A business must rely on an accountant to prepare financial statements and carry out an important analysis based on these reports. An accountant compiles the information provided by business statements, reviews them with the help of business representatives, and audits the final reports to ensure their accuracy. So, the first task to ensure accurate financial analysis is to hire the services of an expert accountant.
Financial statement analysis involves the comparison of information of one entity over different periods of time or the comparison of information of different entities during the same period. The four main statements that are analyzed during the procedure include the balance sheet, income statement, statement of owner's equity, and statement of cash flows.
The remaining part of the discussion provides information on the three important methods of financial statement analysis-
With the help of horizontal financial analysis, you can compare a business entity over different months or defined periods within a fiscal year. For example, revenue generated over different months of a year can be compared to analyze the overall performance of business or a particular project.
An accountant can follow one of the two given below methods to conduct a horizontal financial analysis:
This involves the procedure of comparing different figures of separate entities to one specific figure of an entity for one specific period of time. This type of analysis is of great significance in carrying out the decision making process. An accountant can also expand the vertical analysis by comparing the figures of one specific period with those of another period.
Analysis of the balance sheet is one good example of carrying out vertical financial analysis. Each item of the balance sheet can be compared to the total assets calculated. Vertical analysis is useful for answering the questions related to business liabilities and equity. This type of analysis is also referred to as common-size analysis.
This is the method in which the ratio between two or more variables related to the business is compared.
There are many ratios used to analyze financial statements:
All these ratios are collectively used to carry out the financial analysis of business to assess growth, profitability, and solvency of a business. Remember that ratio analysis is as important as horizontal and vertical analysis and must not be overlooked.
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