• Define financial statement analysis

 

We previously introduced the four financial statements. We discussed how these statements provide information about a company’s performance and financial position. Here, we extend this discussion by showing you specific tools you can use to analyze financial statements in order to make a more meaningful evaluation of a company.

Ratio Analysis

Ratio analysis expresses the relationship among selected items of financial statement data. A ratio expresses the mathematical relationship between one quantity and another. For analysis of the primary financial statements, we classify ratios as:

• Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected cash needs.
• Operating efficiency ratios measure how efficiently a firm is paying its bills, collecting cash from customers, and turning inventory into sales.
• Profitability ratios measure the income or operating success of a company for a given period of time.
• Solvency ratios measure the ability of the company to survive over a long period of time.

Comparative Analysis

A single ratio by itself is not very meaningful. Accordingly, we will use various comparisons to shed light on company performance:

1. Intracompany comparisons covering two years for the same company.
2. Industry-average comparisons based on average ratios for particular industries.
3. Intercompany comparisons based on comparisons with a competitor in the same industry.