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What is 'Financial Statement Analysis'

Financial statement analysis is the process of reviewing and evaluating a company's financial statements (such as the balance sheet or profit and loss statement), thereby gaining an understanding of the financial health of the company and enabling more effective decision making. Financial statements record financial data; however, this information must be evaluated through financial statement analysis to become more useful to investors, shareholders, managers and other interested parties.

BREAKING DOWN 'Financial Statement Analysis'

Financial statement analysis is an evaluative method of determining the past, current and projected performance of a company. Several techniques are commonly used as part of financial statement analysis including horizontal analysis, which compares two or more years of financial data in both dollar and percentage form; vertical analysis, where each category of accounts on the balance sheet is shown as a percentage of the total account; and ratio analysis, which calculates statistical relationships between data.

[ Financial statements are the most important documents for long-term investors to understand and analyze to find opportunities. In addition to showing revenue growth and profitability, financial statements can show debt coverage ratios, free cash flow generation, and other important information. Investopedia's Fundamental Analysis Course will show you how to read financial statements, interpret financial ratios, and make informed investment decisions in over five hours of on-demand video, exercises, and interactive content. ]

Financial Statements

Financial statement analysis allows analysts to identify trends by comparing ratios across multiple time periods and statement types. These statements allow analysts to measure liquidity, profitability, company-wide efficiency and cash flow. There are three main types of financial statements: the balance sheet, income statement and cash flow statement. The balance sheet is a snapshot in time of the company's assets, liabilities and shareholders' equity. Analysts use the balance sheet to analyze trends in assets and debts. The income statement begins with sales and ends with net income. It also provides analysts with gross profit, operating profit and net profit. Each of these is divided by sales to determine gross profit margin, operating profit margin and net profit margin. The cash flow statement provides an overview of the company's cash flows from operating activities, investing activities and financing activities.

Financial Statement Analysis

Each financial statement provides multiple years of data. Used together analysts can track performance measures across financial statements using several different methods for financial statement analysis, including vertical and horizontal analysis. An example of vertical analysis is when each line item on the financial statement is listed as a percentage of another. Horizontal analysis compares line items in each financial statement against previous time periods. In ratio analysis, line items from one financial statement are compared with line items from another. For example, many analysts like to know how many times a company can pay off debt with current earnings. Analysts can do this by dividing debt, which comes from the balance sheet, by net income, which comes from the income statement. Likewise, return on assets (ROA) and the return on equity (ROE) compare company net income found on the income statement with assets and stockholders' equity as found on the balance sheet.

RELATED TERMS
  1. Financial Statements

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  2. Comparative Statement

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  3. Vertical Analysis

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  4. Income Statement

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  5. Common Size Income Statement

    An income statement in which each account is expressed as a percentage ...
  6. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and ...
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RELATED FAQS
  1. How are the three major financial statements related to each other?

    Learn why investors analyze a company's financial statements, and how the income statement, balance sheet and cash flow statement ... Read Answer >>
  2. Which financial statements are most important when performing ratio analysis?

    Learn which financial statements are used for ratio analysis. Find out what financial data is needed to conduct fundamental ... Read Answer >>
  3. What is the difference between an income statement and a balance sheet?

    The balance sheet illustrates a company’s book value, and the income statement shows how assets and liabilities are used. Read Answer >>
  4. Which financial accounting statement contains information on a company's net sales?

    Find out which accounting statement contains information on a company's net sales as well as other key statements analysts ... Read Answer >>
  5. What is the difference between a cash flow statement and an income statement?

    Learn how a cash flow statement measures the sources and uses of a company's cash, while an income statement measures a company's ... Read Answer >>
  6. What is the difference between a compiled and a certified financial statement?

    All publicly-traded companies are required to provide financial statements, including a balance sheet, cash flow statement ... Read Answer >>
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