Introduction to Financial Statement Analysis
Purpose: Understand how to read, interpret, and evaluate a company’s financial reports to assess performance, financial health, and future prospects.
1. Why Analyze Financial Statements?
| Goal |
What It Reveals |
| Profitability |
Ability to generate earnings (e.g., margins, ROE) |
| Liquidity |
Short‑term ability to meet obligations (e.g., current ratio) |
| Solvency |
Long‑term financial stability (e.g., debt‑to‑equity) |
| Efficiency |
How well assets are used (e.g., asset turnover) |
| Valuation |
Relative worth of the firm (e.g., P/E, EV/EBITDA) |
| Trend identification |
Changes over time that signal improvement or risk |
2. Core Financial Statements
| Statement |
Primary Focus |
Key Line Items |
| Balance Sheet |
Snapshot of resources & claims at a point in time |
Assets, Liabilities, Equity |
| Income Statement |
Performance over a period |
Revenue, COGS, Operating Expenses, Net Income |
| Cash Flow Statement |
Cash generation & usage |
Operating, Investing, Financing cash flows |
| Statement of Changes in Equity |
Movements in owners’ interest |
Issuance/repurchase of shares, dividends, retained earnings |
3. The Analytical Process
- Collect the data – Obtain audited statements for at least 3–5 years and any interim reports.
- Standardize – Restate figures (e.g., common‑size percentages) to enable comparison across periods or firms.
- Compute ratios – Use liquidity, profitability, leverage, and activity metrics.
- Trend analysis – Plot key ratios and line‑items over time to spot patterns.
- Benchmark – Compare with industry averages, peers, and historical performance.
- Interpret – Relate findings to business model, economic environment, and management strategy.
- Report – Summarize insights, highlight risks, and suggest actions.
4. Key Ratio Categories & Sample Formulas
| Category |
Representative Ratios |
Formula (basic) |
| Liquidity |
Current Ratio, Quick Ratio, Cash Ratio |
Current Ratio = Current Assets / Current Liabilities |
| Profitability |
Gross Margin, Operating Margin, Net Margin, ROA, ROE |
Net Margin = Net Income / Revenue |
| Leverage |
Debt‑to‑Equity, Debt‑to‑Assets, Interest Coverage |
Debt‑to‑Equity = Total Debt / Shareholders’ Equity |
| Efficiency |
Asset Turnover, Inventory Turnover, Receivables Days |
Receivables Days = (Accounts Receivable / Revenue) × 365 |
| Market |
EPS, P/E, Price‑to‑Book, EV/EBITDA |
P/E = Market Price per Share / Earnings per Share |
Tip: Use common‑size statements (e.g., each balance‑sheet item as % of total assets) to compare firms of different sizes.
5. Common Analytical Techniques
| Technique |
Description |
Typical Use |
| Horizontal analysis |
Compare line‑items across periods (year‑over‑year % change). |
Detect growth trends, unusual spikes. |
| Vertical analysis |
Express each item as a % of |
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