Analysis of financial statements is reading the company’s diary. It tells you how well the company is performing and where it is likely to go. Whether owner or investor manager, this skill can help you detect opportunities and avoid expensive mistakes. Once you can read these figures, you are no longer guessing in the dark. You are making informed decisions.
The Three Primary Financial Statements
A company tells its tale through three main financial statements.
- Income Statement – This shows how much money is coming in, how much is going out, and whether there is a profit or a loss. It’s sort of the report card for a specific period
- Balance Sheet – This is a snapshot of everything the business has and everything that it owes on a specific date
- Cash Flow Statement – This follows actual cash flowing in and out of the business, which can reveal problems that profits will hide
If you put these three together, you have a good idea of performance and stability.
Numbers to Watch
Financial statement analysis works best when you understand what numbers are most significant.
- Profit Margins reveal how much of each dollar earned is profit
- Liquidity Ratios determine if the company can meet its short-term liabilities
- Debt to Equity Ratio determines the level of borrowing by the company compared to owner investment
Tracking these over time is as important as the figures. Consistent growth in the upward direction can be reassuring, and sudden falls can indicate times of hardship are ahead.
Making Sense of the Numbers
Numbers alone do not work. Financial statement analysis is all about connecting the numbers to reality. Compare the performance of the company to the industry average as well as to itself over time. Track steady growth or troubles brewing. See if suddenly costs skyrocket or revenue drops sharply. Be eternally curious and wonder why.
Tips for Beginners
Start simple and small. Tackle one statement at a time. Deal with the big numbers first before worrying about the trivialities. Make comparisons between years using percentages. Write down anything unusual so you can look into it later. The more you do it, the more easily you can see the story behind the numbers.
Final Thoughts
Financial statement analysis is not an overnight feat, but it is more than worth the effort. After getting proficient at it, you will be making business and investment decisions so much more confidently. Elite Solutions distills complex financial data into compact insight that is the precursor to improved action.