In simplest terms, financial statements are the documents presented by a business organisation which convey the activities conducted in a specific period of timeline. These statements often serve as important documents for the business and its stakeholders. The business organisation uses the financial statements to conduct ratio analysis for comparing the performances year to year. Thus, it can be said that the analysis of the financial statements helps the business organisation to grow. The financial statements are used by the stakeholders to analyse the growth of the organisation and are audited by the government to determine the truthfulness of the data and information provided.
Types of financial statements
There are generally 4 different financial statements that are made and analysed by the organisation – Cash Flow Statement, Income Statement, Balance Sheet and Shareholder’s Equity. It is important to note here that the shareholder’s equity is a part of the balance sheet only. The cash flow statement simply reports the inflow and outflow of cash in the business entity. There are three distinct parts of the cash flow system – operating activities, investing activities and financial activities.
The cash flow statement will allow the organisation to calculate the cash flow coverage ratio. It is calculated with the help of dividing the total operating cash flow by total debt.
The income statement is also known as the profit and loss statement. It shows the expenses and income of the organisation for a financial year. The bottom line of the statement consists of a very important figure – net earnings and net loss. It is important to note that the income statement also reports the Earnings Per Share, the income statement follows a path of the process to determine if the organisation is profitable or not.
The income statement allows the organisation to calculate various important ratios such as the profit margins. Following this, the balance sheet and the statement of shareholders’ equity are made. The balance sheet shows the financial health of the organisation. It helps the organisation in analysing various important and efficient ratios – gearing and liquidity. The balance sheet generally has two important divisions – assets and liabilities.
Thus, it can be seen that the financial statements consist of important information needed for proper financial analysis.
The importance of financial analysis
Financial statement analysis helps the organisation properly understand its performance qualitatively. One of the main goals of financial analysis is to analyse if the organisation is stable and solvent. Understanding the creditworthiness will allow the organisation to ensure that it can make use of l procedures. Most importantly financial analysis helps the organisation in making faster and better decisions which help in reaping immense benefits.
Financial analysis will also help a business organization in making important investment-based decisions. One of the finest ways to consider investment decision-making is by making use of financial appraisal technique. Some of the most popular forms of financial appraisal techniques are – Net Present Value Calculation and Payback Period Calculation. Most of these calculations are based on discounted cash flow methods. Using such financial appraisal tools will allow the business entity to understand if the investment into a project is worth it.
Investment is one of the most important activities that a business needs to undertake. It allows the organisation to grow and gain financial resources. For instance, a production and manufacturing organisation might opt-in to invest in a new form of technology or machinery to increase production. It will require using of financial appraisal techniques to properly analyse the options.
Another important function and role of financial analysis are to provide a competitive edge to the organisation in question. The company can make use of ratio analysis data of the competitors and compare it with its own to understand where it stands in the competitive market. In simple terms, the rigorous analyses of the financial statements will allow the business enterprise to scrutinise the weaknesses and the significant mistake it has made in the financial year. With the help of the analysis report, the company will be able to take figurative and logical actions to resolve the problems.
Important ratios to fuel growth
There are certain particular ratios that the organisation to make pivotal decisions and fuel the growth of the business.
Net Profit Margin
It helps the organisation understand what percentage of the revenue earned has been profitable for the organisation. Analysing the causes of this figure will allow the organisation to find out ways to control the expenses and take actions to increase the business profits.
Current and Quick Ratio
The current and quick ratios are two of the most important forms of liquidity metrics. With the help of the current ratio, the organization will be able to understand if the liquidity it has is optimal or not. On the other hand, an extremely high ratio will imply that the company has not been using its resources properly. The analysis of the ratio will help the enterprise in maintaining a healthy working capital which is extremely important for proper business growth. https://businessfig.com/
