Financial performance of a business is one of the most important aspects to be understood. To do so, companies employ tools and methods to gauge their financial health. Financial statement analysis is one of its most important tools. To put it simply, financial statement analysis tells us how good or how bad a company does. Indicates whether a business is profitable, efficient or struggling.
Different types of Financial Statement Analysis assist in discovering specific details. Some examine changes over periods of time, some compare one business to others, and some hone in on numbers such as profits or assets. Therefore, when asked, “what are the types of financial statement analysis?, the answer is — there are, and each is valuable in its own right.
What is Financial Statement Analysis?
Financial statement analysis is like checking whether the company which provides your salary is fine or not. It demonstrates the performance of the business using its income statement, balance sheet, and cash flow statement.
Understanding the Concept
What’s more, every single business records every money activity it receives or pays. We call those records financial statements. They show everything from incomings to outgoings to profit and liability and all that money stuff. Hence we can analyse by observing these, how good is a consideration of a company Working.
Financial statement analysis comprises multiple types, each of which has a specific purpose. Some are like accountants, going through all the records from the past, and others like fortune tellers, predicting the future. In this sense, these tools are helpful for students and business owners to identify parts they can improve.
- This reflects big questions like:
- Is the company growing?
- Is it spending too much?
- Is it making enough profit?
- Can it pay its debts?
Simple Example
Imagine you own a shop. You keep a monthly tally of what you earn and what you spend. In the 6th month, you can check these notes and you can see that whether you are in a loss or in a profit. It is the very basics of financial statement analysis.
Objective of Financial Statements Analysis
Uses of Financial Statement Analysis There are several applications of financial statement analysis. For business owners, managers, investors, bank while students it becomes a useful tool for taking wise decisions.
Why Do We Use It?
The purpose is primarily to gauge whether a firm is strong, weak or stable. It assists in identifying risks, budgeting, and discovering growth opportunities. Here are some major purposes:
- To measure performance: you can see which company has done better or worse.
- To benchmark against others: See how your business compares to competitors.
- In order to plan for the future: Use the data to set the new goals.
- To test for financial health: Check whether the business is able to pay back loans and remain solvent in the market
- As a basis for decision making: Investors analyze figures and topics in order to make the decision of whether or not to invest
Real-World Use
Banks want to check the financial statements before providing loans. Investors look them up before purchasing shares. Business owners rely on them to create budget plans.
These users all want accurate and honest data. This is why the different types and methods of financial statement analysis are utilized only under situations where appropriate.
What are the Important Components of Financial Statements Used in the Analysis?
We must know what we are analysing before performing any type of analysis. There are three main parts of financial statements. These are employed in nearly every classification and form of financial statement analysis.
Income Statement
This indicates the income or loss that was earned during a period. It has:
- Revenue (money earned)
- Expenses (money spent)
- Net profit or loss
It works on the system of income and cost pattern.
Balance Sheet
It shows the financial position as at a date. This includes:
- Balance Sheet (Who is the owner of the company)
- Liabilities (what is owe)
- Owner’s equity(owner part) It is useful to determine the strength or weakness of the company.
Cash Flow Statement
This attempts to track the real cash coming in and flowing out. It includes:
- Operating cash
- Investing cash
- Financing cash
It aids in figuring out if this firm possesses sufficient liquidity to not get stuck.
And all these all, help together, to do the types of ratios in statement analysis of finance. By comparing numbers from these statements using ratios, actual performance is demonstrated.
Different Types of Financial Statement Analysis
Now tell us what are different types of financial statement analysis types? They each have their own application and method. All three of these help you to analyze company performance from different perspectives.
Horizontal Analysis
Horizontal analysis (or trend analysis) examines financial data over a series of time periods. It will help you recognize whether performance has improved or decreased as time passes.
Major points to remember:
- To look at the data year over year
- Identify long term patterns
- When Deciding that You Want to Calculate the Rate of Return
E.g if in 2022 sales were ₹ 50,000 and for 2023 it was ₹ 60,000 then it is increase of 20%.
This shows a positive trend. Implementation Strawman/setting the stageThis proves useful for strategic planning and goal setting.
Vertical Analysis
Vertical Analysis: This approach gives the items as a percentage of a whole. It displays what fraction each element contributes to a topline number.
Key Points:
- Use percentage of total
- Good for one-period analysis
- Common-size statements used
Example:
For example, net sales = ₹1,00,000, cost of goods sold = ₹40,000, and COGS = 40% of the sales.
This is to identify the high-cost and needed to be controlled.
Ratio Analysis
It’s one of the most frequent types. It takes two numbers that are related to each other and numerically compares them to arrive at some usable entity.
Financial statement analysis has many ratios such as:
These include
- profit-attributable ratios (i.e. net profit/turnover), return on investment (ROI).
- Liquidity Ratios — Current ratio, Quick ratio
- SOLVENCY RATIOS (DI) (Debt-equity ratio)
- Inventory turnover Efficiency Ratios
Ratios allows faster and faster decision making. They’re employed in all types of industries and businesses.
Financial Comparison
An essential technique for telling apart similar companies.
This method allows for comparison of the financial performance of two or more companies. It also helps me compare different years under the same company.
Use Cases:
- Best for investors
- Helps in the business benchmark
- Identifies strengths and weaknesses
- A higher profit margin and lower debt indicate better financing control.
Trend Analysis
It is a part of horizontal analysis but with more focus on the pattern. This verify whether there is a certain trend of boom or decline.
Use cases:
- Used in long -term scheme
- Helps forecast
- Observe the red flag quickly
These are the various types of financial statement analysis students, managers, and finance specialists are using all the time.
Financial Statement Analysis Importance for Decision Making
It is the basis for all major and minor decisions taken in a business. It has a clear picture of financial health.
Why Is It So Important?
- Helps in investment decisions
- Investors have to check if the company is capable of giving better returns.
- Supports lending decisions
- They verify whether the company can repay the loan.
- Helps managers control cost
- It indicates rising costs and profits.
- Helps government bodies
- Officials examine tax fraud or compliance issues along with analysis.
Relevance to ACCA Syllabus
Students taking a number of papers on the ACCA syllabus (notably Financial Reporting (FR), Performance Management (PM), and Strategic Business Reporting (SBR)) need to be able to interpret financial statements using horizontal, vertical, and ratio analysis. Such skills are key to internal reporting, external communication, and advising stakeholders on performance.
Types of Financial Statement Analysis ACCA Questions
Q1: Which ACCA exam paper covers in depth financial statement analysis?
A) Audit and Assurance (AA)
B) Business Key Reporting (SBR)
C) Taxation (TX)
D) Business & Technology (B&T).
The answer is B) Strategic Business Reporting (SBR)
Q2: What type of financial analysis compares the same item across different periods?
A) Ratio analysis
B) Cash analysis
C) Horizontal analysis
D) Trend forecasting
Answer: C) Horizontal analysis
Q3: Which one of the given belongs to profitability ratio in ratio analysis?
A) Quick ratio
B) Current ratio
C) Net profit margin
D) Debt to equity ratio
Answer C) Net profit margin
Q4: How does vertical analysis facilitate understanding?
A) Multiple year liquidity
B) Financial Trends of Competitors
C) Proportion of each article in contrast to an amount
D) Industry average
Ans: C) the comparison of all the items versus the clan.
Q5: Why ratio analysis is important for ACCA students
A) Helps evaluate capacity of technical skills
B) It tests tax knowledge
C) It presents a simplified view of performance in monetary terms
D) It avoids audit risks
Answer: C) It represents an oversimplification of financial performance
Relevance to CMA Syllabus
In US CMA Part 1, Performance Management and Financial Reporting are covered, in these subjects the students learn techniques for analyzing financial statements in order to aid management in making good financial decisions. Train the trend and ratio analysisData from Trend analysis supporting budgeting, forecasting and decision-making.
Types of Financial Statement Analysis US CMA Questions
Q1: Why even analyze financial statements when it is a major business decision and important to management accounting?
A) Completing tax paperwork
B) External audit
C) Decisions making in the organization
D) Compliance tracking
Answer: C) The decisions within the business.
Q2: What ratio is most useful in assessing the small size of the company?
A) gross margin
B) Return to assets
C) accelerated ratio
D) loan-to-equity ratio
Answer: C) Quick Ratio
Q3: If a company has been around for five years, what is the best way to evaluate their performance?
A) vertical analysis
B) forecast future trends
C) horizontal analysis
D) cash based account
Answer: C) horizontal analysis
Q4: What is it that is the most useful (relative financial analysis):
A) internal control
B) trade combination
C) Performance Benchmarking
D) Risk audit
Ans: C) Performance Benchmarking
Q5: What is the CMA classify each percent of each item as a percentage of net sales?
A) horizontal
B) General size or vertical
C) trend
D) Operations
Ans: B. Common-size or vertical
Relevance to CPA Syllabus
Types of financial statement analysis are also tested on CPA exam sections, such as the sections of Financial Accounting and Reporting (FAR) and Auditing and Attestation (AUD), where its applications on audits, in reporting, and in preparing financial statements are emphasized.
Financial Statement Analysis CPA Questions
Q1: What does planning for a financial audit involve?
A) Market analysis
B) Trend analysis
C) Strategic mapping
D) Variance analysis
Answer: B) Trend analysis
Q2: In ratio analysis, how many other ratios be evaluated including debt to equity ratio
A) Profit margins
B) Liquidity
C) Leverage
D) Asset turnover
Answer: C) Leverage
Q3: Which CPA section requires the greatest amount of time dedicated to analyzing financial statements?
A) regulation
B) Group 2: General /oedd: 70578 | Accounting and writing (far).
C) commercial environment
D) audit simulation
Ans: b. Financial accounting and reporting (far)
Q4: The current ratio you said is less than 1?
A) High profitability
B) insolvency risk
C) Strong liquidity
D) Excellent credit rating
Answer: B Solvency Risk
Q5: CPA reports contain horizontal analysis:
A) Industry average
B) Historical Data Trends
C) Yearly, based on a basin quantity
D) Total cost method
Reference: C) Percent of the base amount in one annum
Relevance to CFA Syllabus
Once again, CFA candidates are taught with the help of Financial statements analysis type ratios and metrics, to evaluate firms under the level of Financial Reporting and Analysis. Helps in value, equity and investment decision making.
Types of Financial Statement Analysis CFA Question
Q1: What is the limitation of horizontal analysis for investment assessment?
A) Can not compare percentage
B) Time-series ignores data
C) ignores the consequences of inflation
D) focuses only on one year
Answer: C) does not take into account the influence of inflation
Q2: What method do we need to decompose the anatomy around financial statements?
A) sensitivity analysis
B) vertical analysis
C) Market regression
D) internal audit
Answer: B) vertical analysis
Q3: Which measures the performance of a company relative to the best?
A) Return to capital
B) Inventory Turnover
C) current ratio
D) loan-equity ratio
Answer: B. Inventory turnover
Q4: CFA candidates mainly use comparative analysis to:
A) Prepare tax returns
B) Compare company performance to past or peers
C) Design audit procedures
D) Value goodwill
Ans: B) Compare company performance over time or against peers
Q5: Ratio analysis is one of the most important topics covered within CFA study because of the following:
A) The Advantages of Portfolio Diversification
B) Help towards depth in fundamentals of the company
C) Neither is marked to market
D) Is a legal requirement
Answer: B) Benchmarks company fundamentals
