysis.

1. Ratio Analysis

The other common method used for analysis is the ratio method. This method is widely used as it gives information about a lot of different business fields. You can also use this method to compare ratios of one business entity with its competitor’s.

The commonly used ratios are:

• Debt to equity ratio: This ratio is used to analyze the company’s total debt with its equity.
• Payable Ratio: It determines how quickly a business pays its suppliers
• Receivable ratio: It determines how quickly a business recover its debts from its debtors.
• Return on assets: It determines how much profit is generated by the company against its total assets. 

Step 3: Process Data:

After gathering all the required data in step 1 and step 2, now you need to evaluate all your findings and make reports. You can easily find computer software which can serve you as a useful tool for financial statement analysis. The most famous and common used programs by small businesses are MS excel and access. As mentioned before, these are useful for small data analysis since they can’t give you automatic reports for presentation as they are very generic in nature. Hence, if you want to handle some large data and customize reports, you will have to purchase some specialized software, which is specifically for providing data analysis and reporting.

Step 4: Prepare Reports:

The final stage of all the hard work is to compile the finding into a report form. The report should be based on the results obtained from financial statement analysis.

The main aim of this report is to provide a detailed analysis of the entity’s financial performance and guide management in decision making for the betterment and growth of the business. The report should highlight the weak areas and gives recommendations for improvements. Nowadays financial records are not just a record as you can analyze and make decisions on the basis of previous financial information.