CHAPTER-2

FINANCIAL STATEMENT ANALYSIS

Tayeba Akter
Lecturer, Finance
Army Institute of Business Administration (AIBA), Savar
 WHAT IS FINANCIAL STATEMENT ANALYSIS?

Financial statement analysis is the process of analyzing a company’s financial statements for decision-making
purposes. External stakeholders use it to understand the overall health of an organization and to evaluate financial
performance and business value. Internal constituents use it as a monitoring tool for managing the finances.

•KEY TAKEAWAYS

 Financial statement analysis is used by internal and external stakeholders to evaluate business performance and
value.
 Financial accounting calls for all companies to create a balance sheet, income statement, and cash flow
statement, which form the basis for financial statement analysis.
 Horizontal, vertical, and ratio analysis are three techniques that analysts use when analyzing financial
statements.
What Are Financial Statements?

Financial statements are key tools businesses use to track and provide insights into a
company’s overall financial performance and health. These reports provide a snapshot of
a business’s financial situation, results of operations, and cash flows.
While financial statements are used internally to guide management decisions, they are
also used by external stakeholders such as investors, creditors, analysts, and regulators.
Financial statements aid in making decisions about investing in a company, lending
money to a company, or providing other forms of financing.
There are three main types of financial statements: balance sheets,
income statements, and cash flow statements.
These are compiled using Generally Accepted Accounting Principles (GAAP). GAAP is
a set of guidelines and standards U.S.-based companies must follow when preparing their
financial statements.
Income Statement
The income statement is a financial statement that reports a company’s revenue,
expenses, and profit (or loss) over a period of time.
It is also known as the profit and loss (P&L) statement and is important in gauging the
profitability of a business.
Components of an Income Statement
The components of an income statement vary depending on the company but below are
some of the most common items:
Revenue
Revenue pertains to the money a company earns from selling its goods or services.
Depending on the company, revenue can also be called “sales revenue” or “sales.”
Revenue is typically listed as net sales as it would exclude any applicable sales returns,
allowances, and discounts before cost of goods sold is deducted to arrive at gross profit.
Cost of Goods Sold (COGS)
COGS refers to the direct costs associated with the production of a good. This is known as
the cost of sales for businesses that provide services. This includes the cost of direct
materials, direct labor, and direct factory overhead.
Gross Profit
Gross profit is the difference between a company’s revenue (net sales) and the cost of
goods sold. It reflects the efficiency of a company in its production and selling process.
Cash Flow Statement
A cash flow statement is another type of financial statement that provides a snapshot of a
business’s cash inflow and outflow during a specific period. This statement shows how
much cash is being generated or used by a company, and can be used to assess its
financial health.

Components of a Cash Flow Statement

Cash Flow From Operating Activities (CFO)

This indicates how much cash the company has generated or used from investing
activities. This can include things like buying property, plant, & equipment or investing in
securities.
Companies use CFI to assess their ability to generate cash from their investments and to
make decisions about future investment opportunities.

Cash Flow From Financing Activities (CFF)

This indicates the amount of money the company has generated or used from its
financing activities. This can include issuing new equity, taking out loans, or repaying
debt.
Companies use CFF to assess their operations’ ability to finance and make decisions
about issuing new equity and debt financing.
 HOW TO ANALYZE FINANCIAL STATEMENTS

•The financial statements of a company record important financial data on every aspect of a business’s activities. As
such, they can be evaluated on the basis of past, current, and projected performance.
•In general, financial statements are centered around generally accepted accounting principles (GAAP) in the United
States. These principles require a company to create and maintain three main financial statements: the balance
sheet, the income statement, and the cash flow statement. Public companies have stricter standards for financial
statement reporting. Public companies must follow GAAP, which requires accrual accounting. Private companies
have greater flexibility in their financial statement preparation and have the option to use either accrual or cash
accounting.
•Several techniques are commonly used as part of financial statement analysis. Three of the most important
techniques are horizontal analysis, vertical analysis, and ratio analysis. Horizontal analysis compares data
horizontally, by analyzing values of line items across two or more years. Vertical analysis looks at the vertical effects
that line items have on other parts of the business and the business’s proportions. Ratio analysis uses important
ratio metrics to calculate statistical relationships.