Loading the player...

What is 'Financial Statement Analysis'

Financial statement analysis is the process of analyzing a company's financial statements for decision-making purposes and to understand the overall health of an organization. Financial statements record financial data, which 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, in which 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 and easily understood documents for long-term investors to analyze for new investment opportunities. In addition to showing revenue growth and profitability, financial statements show debt coverage ratios, free cash flow generation, and other important information. Investopedia's Fundamental Analysis Course (a five-hour course with on-demand video, exercises, and interactive content) demonstrates how to read financial statements, interpret financial ratios, and make informed investment decisions.]

Financial Statements

Financial statement analysis allows analysts to identify trends by comparing ratios across multiple 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 of the company's assets, liabilities, and shareholders' equity at a specific period. 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 the 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, respectively. 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 track performance measures across financial statements using several different methods for financial statement analysis, including vertical, horizontal, and ratio analyses. 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 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 found on the balance sheet.

RELATED TERMS
  1. Income Statement

    An income statement is one of the three major financial statements ...
  2. Comparative Statement

    A statement which compares financial data from different periods ...
  3. Profit and Loss Statement (P&L)

    The profit and loss statement is a financial statement that summarizes ...
  4. Accounting Ratio

    Accounting ratios, also known as financial ratios, are used to ...
  5. Cash Flow From Investing Activities

    Cash flow from investing activities reports the total change ...
  6. Account Statement

    An account statement is a periodic summary of account activity ...
Related Articles
  1. Investing

    12 things you need to know about financial statements

    Before investing, discover 12 characteristics of financial statements that can help you evaluate companies and increase your chances of choosing a winner.
  2. Investing

    Breaking Down The Balance Sheet

    Knowing what the company's financial statements mean will help you to analyze your investments.
  3. Investing

    Cash Flow From Operating Activities

    Cash flow from operating activities is a section of the Statement of Cash Flows that is included in a company’s financial statements after the balance sheet and income statements.
  4. Investing

    Understanding Vertical Analysis

    In vertical analysis, each line item on a company’s financial statements is presented as a percentage of a larger number.
  5. Investing

    Reading the Balance Sheet

    Learn about the components of the statement of financial position and how they relate to each other.
  6. Investing

    What are Financial Statement Assertions?

    Understand financial statement assertions and what they mean in accounting. For investors, it is important that assertions be accurate.
  7. Investing

    Why Financial Statements Are Harder to Read Than Ever Before

    Understand four major reasons that financial statements published in 2016 are more complicated and difficult to read than they were in the past.
RELATED FAQS
  1. 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 >>
  2. How do marketable securities impact a company's financial statements?

    Understand how the various components of the financial statements are impacted by investments in marketable securities owned ... Read Answer >>
  3. What kind of financial reporting requirements does GAAP set out?

    Look at some of the major financial reporting requirements set forth by the generally accepted accounting principles and ... Read Answer >>
  4. How are a company's financial statements connected?

    When you do research on different companies by looking at their annual reports, you will typically come across two separate ... Read Answer >>
  5. What does financial accounting focus on?

    Learn the main tenets of financial accounting, the guidelines by which it is governed and how outsiders use it to gauge a ... Read Answer >>
  6. Do tax liabilities appear in the financial statements?

    Find out how taxes are shown on the balance sheet, the income statement and the cash flow statement, and why taxes are an ... Read Answer >>
Hot Definitions
  1. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  2. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  3. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  4. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  5. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  6. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
Trading Center