Why Do a Financial Statement Analysis?

Financial analysts comb through companies' accounting reports for the same reason attentive parents delve into their children's grade reports: to find out how well a company performed during a specific period, and identify elements that dragged overall performance down. Financial statement analysis requires attention to detail, familiarity with accounting principles and knowledge of regulatory rules.

Financial Statements

By preparing accurate, complete financial statements, corporate management provides valuable information about the firm's products and services, and directs investor queries to specific personnel. For example, external financiers may question managers in a business unit that posted mediocre performance, asking why their segment is lagging behind others, with respect to revenue and sales growth. By reviewing financial statements, investors can set profitable companies apart from market losers. A full set of accounting data summaries includes a statement of financial position, a statement of profit and loss, a statement of shareholders' equity and a statement of cash flows.

Analysis

In the global marketplace, external forces and uncertainty often change the way businesses operate, transforming the competitive landscape every now and then. This continuous metamorphosis clears the way for market winners, helping escort losers out of the economic playing field. Financial statement analysis tells investors and the public which firms are more likely to remain in business in the long term --- such as in one, two, five or 10 years. To analyze a company's accounting reports, investors can use one of three methods: horizontal analysis, vertical analysis and ratio analysis. Horizontal analysis indicates to investors whether a particular period --- such as a fiscal year --- was pivotal to the business, financially speaking. This method compares performance data period after period. Vertical analysis helps investors compare financial-statement items with a specified benchmark. For example, business heads may compare net income and administrative expenses with sales revenue --- sales revenue being the benchmark. Ratio analysis relies on the use of financial metrics, such as net profit margin and debt-to-income ratio, to review corporate performance data.

Strategic Relevance

Financial-statement analysis tells business partners the challenges that corporate management faces, and how department heads confront rivals' marketplace tactics. This constant scrutiny is essential to preventing bad investment bets or day-to-day business decisions. For example, business partners --- such as lenders, suppliers and customers --- keep a close eye on a firm's financial statements to make sure it's not tinkering with bankruptcy.

Beneficiaries

Various groups benefit from financial-statement analysis. For starters, corporate management can adjust the firm's strategic course by reviewing financial statements. Government agencies also heed accounting reports to understand how the activities of various market players could affect the viability of an economic sector, something economists dub "systemic risk." A third group of beneficiaries includes investors and portfolio managers.