4 Steps to Effective Financial Statement Analysis

By Marianne Chrisos - Last Updated on January 6, 2020
4 Steps to Effective Financial Statement Analysis

You know that financial statement analysis is one of the most important steps in decision-making for your business – here’s how to get the most from your analysis.

Financial analysis is a crucial procedure for any business. Though it is often a long, involved and detailed process, it tells the story of a business’s financial standing and helps business owners, executive teams, investors, and other stakeholders understand both the problems and the possibilities.

Financial statement analysis is useful for answering questions like:

  • What are the business trends over the past few years?
  • What is the debt to income ratio?
  • In what business areas are profits and losses happening?
  • Does the business have the financial ability to expand, hire more employees, or develop additional products?
  • What areas need immediate attention to help balance the financial profile of the business?
  • Is the business at risk? Is it profiting in accordance with projections?

The most important steps in analyzing a company’s financial statement.

Being able to successfully answer these questions annually can help businesses make better decisions about the direction of the organization into the next year and beyond. Here are 4 steps to conducting a thorough, accurate, and useful financial statement analysis.

1. Decide which method of financial statement analysis to use

There are two primary methods for analyzing financial statements. One is horizontal and vertical analysis, where horizontal analysis compares data sets across certain time periods, while vertical analysis reports costs and assets as a percentage of the entire financial statement. Horizontal analysis is useful for reviewing financial information over a set period (such as sales over the last 5 years), while vertical is useful for understanding different areas of business in comparison to each other (to help analyze marketing budget spend vs. sales budget spend, or how much money is spent on salaries vs. product development).

The second method is the ratio method. This can help you analyze dozens of areas of your business and compare them to overtime or even compare them other businesses in your industry. Some ratios businesses choose to examine include:

  • Accounts payable ratio, which shows how quickly a business pays its suppliers
  • Accounts receivable ratio, which measures how quickly a company collects payment
  • Debt to equity ratio, which measures the amount of debt that is being used to fund operations
  • Return on assets, which shows how much profit is generated based on a company’s combined assets (which can include product, personnel, working capital, and more)

What method you decide to use for your statement analysis will depend on what kind of business you have, how long the business has been in operation, and ultimately the goals for your financial statement analysis.

2. Gather all documents

A financial statement analysis includes many pieces, often from disparate areas of business. To be able to accurately assess the financial position of a company, you’ll need to audit records from different departments and possibly even other businesses, including:

  • Sales records
  • Annual budgets
  • Profit and loss statement
  • Supplier invoices and contracts
  • Inventory records
  • Supply chain bills

For the most part, accounting teams like accounts payable and accounts receivable, HR, executive leadership, procurement teams, and IT can help find and gather all the necessary data.

3. Process all the data

Once all the paperwork has been gathered, it needs to be evaluated. There are lots of programs that serve as useful tools of financial statement analysis and can help a business prepare and understand their data. Excel and Access databases can serve for small businesses, but as your business grows (and your data along with it), you’ll need a more robust solution that can not only handle the data but assist in presenting it.

Some of the leading comprehensive vendors are:

  • AFP
  • Adaptive Insights
  • Sageworks
  • Capterra

4. Analyze and report on findings

The goal of going this process is to ultimately create a financial statement analysis report. This should be based on the data that you gathered and compared and help guide business leadership in making decisions for the future of the business. One of the benefits of using a financial processing program like the ones listed above is that they are often able to highlight areas that need immediate attention or make recommendations based on the data.

Being able to prepare and understand a financial statement analysis is critical to the health of your business, as it can be a tool used to help shape your organization and be used to gain credit, capital, or record business compliance. Make sure you understand what’s involved in conducting your analysis accurately and effectively.

Marianne Chrisos | Born in Salem, Massachusetts, growing up outside of Chicago, Illinois, and currently living near Dallas, Texas, Marianne is a content writer at a company near Dallas and contributing writer around the internet. She earned her master's degree in Writing and Publishing from DePaul University in Chicago and has worked in publishing, advertising, digital marketing, and content strategy.

Marianne Chrisos | Born in Salem, Massachusetts, growing up outside of Chicago, Illinois, and currently living near Dallas, Texas, Marianne is a content writer at a c...

Related Posts