Analysis of financial statements
The financial statement analysis is a comprehensive assessment of the company’s business activities or any other business-related issues to obtain information that help stakeholders in planning and evaluating the project’s operations and answer many of the questions relating to the decision-making process.
Is the project profitable? Is the business operating efficiently? Can the business implement its plans? Can it meet its future obligations on time? Therefore, the analysis of financial statements is important and necessary for all parties involved in the project as it is part of the financial planning and decision-making process based on evaluation, monitoring and follow up.
The financial analysis stage follows the financial audit process.
Reports are examined by auditors who draw conclusions. Investment projects are then assessed in terms of completion rates, which are inferred from data systems, ratios and statistics in the documented reports. In other words, financial analysis is conducted through data, statistics and ratios assessment, and then formulated in the form of analytical reports.
For instance,
1. Product production rate (high) + product marketing (low) = loss2. Product production rate (low) + marketing needs for this product (high) = loss3. Product production rate (high) + Product marketing (high) = gain4. Example: Inventory investment analysis is the accumulation of stocks of goods, and may be positive or negative
Return on investment = production – sales
If the production per time unit exceeds the expected sales rate per time unit, it means that the investment per time unit is positive, and accordingly at the end of the period, the expected return on investment will be achieved, and vice versa. If production is less than sales, based on the above:
5- Evaluate the general level (excellent – average – below average) while identifying the economic level
6- Consider the possibilities to solve the problem and raise efficiency
7 – Correct errors and provide support
8- Provide documented information to clients
Stages of financial statement analysis:
1) Reformulation of financial statements
2) Analysis and resetting of measurement errors.
3) The financial ratios are analyzed on the basis of the redrafted financial statements adjusted in step 1 and 2 in which financial ratios are calculated only on the basis of the figures in reports which may include some adjustments.
The financial analysis is carried out by financial analysts who prepare reports using ratios and data from financial statements and other reports. These reports are then presented to the senior management to issue decisions on the following:
– To purse or discontinue its main operations or part of its operations.
– To purchase some material that is necessary to manufacture their products.
– To own or rent machinery and equipment specialized in the production of goods
– To negotiate a bank loan to increase working capital.
– To make decisions relating to investments or lending capital.
Elements of financial analysis:
1. Profitability: Indicates the ability of the company / institution to earn income while maintaining growth in the short and long term. The company’s level of profitability depends on the income statement, which reflects the results of the company’s cash flow.
2. Ability to pay debt: It means the ability of the company to meet its obligations to creditors and any other parties dealing with the company in the long term.
3. Liquidity: the company’s ability to maintain positive cash flow, to meet any immediate obligations. It should be noted that both steps 2 and 3 depend on the company’s balance sheet; which refers to the financial position of the company at a given point of time.
4. Stability: the company’s ability to stay in business in the long term, without the need to incur significant losses in the course of its operations. The assessment of the company’s stability requires the evaluation of both income statement and balance sheet, in addition to other financial and non-financial indicators.
Methods of financial analysis:
- Ratio analysis: This analysis is based on an assessment of financial ratios on the basis of specific criteria in order to obtain information about the indicators and prevailing conditions for the company.
- Sources and uses of funds: This analysis is based on identifying the sources of company funds and how these funds were used during a specified period of time to identify the importance of both internal and external sources in financing the operations of the company and the appropriateness of these sources in terms of quality and quantity.
- Estimated cash balances or cash flow statements: This analytical tool provides useful information on the timing of cash flows from and to the company and determines the amount of funds needed by the institution during a future period as well as when these funds are needed.
- Estimated financial statements: The objective is to identify the estimated value of assets, liabilities, equity and financial needs, as well as the expected profit.
- Breakeven Analysis: It aims to identify the number of units sold or sales that generates profits before interest and taxes, or identify the number of units to be sold or the level of sales required to achieve a certain amount of profits.
- Comparative Financial Statements: This analysis provides a comparison of financial performance over multiple periods by comparing statements over a number of years.
- Trend analysis: This analysis technique shows changes in the amounts of corresponding financial statement items over a period of at least two years to avoid the disadvantages of year over year comparisons.
