Financial Statements Analysis: Ratio, Common-Size, Cash Flow

Understanding Financial Statements Analysis

Financial statements analysis is a vital tool for assessing a company's health and future prospects. By analyzing balance sheets, income statements, and cash flow statements, you can evaluate a company's efficiency, effectiveness, and financial strength. In this article, we'll cover three key aspects of financial statements analysis: ratio analysis, common-size statements, and cash flow analysis.

Ratio Analysis

Ratio analysis involves comparing one financial statement item to another, often expressed as a percentage. It helps you evaluate a company's performance, liquidity, solvency, profitability, and efficiency. Some popular ratios include:

• Liquidity ratios: Quick ratio, Current ratio
• Solvency ratios: Debt-to-equity ratio, Debt-to-assets ratio
• Profitability ratios: Return on equity (ROE), Gross profit margin, Net profit margin
• Efficiency ratios: Accounts receivable turnover ratio, Inventory turnover ratio

Common-Size Statements

Common-size statements display financial statements as a percentage of a chosen base figure, typically total revenue or sales. This normalization makes it easier to compare a company's performance over time and identify trends or changes in the use of financial resources. Common-size analysis can be applied to balance sheets, income statements, or cash flow statements.

Cash Flow Analysis

Cash flow analysis focuses on the movement of cash in and out of a business. It's essential to assess a company's ability to generate and manage cash. Analyzing cash flow ratios, such as the cash conversion cycle, provides insights into a company's ability to generate cash from operations and convert it into assets. It's also important to track the evolution of a company's cash balances over time.

Conclusion

By combining ratio analysis, common-size statements, and cash flow analysis, you can develop a comprehensive understanding of a company's financial position. This information is crucial for making informed decisions about investment, lending, or strategic partnerships. Remember that financial statements analysis is a dynamic process that requires you to stay updated with a company's financial performance, industry trends, and relevant economic factors.