Question

Corporate Finance management - MBA

why do we need to analyze the financial statement of companies?

Answer 1

Financial statement analysis helps users identify the relationships between various items on the financial statement and also identify trends that develop over the years.Financial statement analysis include horizontal analysis vertical analysis and financial performance analysis(ratio analysis)

Horizontal Analysis also known as trend analysis involves comparison of items in a year to that of the base year.It helps the user in identifying the driving factor and also helps spot seasonality.

Vertical Analysis is also known as common size statement analysis and involves the depiction of each item as a percentage of Total Asset or Total Liabilities.It can be used both in balance sheet or Income Statement.(items will be expressed as a percentage of revenue or sale )It helps the user to understand whether the performance metrics are improving or deteriorating.

Financial Performance analysis(ratio Analysis)It includes the asessment of a company's liquidity solvency profitability turnover and market performance.Ratios like Current Ratios Quick ratios Etc are used to analyze the liquidity while financial leverage ratio,Interest coverage ratio etc are used to asses the solvency.Ratios Net profit ratio and Return on Investment are used to identify the profitability ,while ratios like Inventory turnover ratio and receivables turnover ratio are used for studying the firm's turnover.Market ratios Like price earnings ratio and Dividend payout ratios shows the value of company's shares on the stock market

In conclusion financial statement analysis gives information that is helpful in decision making to both the internal and external users thereby making it important.