How to Analyse Financial Statements: 6 Steps to an Effective Financial Statement Analysis in 2018
The work of a business owner or manager is never complete – a story you know all too well. Once the bookkeepers have entered all the data and the accountants have analysed them and formed financial statements, the question arises if you can trust the numbers you see. Although you may know how to read your financial analysis statements - such as a net income statement - it is also important to understand how to analyse financial statements and how to verify if the information is correct. This allows you to assess your financial ratios and to understand your current liabilities, total assets, stockholders' equity and so on.
You can probably never be completely certain all data are correct, but with a scientific approach, you can check your strategies. From here, you can correct your future statements if you notice any issues or areas of concern.
Six Steps to Analysing Financial Statements
Financial statements are formal reports detailing your company’s financial health. Having regular and detailed financial statements can improve your company’s accountability, as well as your company’s reliability in front of investors, shareholders and banks. This reliability can be severely damaged if the statements were created in a sloppy way, or if they contain bad data.
Thankfully, there are several steps you can take to ensure your statements are factual, and to preserve the trust your business partners and financial institutions have in your management.
1. Check the Quality of the Company’s Financial Statements
You will need to familiarise yourself with current accounting standards and you will need to review the financial statements for their quality. The most important question should be the integrity of the balance sheet and whether it represents the complete picture of the company’s financial situation. Additional essential parts to evaluate should be items such as classification, valuation and recognition. Finally, check the cash flow of your business to assess liquidity and compare it with the financial operations that were conducted by the company.
2. Check the Value of Your Company
The most important issue for your shareholders and any future investors is your company's steady increase in value. This increase may be measured in many ways, one of which is the comparison between your equity statements, your debt-to-equity ratio and your cash flow account, showing the precise amounts of free cash flow. This analysis will help you in several ways, as it can show mistakes and issues that came up. It can also become a way to communicate your company’s financial health to the stakeholders, as well as shareholders' equity, so as to ensure their future trust.
3. Devise Better Strategies
It is seldom easy to predict the future. Nevertheless, you will need to make strategies to predict the movements of your company and the market as a whole. For that, you will need the reliability of the data inside your financial statements. Try to account for as many factors as possible and use various techniques, such as the Percentage of Sales (PoS) approach. Once you have a detailed plan, you can analyse how the financial statements you have made compare to the situation and revise your positions accordingly.
4. Clear Picture of Your Industry
You should analyse the complete production chain of your company and the impact various industries and markets have on your business process. There can be multiple factors in your supply chain that can seriously impact your business and you will need to know how they are portrayed in the financial statements to have a better idea of future actions. To do this, you can utilise several techniques like Porter’s Five Forces or consult with your accountant on the best way to approach this issue.
5. Analyse Profits and Liabilities
This point can truly benefit your company and add a lot of value for both the stakeholders and the financial statements themselves. The usual approach is to assess critical reports, such as ratios that relate to profitability, liquidity, asset management and the management of risk and debt.
You will need to make sure to analyse these issues, both from the managerial perspective — regardless of the source of financing — as well as from a shareholder perspective; he or she will definitely be interested in the overall profitability of the company. Additionally, these statements should be compared to those from an earlier period so as to determine trends and tendencies within the company.
6. Have Regular Audits
Regular audits provide an extra pair of eyes to check your quality of reporting and your company’s financial health. Moreover, they can help you assess the reliability of the data you are working with, so you gain a more in-depth insight into your company’s financial health. Consequently, it will be easier for shareholders, investors, banks and tax services to trust you and your financial management skills.
You can always do a comparative analysis of the financial statements, current assets, shareholders' equity reports and the auditing reports and compare them with earlier editions in order to determine if problems are being solved, as well as whether the strategies that you have developed in the past are yielding the expected results.
You can never be entirely confident that all your statements will always be impeccable. However, you should do everything in your power as a business owner or manager to keep your records trustworthy. This will assist both you and your team in improving your quality of work and will improve your relations with the stakeholders in your company. Additionally, don’t hesitate to ask help from an external accountant, who can offer a fresh perspective on your company’s financial health.
Finally, if you don’t regularly check your financial statements, HMRC will — and you should always do your best not to have any mistakes. After all, it is much easier to clear mistakes in advance than to resolve them under suspicion of wrongdoing.
Posted: October 26, 2018