How To Analyze Financial Statements For A Corporation. 4 Types of Financial Analyses

Introduction

This tutorial will guide you through the process of analyzing financial statements for a corporation by exploring four common types of financial analyses. Understanding these analyses will enhance your ability to assess a company’s financial health, make informed decisions, and communicate effectively with stakeholders.

Step 1: Understanding Accounting vs. Managerial Analysis

• Accounting Analysis focuses on historical data and compliance with financial reporting standards. It is typically used for external reporting.
• Managerial Analysis is oriented towards internal decision-making, utilizing financial data to inform strategy and operations.

Practical Tips

• Use accounting analysis for preparing financial statements and audits.
• Employ managerial analysis for budgeting, forecasting, and performance evaluation.

Step 2: Conducting Horizontal Analysis

• Horizontal Analysis examines financial data over a series of periods to identify trends.
• Steps to perform Horizontal Analysis:
  1. Select the financial statements (income statement, balance sheet).
  2. Compare line items across multiple periods.
  3. Calculate the percentage change for each item.

Practical Tips

• Focus on significant changes (more than 10%) to identify areas needing attention.
• Use this analysis to predict future performance based on past trends.

Step 3: Comparing Actual vs. Budget

• This analysis evaluates how actual financial performance stacks up against budgeted figures.
• Steps to analyze:
  1. Gather actual financial results and budgeted figures.
  2. Create a variance report showing differences for each line item.
  3. Analyze the causes of variances (favorable vs. unfavorable).

Practical Tips

• Keep a running log of explanations for major variances to inform future budgeting.
• Use insights from this analysis to adjust future budgets or operational strategies.

Step 4: Performing Vertical Analysis

• Vertical Analysis assesses each line item as a percentage of a base figure (e.g., total revenue for the income statement, total assets for the balance sheet).
• Steps to conduct Vertical Analysis:
  1. Select a specific financial statement.
  2. For each line item, divide by the base figure and multiply by 100 to get a percentage.
  3. Analyze the percentage to understand the structure of financial statements.

Practical Tips

• Use this analysis for benchmarking against industry standards.
• It helps in understanding the proportion of expenses and profitability.

Step 5: Conducting Ratio Analysis

• Ratio Analysis evaluates relationships between financial statement items to assess performance and financial health.
• Key Ratios to consider:
  • Liquidity Ratios (e.g., Current Ratio, Quick Ratio)
  • Profitability Ratios (e.g., Gross Profit Margin, Net Profit Margin)
  • Leverage Ratios (e.g., Debt to Equity Ratio)

Practical Tips

• Use industry benchmarks to contextualize ratios.
• Regularly track ratios over time to identify trends in financial health.

Conclusion

By following these steps, you can effectively analyze financial statements and gain valuable insights into a corporation's performance. Start by distinguishing between accounting and managerial analysis, then dive into horizontal and vertical analyses, compare actual vs. budgeted results, and conduct ratio analysis. These skills will empower you to make informed financial decisions and enhance your professional capabilities in finance.