Question

Explain the key techniques you can use to analyze financial statements. What starting information is required, what steps are performed, what are the results, and how are they used in decision-making?

Answer 1

Solution. An organization operating in a competitive economic market needs to record and present true financial position to sustain and achieve social responsibility. Financial statements namely Income Statement, Balance Sheet, Statement of Earnings and Cash Flow Statement are recorded and analyzed encompassing horizontal analysis techniques, vertical analysis and ratio analysis techniques. Starting information of the nature and size of the business activities and collection of relevant data pertaining to the financial statements from internal management meetings and accountants.

Horizontal Analysis encompasses the evaluation of changes in financial data to that of assumed base year over time, often called trend analysis. Vertical Analysis encompasses common size analysis by encompassing groups of assets, liabilities and equities as proportionate percentage to that of base data. Ratio analysis encompasses quantitative analysis of company's financial data by using established formulas.

Information gained through analysis of financial statements help in facilitating decision making to improve efficiency, reduce total cost, decisions on purchasing of assets, sources of raising finances, etcetera. External analysis done by auditors help in raising stakeholders interest and creditworthiness of an organization to sustain in long run along with meeting general objective of giving back to society.