Ask a typical American on the street about their interest in analyzing financial statements and you’ll likely get a glassy look or loud laughter. But, to every business executive, financial statement analysis is no laughing matter because the analysis is both informative and critical for business success.
What are Financial Statements and Why are They Important?
The financial statements of a company record financial data reflecting the components of its business activity. Financial statement analysis is simply the process of reviewing the financial data (accounting reports) for decision-making purposes regarding a company’s economic standing and profit levels. Essentially measuring its health, strength and financial opportunities.
There are three main financial statements that every company creates and should review regularly:
- The income statement (profit and loss statement.) This is the primary statement used to measure a company’s profitability over each operating period. It captures all revenues, then subtracts all expenses including interest expenses and taxes to yield the “bottom line,” net income (profit or loss.)
- The balance sheet statement. This reflects what the company owns—all types of its assets (accounts receivable, cash, marketable securities, inventory, prepaid expenses plant and equipment and vehicles,) what it owes—liabilities (accounts payable, notes and taxes payable, mortgages payable and long-term payables,) and retained earnings.
- The cash flow statement. This provides a picture of the company’s flows of cash from its operating, investing and financing activities. It shows where money is received and how it is used. Every company must have cash to survive and using it wisely is critical to a company’s health.
Each financial statement is generated from the internal accounting records of a company. Accurate record-keeping and being able to critically analyze the statements generated can contribute to good decision-making and business success.
Who Uses Financial Statements?
There are many users of financial statements:
- Company owners and management use the data to determine the profitability of the company and to make key operating decisions, such as how much and when to invest in inventory, when new hires can be added, when to expand production, etc.
- Investors use the data to understand how a company is performing and to determine what to do with their investments in the company.
- Creditors use the statements to understand if they will be paid appropriately.
- Government entities use the data to determine financial policies and to apply taxes.
- Employees use the statements to gain confidence in their employment and security of the company’s future.
- Customers and clients use financial statement data to measure the company’s ability to serve them in the future.
- The general public may have an interest in financial statement information to evaluate the company’s effects on the environment, community programs, hiring plans, etc.
As one can see, numbers are important and not necessarily limited to a few interested users.
Suggestions for Financial Statement Analysis
Financial statements are great tools to analyze the past performance of a company and to help guide and even predict future performance. Use these suggestions to aid in productive analysis:
- Look at trends in performance over multiple time periods.
- Use ratios to determine the relationship between various accounts.
Get Expert Financial Assistance That You Can Rely On
Contact Doerhoff & Associates, CPA, based in Jefferson City, MO for professional financial, accounting, and financial statement assistance that you can count on. Doerhoff & Associates has one goal in mind, to provide comprehensive business accounting services designed specifically for your success.