The techniques for analyzing financial statements help the users of financial data understand the working of the company. Horizontal analysis, vertical analysis, ratio analysis, and trend analysis are some of these techniques. They help users like investors, students, and company managers to make right decisions. The term “Techniques of financial statement analysis” is used to describe the methods of analyzing financial statements to assess the financial position of a firm.
Financial statements tell a business’s money story. But you can’t grasp the full story from the numbers alone. You have to understand what those numbers represent. This is where the techniques of financial statement analysis come into play. These tools translate numbers into valuable ideas. These methods lead you towards the betterment of a business or how well the business is doing. You find out whether the business is growing, how much money it makes and whether it has enough cash to pay its bills. These techniques provide clarity about financial health.
Essential Techniques of Financial Statement Analysis
To analyze and comprehend financial statements we use statistical techniques. The reason is that these techniques allow us to discover the strengths and weaknesses of a company. They also assist in comparing one year with another or one business with another.
Horizontal Analysis
Horizontal Analysis: Examine the Financial Data Over Time It compares the same line item on a financial statement for two or more years. It represents the difference between the two periods.
To illustrate, if the sales for 2023 was ₹1,00,000 and for 2024 was ₹1,20,000 than horizontal analysis gives us that sales increased by ₹20,000 or 20%. This allows us to study growth trends. It indicates whether the business is improving or declining over time.
Horizontal analysis allows students and investors to view long-term trends. They further set this against its peers in the space. This is simple and most useful technique. It can be applied to income statement, balance sheet, and cash flow statement.
| Year | Sales (₹) | Change (₹) | Change (%) |
| 2023 | 1,00,000 | – | – |
| 2024 | 1,20,000 | 20,000 | 20% |
The horizontal analysis made numbers come alive as it showed what has changed over the years.
Vertical Analysis
Vertical analysis expresses each item as a percentage of a total in the same statement. When looking at the income statement, the items each become a percentage of sales. On the balance sheet, everything is a percentage of assets.
Assume the sales is ₹2,00,000 and cost of goods sold (COGS) is ₹80,000. The vertical analysis will be such that COGS is 40% of sales. This enables comparison of the cost structure with other companies, even if they are of different sizes.
Vertical analysis is known as common-size analysis. It allows for a comparison of businesses of various sizes. Vertical analysis can be used to study a small business and a big business together.
| Item | Amount (₹) | Percentage of Sales |
| Sales | 2,00,000 | 100% |
| Cost of Goods Sold | 80,000 | 40% |
| Gross Profit | 1,20,000 | 60% |
Vertical analysis allows you to identify high costs. When you know the size of these in relation to sales, you can control these costs much better.. This financial statements are with two or more years next to each other Both horizontal and vertical analysis is used in these statements. They provide a clear comparison between different periods of time. This enables students to see patterns. Having profit increases every year is a good sign. If debt is growing quicker than assets, it can indicate an issue.
Comparative Financial Statements
Comparative financial statements are excellent business planning tools. They all assist in comparing information in a single interface. There is no need to turn back and forth between pages. All the significant data is in a single table.
Horizontal, vertical and comparative statements all give us an idea of the areas of growth in our business, the areas where we are weak and what needs improvement.
Ratio Analysis
Ratio analysis is one of the techniques of financial statement analysis. It takes numbers from financial statements and makes basic ratios. They provide an insight into the performance and health of a business.
Ratios can demonstrate how profitable a company is, how well it controls debt management and how easily it pays bills. Ratio analysis is classified into different types. Each one focuses on a different aspect of the business.
Liquidity Analysis
This is liquidity, which shows whether the business can pay its short-term bills. Liquidity ratios are commonly used, including:
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Current Assets – Inventory) / Current Liabilities
For example, if the current ratio is 2:1, it indicates that the company has ₹2 in its assets for every ₹1 it is liable to pay. That shows good liquidity. If you have studied commerce, then Indian students must know that it may not be able to pay its bills on time as the liquidity ratio is less than 1. That is a warning sign.
Profitability Ratios
These ratios provide insights regarding one’s ability to generate profits. The higher these ratios, the better the company performs.
Net Profit Margin = Net Profit / Sales
ROA = Net Income ÷ Total Assets
ROE = Net Income ÷ Shareholder’s Equity
When a company has a net profit margin of 20%, it means there is a profit of ₹20 in every ₹100 sales. That is a very healthy profit margin.
Profitability ratios can then be used by Indian students preparing for exams or jobs to compare company profitability across different time periods.
Honeywell Financial Performance Analysis
These ratios combined provide a complete overview. They demonstrate the way the company is spending money. Rising profits without rising liquidity may mean we have a growing company that is facing difficulties with cash flow.
Smart decision-making is supported by evaluation of financial performance. These ratios help managers detect weak spots. They then act to correct them. Therefore, ratio analysis is a maximum qualitative technique of reading financial data. It reduces complex numbers to simple, straightforward facts.
Analysis of the Financial Statements
That means knowing what the numbers say. Not reading, but thinking. You examine the connections among sales, costs, debts, and profits. You also pitch the company against peers. You ask:
- Improved version above Is this company better than the average?
- more riskier or more stable or less riskier?
- Can it pay back a loan?
Reading financial statements may take a while to get the hang of. This skill can be through simple examples. Work on papers that have existing financial statements and work with real companies. The moment you learn to make sense of, you can act better in business. You plan well and don’t make mistakes.
Relevance to ACCA Syllabus
Industry financial statements analysis, however, is the central concept in ACCA syllabus, noticeably in Financial Reporting (FR) and Strategic Business Reporting (SBR) papers. Performance evaluation requires knowledge of horizontal analysis, vertical analysis, ratio analysis, and other financial analysis techniques. These ideas also feature in some of the higher level areas e.g. consolidation, investment appraisal, and financial management. Understanding of these techniques plays an important role in solving scenario based question of different papers.
Techniques Of Financial Statement Analysis ACCA Questions
Q1: What exactly is horizontal analysis in financial statement reporting?
A) Multi-period financial side by side
B) Showing items as a percentage of total assets
C) Best & worst performance periods
D) Calculating profit through a point in time
Answer: A) Analyzing financial information over multiple accounting periods
Q2: What does liquidity analysis focus on?
A) Debt to Equity Ratio
B) Return on Capital Employed
C) Current Ratio
D) Earnings Per Share
Ans: C) Current Ratio
Q3: A vertical analysis of the income statement expresses each item as a percentage of:
A) Total assets
B) Net profit
C) Revenue
D) Cost of goods sold
Ans: C) Revenue
Q4. Financial Analysis That Help You In To Find Trend In Long Run?
A)Test of Compare Statement
B) Trend analysis
C) Cash flow analysis
D) Vertical analysis
Ans: B) Trend analysis
Q5: What a best type of ratio to study a firm efficiency in relation of the recourses it utilizes?
A) Current Ratio
B) Gross Profit Margin
C) Return on Assets
D) Quick Ratio
Ans: C) Return on Assets
Relevance to USA CMA Syllabus
US CMA (Certified Management Accountant) syllabus of Part 1: Financial Planning, Performance, and Analytics lists financial statement analysis as the content included in the syllabus. These are the techniques & tools used by CMAs for budgeting, forecasting & artisanship. You have to know how to read any kind of business financial statement in terms of managing cost, risk and performance.
Techniques Financial Statement Analysis CMA Questions
Q1 For last year; In analysing financial statements; Whatever we are going to use in percentage from last year, Which method we will use?
A) Vertical Analysis
B) Cash Flow Analysis
C) Horizontal Analysis
D) Profitability Analysis
Ans: C) Horizontal Analysis
Q2: What is excluded in the quick ratio?
A) Cash
B) Accounts Receivable
C) Inventory
D) Prepaid Expenses
Ans: C) Inventory
Q3: Ratio that shows us how much a dollar sales earns a company in profit?
A) Gross Profit Margin
B) Net Profit Margin
C) Operating Margin
D) Return on Equity
Ans: B) Net Profit Margin
Q4: What is one of the biggest disadvantage of vertical analysis?
A) This ignores past patterns
B) There are apples and oranges since the size of companies vary
C) it only relies on absolute numbers.
Ans: A) This ignores past patterns
Q5: Type of financial analysis that is best suited for variance analysis.
A) Trend Analysis
B) Comparative Analysis
C) Cash Flow Analysis
D) Horizontal Analysis
Ans: D) Horizontal Analysis
Relevance to CPA Syllabus
Financial analysis is covered in two sections of US CPA exam, FAR (Financial Accounting and Reporting), and BEC (Business Environment and Concepts). We added financial reading and also financial analysis from a financial statement. Main Assessment Type: Skills tests (multiple-choice items and task-based simulations related to profit margins, liquidity assessments, and financial performance evaluations)
Techniques Of Financial Statement Analysis CPA Questions
Question 1 — What is current ratio?
A) Net Profit Margin
B) Return on Assets
C) Quick Ratio
D) Debt to Equity Ratio
Ans: C) Quick Ratio
Q2: Vertical analysis can help a CPA to determine:
A) Financial trends over time
B) effectiveness in proportfolio management
C) Each item grade, expressed as a percentage of a grand total
D) Liquidity position
Ans: C) Breakout of total grade per item as a percentage of grand total
Q 3: What are included in the Profitability ratios?
A) Inventory Turnover
B) Current Ratio
C) Return on Equity
D) Debt Ratio
Ans: C) Return on Equity
Q4: Which of the following most resembles trend analysis?
A) Company vs Industry Average
B) Items % of total assets
B) Ratios may be the basis for credit determination
D)Interpreting Financial statement over several periods
Ans:D) Interpratation of Financial statement of multiple periods
Q5: In CPA practice, the financial statement interpretation is mainly due to _.
A) Prepare tax returns
B) Make data-driven decisions
C) Conduct audits
D) Maintain ledgers
Ans: B) Take decisions based on data
Relevance to CFA Syllabus
Financial Statement Analysis is also covered in the financial reporting and analysis (FRA) section of both the level I and level II CFA (chartered financial analyst) curriculum. Trend, horizontal and vertical analysis will assess a company and its potential investmentfor CFA:: Ratio related methods are inputs to equity valuation, credit analysis, and portfolio management.
Techniques Of Financial Statement Analysis CFA Questions
Q1: How to interpret the financial statements of the company?
A) Price-Earnings Ratio
B) Dividend Policy
C) Inventory Valuation Method
D) Corporate Governance
Ans: A) Price-Earnings Ratio
Q2 Where are you showing an analysis that reflects items as a percent of base-year values?
A) Vertical Analysis
B) Common Size Analysis
C) Trend Analysis
D) Forecasting
Ans: C) Trend Analysis
Q3 : ROE (return on equity ratio) = Net income / Total equity
A) Return on Equity
B) Gross Profit Margin
C) Current Ratio
D) Operating Margin
Ans: A) Return on Equity
Q4: Surely working soundness will be deducted from what piece of an elucidation of a record stream mandate?
A) Quick Ratio
B) Gross Margin
C) Inventory Turnover
D) Debt to Equity
Ans: C) Inventory Turnover
Q5: Which of the following method of the financial statement analysis techniques expresses each individual line item in a financial statement as a percentage of some number in the statement?
A) Horizontal Analysis
B) Vertical Analysis
C) Liquidity Analysis
D) Break-even Analysis
Ans: B) Vertical Analysis
