Financial statement analysis (or financial analysis) refers to an assessment of the viability,

stability and profitability of a business, sub-business or project.

It is performed by professionals who prepare reports using ratios that make use of information
taken from financial statements and other reports. These reports are usually presented to top
management as one of their bases in making business decisions. Based on these reports,
management may:

• Continue or discontinue its main operation or part of its business;

• Make or purchase certain materials in the manufacture of its product;
• Acquire or rent/lease certain machineries and equipment in the production of its goods;
• Issue stocks or negotiate for a bank loan to increase its working capital;
• Make decisions regarding investing or lending capital;
• Other decisions that allow management to make an informed selection on various
alternatives in the conduct of its business.

Goals

Financial analysts often assess the firm's:

1. Profitability - its ability to earn income and sustain growth in both short-term and long-term. A
company's degree of profitability is usually based on the income statement, which reports on the
company's results of operations;

2. Solvency - its ability to pay its obligation to creditors and other third parties in the long-term;
3. Liquidity - its ability to maintain positive cash flow, while satisfying immediate obligations;

Both 2 and 3 are based on the company's balance sheet, which indicates the financial condition
of a business as of a given point in time.

4. Stability- the firm's ability to remain in business in the long run, without having to sustain
significant losses in the conduct of its business. Assessing a company's stability requires the use
of the income statement and the balance sheet, as well as other financial and non-financial
indicators.

Methods

Financial analysts often compare financial ratios (of solvency, profitability, growth, etc.):

• Past Performance - Across historical time periods for the same firm (the last 5 years for
example),
• Future Performance - Using historical figures and certain mathematical and statistical
techniques, including present and future values, This extrapolation method is the main
source of errors in financial analysis as past statistics can be poor predictors of future
prospects.
• Comparative Performance - Comparison between similar firms.

These ratios are calculated by dividing a (group of) account balance(s), taken from the balance
sheet and / or the income statement, by another, for example :

n / equity = return on equity

Net income / total assets = return on assets
 Stock price / earnings per share = P/E-ratio

Comparing financial ratios is merely one way of conducting financial analysis. Financial ratios
face several theoretical challenges:

• They say little about the firm's prospects in an absolute sense. Their insights about
relative performance require a reference point from other time periods or similar firms.
• One ratio holds little meaning. As indicators, ratios can be logically interpreted in at least
two ways. One can partially overcome this problem by combining several related ratios to
paint a more comprehensive picture of the firm's performance.
• Seasonal factors may prevent year-end values from being representative. A ratio's values
may be distorted as account balances change from the beginning to the end of an
accounting period. Use average values for such accounts whenever possible.
• Financial ratios are no more objective than the accounting methods employed. Changes
in accounting policies or choices can yield drastically different ratio values.
• They fail to account for exogenous factors like investor behavior that are not based upon
economic fundamentals of the firm or the general economy (fundamental analysis).

Financial analysts can also use percentage analysis which involves reducing a series of figures
as a percentage of some base amounts. For example, a group of items can be expressed as a
percentage of net income. When proportionate changes in the same figure over give time period
expressed as a percentage is know as horizontal analysis. Vertical or common-size analysis
reduces all items on a statement to a “common size” as a percentage of some base value which
assists in comparability with other companies of different sizes.

Another method is comparative analysis. This provides a better way to determine trends.
Comparative analysis presents the same information for two or more time periods and is
presented side-by-side to allow for easy analysis.

SWOT

SWOT Analysis is a strategic planning method used to evaluate the Strengths, Weaknesses,
Opportunities, and Threats involved in a project or in a business venture. It involves specifying
the objective of the business venture or project and identifying the internal and external factors
that are favorable and unfavorable to achieving that objective. The technique is credited to Albert
Humphrey, who led a convention at Stanford University in the 1960s and 1970s using data from
Fortune 500 companies.

A SWOT analysis must first start with defining a desired end state or objective. A SWOT analysis
may be incorporated into the strategic planning model. Strategic Planning, including SWOT and
SCAN analysis, has been the subject of much research.

• Strengths: attributes of the person or company those are helpful to

achieving the objective.
• Weaknesses: attributes of the person or company those are harmful to
achieving the objective.
• Opportunities: external conditions those are helpful to achieving the
objective.
• Threats: external conditions which could do damage to the objective.
Identification of SWOTs is essential because subsequent steps in the process of planning for
achievement of the selected objective may be derived from the SWOTs.

First, the decision makers have to determine whether the objective is attainable, given the
SWOTs. If the objective is NOT attainable a different objective must be selected and the process
repeated.

The SWOT analysis is often used in academia to highlight and identify strengths, weaknesses,
opportunities and threats. It is particularly helpful in identifying areas for development.

Corporate planning

As part of the development of strategies and plans to enable the organization to achieve its
objectives, then that organization will use a systematic/rigorous process known as corporate
planning. SWOT alongside PEST/PESTLE can be used as a basis for the analysis of business
and environmental factors.

• Set objectives – defining what the organization is going to do

• Environmental scanning
o Internal appraisals of the organization's SWOT, this needs to
include an assessment of the present situation as well as a portfolio of
products/services and an analysis of the product/service life cycle
• Analysis of existing strategies, this should determine relevance from
the results of an internal/external appraisal. This may include gap analysis which
will look at environmental factors
• Strategic Issues defined – key factors in the development of a corporate
plan which needs to be addressed by the organization
• Develop new/revised strategies – revised analysis of strategic issues
may mean the objectives need to change
• Establish critical success factors – the achievement of objectives and
strategy implementation
• Preparation of operational, resource, projects plans for strategy
implementation
• Monitoring results – mapping against plans, taking corrective action
which may mean amending objectives/strategies.[8]

Cash Flow Statement

In financial accounting, a cash flow statement, also known as statement of cash flows or
funds flow statement,[1] is a financial statement that shows how changes in balance sheet
accounts and income affect cash and cash equivalents, and breaks the analysis down to
operating, investing, and financing activities. Essentially, the cash flow statement is concerned
with the flow of cash in and cash out of the business. The statement captures both the current
operating results and the accompanying changes in the balance sheet.[1] As an analytical tool, the
statement of cash flows is useful in determining the short-term viability of a company, particularly
its ability to pay bills. International Accounting Standard 7 (IAS 7), is the International Accounting
Standard that deals with cash flow statements.

People and groups interested in cash flow statements include:

• Accounting personnel, who need to know whether the organization will be able to cover
payroll and other immediate expenses
• Potential lenders or creditors, who want a clear picture of a company's ability to repay
• Potential investors, who need to judge whether the company is financially sound
• Potential employees or contractors, who need to know whether the company will be able
to afford compensation
• Shareholders of the business.