Analysis of Financial Statements
Why analyse financial statements
Say what analysis and interpretation mean and how each user group benefits.
A company's financial statements are full of figures. On their own, they tell you little. Financial analysis makes sense of them in two steps:
- Analysis: simplifying the data by sorting and grouping it in a methodical way.
- Interpretation: explaining what the simplified figures mean.
The two need each other: without analysis there is nothing clear to interpret, and analysis without interpretation is just more numbers.
Figures are compared in two ways: with other firms in the same year (cross-sectional analysis), and with the firm's own past (time series analysis).
Different users look for different things:
| User | Mainly looks at |
|---|---|
| Trade payables (suppliers) | liquidity: can it pay short-term debts? |
| Lenders (banks, debentureholders) | solvency: can it repay long-term loans? |
| Investors | profitability |
| Labour unions | whether it can pay higher wages |
| Management | efficiency and planning |
| Government | licensing, price fixing, profit ceilings, tax concessions |
The objectives: to judge the firm's profitability and efficiency, the importance of each part, the reasons for change over time, and its ability to pay its short-term and long-term debts.
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