Financial Statement Analysis
To analyze the performance and manage the growth of a company, financial statements are a handy tool.
A financial statement is a summary document drawn up periodically. Information on performance, financial and accounting situation, and the development of a company from one accounting year to the next appears.
It is presented in an organized and standardized manner and is based on the following concepts and obligations:
- Faithful image and compliant with IFRS (International Financial Reporting Standards, which have been the accounting standard applicable to companies listed on the European market since 2005). The financial statements must be structured and presented in a clear manner and in accordance with the transactions and the facts.
- Going concern: financial statements must be prepared on the assumption that the company will continue its activities for an indefinite period
- Commitment accounting: Expenses and income must be allocated to the period during which they were incurred and attach these funds at the close
- Consistency of presentation: The presentation and classification of items in the financial statements must remain unchanged from one financial year to the next unless there are changes imposed by IFRS standards
- Relative importance and grouping: each significant category of similar elements must be presented separately in the financial statements unless they are not significant
- Non-offsetting of assets, liabilities, charges, and income: Assets, liabilities, charges, and income should not be offset against each other unless required by an IFRS standard
- Comparative information with the previous period: the financial statements must give corresponding information from previous years to allow users to compare the financial situation and the performance of a company over time
The components of the financial statement
1. The balance sheet
is a basic summary table which gives an image of the company's financial situation during a period and presents three main elements:
1. The asset: economic resources controlled by the company from which it expects future economic benefits, or simply what the company has
2. Liabilities: obligation to do or pay, which represents a negative value for the company, or what the company has to pay
3. Equity: net worth of the company resulting from the difference between assets and liabilities.
2. The income statement
commonly called the statement of comprehensive income or PP (loss and profit), is an accounting document that gives an image of the company's economic performance over a given period in terms of gains or losses.
It provides information on what the business has gained and spent and then indicates whether it has made a profit or a loss during the accounting period.
It is the difference between the products, which are the operations that increase the wealth of the company and the charges, which are the consumption of resources that impoverishes the company. The income statement provides useful information on the company's dynamics and its ability to generate profit as well as its positioning in relation to its competitors.
3. The cash flow table
details and explains the change in cash during the entire accounting year. These are the company's bottom-line inflows and outflows for paying off debts and purchasing the products it needs.
The flows are classified into three categories:
1. The flows linked to the company's operational activity: They define the variation of the company's liquidities held by the company linked to its main activity.
2. Flows linked to investment activities: They represent all the expenses and income associated with acquisitions and disposals of fixed assets.
3. Cash flows linked to financing activities: They mainly relate to capital increases and reductions, the payment of dividends to shareholders, and the obtaining or repayment of financial loans.
4.The statement of changes in equity indicates all the transactions that affect an enterprise's total equity during an accounting year. It identifies the wealth created and/or potentially available to shareholders.
5.The appendices are mandatory or significant documents intended to clarify the reading of the balance sheet and the income statement. It also provides useful qualitative information, but absent from the financial statements. For instance, the accounting practices and standards on which the financial statements are established, provisions, pension funds, discontinued operations, dispute resolution, disposal of tangible capital assets, the number of dividends proposed or decided, etc. as well as any other relevant information that could impact the company.
No single financial statement gives a complete picture of the business. They are all linked. The change in assets and liabilities arising from the balance sheet corresponds to the charges and income appearing in the income statement, which determines the company's gains or losses. The cash flows provide additional information on the liquid assets listed in the balance sheet. Financial statements are a valuable source of information for investors and donors for economic decision-making.
Understanding a company's financial statements in 5 points
The financial statements of a company show its economic situation in different aspects. A management tool, these summary documents allow members of the board of directors and managers to make informed decisions in the light of complete and reliable information and to provide third parties with a true picture of the company's situation. Here's how to understand a company's financial statements in 5 points. Three main documents
There are three main types of financial statements:
- the balance sheet which presents a photograph of the assets (assets), debts (liabilities), and assets of shareholders or associates (equity) of the company at the end of the past financial year
- the income statement which lists the revenues (products) and expenses (expenses) over a year
- the statement of changes in a financial position which provides information on the company's operating, financing and investing activities
Financial statement objectives
Quebec law imposes an obligation on companies to present financial statements for the year ended during the annual general meeting. The board of directors has a photograph of the company's economic situation and a report on the past year of activity. The financial statements provide:
- business assets and liabilities
- The charges.
But financial statements also have other uses:
- they help the manager make informed decisions
- they serve as the basis for establishing the price during a transfer
- they allow investors and lenders to analyze the company's situation before deciding to inject funds or finance the development of the activity
- they support an insurance compensation claim in the event of a business interruption linked to a disaster
Evaluate performance and plan for the future
The income statement lists the company's revenues and expenses over a year. It allows you to see whether the financial year is profitable or loss-making and, in particular, to compare each item of expenditure and each category of product with the forecast budget and previous years. Thus, the organization can determine whether the strategic plans are being followed or whether they require a reassessment or even a modification.
The income statement also serves as the basis for establishing the budgets for the coming years by integrating changes linked to the economic situation (increase in the prices of raw materials, the cost of labor, etc.) and managerial decisions (such as an example of hiring or, on the contrary, job cuts, changes of premises, the opening or closing of a department).
Assess the financial strength of a business
In addition to revealing the assets and liabilities of a company, the balance sheet also provides information on the equity of the organization and makes it possible to analyze its financial solidity as well as its capacity to absorb any operating losses.
Analyze the solvency of the organization
The statement of changes in financial position is an indicator of a company's cash flows from operating, investing, and financing activities. It allows:
- collect information on accounts receivable and payable
- monitor purchases and sales of fixed assets
- to examine the methods of financing purchases and the repayment of debts
These elements help to assess the liquidity and the solvency of the company and to determine its capacity to self-finance and to repay its debts.
The annual production of financial statements does not only satisfy a legal obligation. It provides economic data relating to the company's state and development, which helps the manager make informed decisions. It gives a true and complete picture of the organization's situation to third parties.
Author: Vicki Lezama