In the business environment, companies are eager to show investors how they seamlessly combine strategy formulation and marketing acumen to woo customers and gain market share. They consistently analyze corporate financial statements, summarizing important metrics along the way. Accounting ratios help a company indicate significant performance improvements, especially if prior results were negative or mediocre.
In a modern economy in which competitiveness is often the key word, businesses raise the stakes by publishing positive, better-than expected results. In upping the ante, profitable companies take a step toward winning the economic competition and attracting investor interest. To understand financial statement analysis, it’s important to understand the underlying data that make up corporate accounting reports. These include statements of financial condition, shareholders’ equity reports, statements of cash flows and statements of profit and loss. Although all businesses must post performance information, financially shaky firms may be more eager to publish timely reports to shed the bankruptcy stigma that generally looms around insolvent operations.
Financial statement analysis traces a company’s rise or fall from its inception to the reporting date. Investors and financial analysts can review the firm’s operations over many years, pinpointing specific parts of its business along the way. Accounting report review refers to the way a company or investor analyzes corporate performance and how the analyst compares such performance to rivals’ achievements. To analyze a financial statement, investors use three methods: vertical analysis, horizontal analysis and ratio analysis. In vertical analysis, external financiers compare other financial statement items with one item, which is referred to as the benchmark. For example, investors may compare a company’s material costs and salaries expense proportionately to its revenues. Horizontal analysis means comparing one financial item, such as sales or net income, from one period to another. Ratio analysis relies on various accounting metrics, such as net profit margin and debt-to-equity ratio, to evaluate an organization’s financial standing.
Financial statement analysis enables security exchange players to separate "cash cows" from insolvent businesses. By doing so, they can identify companies that are making money, those with inadequate debt levels and others lacking short-term funds to operate. Investors also can zero in on key sectors in which a company conducts its business and generates its primary revenues, as well as billings it derives from non-core, secondary spheres. A cash cow is a business that regularly generates out-sized amounts of cash, often with little management intervention.
Various professionals contribute their intellectual wealth to making financial statement analysis a success. They usually display business acumen, accounting knowledge and a penchant for number crunching. Financial analysts, budget supervisors and accounting managers are among those spending a lot of time going through corporate operating data and determining relationships between various pieces of information. Investment analysts, traders and portfolio managers also engage in accounting report review to guide asset allocation decisions.
Marquis Codjia is a New York-based freelance writer, investor and banker. He has authored articles since 2000, covering topics such as politics, technology and business. A certified public accountant and certified financial manager, Codjia received a Master of Business Administration from Rutgers University, majoring in investment analysis and financial management.