Five approaches to financial statement analysis - Keele University - Study online (2024)

Financial reporting is integral to a business. Any organisation, big or small, is legally required to compile comprehensive documentation of their financial activities.

With ever-evolving legislation presenting a constant challenge to public companies, getting the stats right is essential. That’s where an analyst steps in – and as digital accounting and crypto currencies become more commonplace, the demand for new financial talent is high.

Not only is financial reporting a matter of compliance, but tracking and analysing financial performance equips business leaders and lenders with key intel to better assess the company’s current standing, predict future financial outcomes and make informed economic decisions regarding the management and direction of the organisation.

What is financial statement analysis?

Financial statement analysis is a component of accounting and key to understanding an organisation’s financial condition. External stakeholders use it to understand the overall performance and business value of an organisation, while internal constituents use it as a monitoring tool for managing finances.

Acting as a company’s financial health ‘report card’, it comprises the review of three significant financial statements that every company must maintain: the balance sheet, income statement and cash flow statement.

  • Balance sheet: summary of the assets, liabilities (debt) and equity of a business at the end of an accounting period and a report of the company’s financial worth in terms of book value.
  • Income statement: a detailed account of a company’s revenue earning (also known as the profit and loss statement).
  • Cash flow statement: provides data on how much cash or cash equivalent circulates the company via various inflows and outflows, spanning ongoing operational activities, external investment sources and cash from financing.

As such, a financial statement analysis provides a comprehensive and unbiased overview of a company’s profitability, value, creditworthiness and financial security.

What are the five methods of financial statement analysis?

There are five commonplace approaches to financial statement analysis: horizontal analysis, vertical analysis, ratio analysis, trend analysis and cost-volume profit analysis. Each technique allows the building of a more detailed and nuanced financial profile.

Horizontal analysis

Horizontal analysis compares historical data (such as ratios and line items) and is usually depicted as a percentage growth over the same line item in the base year. This allows financiers to easily spot trends and growth patterns and forecast future projections. This type of analysis also lends insight into the operational results of an organisation and whether it is operating efficiently and profitably, and makes it easier to compare growth rates amongst sector competitors.

Vertical analysis

Vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. For example, every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets. This gives analysts an understanding of overall performance in terms of revenue and expenses.

Ratio analysis

Ratio analysis allows for meaningful comparison between the different elements of a financial statement and is used to reveal a general upward or downward trend. It’s a quick method to obtain an overview of a company’s financial health, but also more granular relationships between data, such as debt and equity or price versus earnings, in addition to liability areas such as staff turnover. Once a ratio has been calculated, it can be compared against the previous period, which is crucial for setting performance targets.

Trend analysis

Trend analysis uses historical data (such as price movements and trade volume) to forecast the long-term direction of market sentiment. It’s based on the idea that what has transpired in the past will occur again in the future, which helps a business to better predict and prepare for upward trends and reversals within particular market segments. Trend analysis is a useful technique as moving with trends (and not against them) will result in profit for an investor.

Cost volume profit analysis

This analysis technique helps businesses better understand the relationship between sales, costs, and business profit. It examines the fixed cost and variable cost and establishes the relationship between sales and variable cost to help business leaders better plan and project profit.

How does financial statement analysis help an organisation?

Financial statement analysis is not only crucial for complying with business laws and regulations, but the data can serve the organisation in a multitude of ways.

Through financial statement analysis, business owners can identify and determine their financial strengths and weaknesses, keep current on their debts and determine their profit margins.

Financial statements are critical when seeking company partners and securing investment capital. The data determines if a company is making money, but also helps investors identify a reasonable cost per share. An unbiased financial profile is equally crucial when claiming funds or applying for loans from lending institutions.

Analysing the financial statements from quarter to quarter and year to year help business owners see trends in growth and formulate new strategies to consider any risks posed to the wider market.

Furthermore, the analysis helps to measure a company’s financial performance against the wider sector, giving business owners an understanding of how they compare to their top competitors.

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Five approaches to financial statement analysis - Keele University - Study online (2024)


Five approaches to financial statement analysis - Keele University - Study online? ›

There are five commonplace approaches to financial statement analysis: horizontal analysis, vertical analysis, ratio analysis, trend analysis and cost-volume profit analysis.

What is the five step financial statement analysis plan? ›

The five step financial statement analysis plan – expanded.

Liquidity, activity, leverage, operating performance and cash flow – use these steps when analyzing financial statements. Determine working capital, your current ratio and quick test ratio to assist in determining liquidity.

What are the best methods 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.

How do you approach financial statements? ›

Here are effective steps to analyse financial statements:
  1. Review objectives of the company. ...
  2. Select the method of analysis. ...
  3. Research industry standards. ...
  4. Prepare forecasted statements. ...
  5. Set reporting date. ...
  6. Calculate your assets. ...
  7. Identify the liabilities. ...
  8. Calculate shareholders' equity.
Mar 13, 2024

What are the three key areas traditionally financial statements analysis focuses on? ›

Financial statement ratio analysis focuses on three key aspects of a business: liquidity, profitability, and solvency. Liquidity ratios measure the ability of a company to repay its short‐term debts and meet unexpected cash needs.

What are the five 5 elements financial statements briefly explain? ›

The major elements of the financial statements (i.e., assets, liabilities, fund balance/net assets, revenues, expenditures, and expenses) are discussed below, including the proper accounting treatments and disclosure requirements.

What are the five statement of financial statements? ›

Statement of financial position (balance sheet); Statement of income and expense (profit and loss account); Statement of cash flows (cash flow statement); Statement of changes in equity; and.

What is a financial statement analysis for beginners? ›

Overall, a central focus of financial analysis is evaluating the company's ability to earn a return on its capital that is at least equal to the cost of that capital, to profitably grow its operations, and to generate enough cash to meet obligations and pursue opportunities.

What is the first step in an analysis of financial statements? ›

The first step in any analysis of financial statements is to compile and analyze the data.

How do you prepare financial statements step by step? ›

5 steps to prepare your financial statements
  1. Step 1: gather all relevant financial data. ...
  2. Step 2: categorize and organize the data. ...
  3. Step 3: draft preliminary financial statements. ...
  4. Step 4: review and reconcile all data. ...
  5. Step 5: finalize and report.
Oct 24, 2023

How to analyze cash flow? ›

One can conduct a basic cash flow analysis by examining the cash flow statement, determining whether there is net negative or positive cash flow, pinpointing how the outflows compare to inflows, and draw conclusions from that.

How to analyze a balance sheet? ›

The strength of a company's balance sheet can be evaluated by three broad categories of investment-quality measurements: working capital, or short-term liquidity, asset performance, and capitalization structure. Capitalization structure is the amount of debt versus equity that a company has on its balance sheet.

What are the basic steps in the financial analysis process? ›

To perform financial analysis, there are five effective steps that businesses can follow:
  • Comparison between Forecast and Actual Monthly Results. ...
  • Identify Exceeding Projections or Off-Track Performance. ...
  • Review Income and Expenses. ...
  • Analyze Cash Flow Statement. ...
  • Review Balance Sheet.
Apr 26, 2023

What is the first step of the five step financial planning process? ›

1) Identify your Financial Situation

The first stage of the financial planning process constitutes assessment on what is happening in your life right now and how you can change your financial situation.

What are the steps in a financial plan? ›

The Financial Planning Process
  1. Step 1: Set Goals. While this seems pretty basic, this step often gets overlooked. ...
  2. Step 2: Gather facts. ...
  3. Step 3: Identify challenges and opportunities. ...
  4. Step 4: Develop your plan. ...
  5. Step 5: Implement your plan. ...
  6. Step 6: Follow up and review yearly.

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