Introduction to Financial Statement Analysis

The financial statements are a window into a company's performance. They can help you decided whether to extend credit to, or invest in, a company.

The 3 most important financial statements are the balance sheet (aka statement of financial position), the income statement, and the statement of cash flows.

A cursory overview of these financial statements can tell you:
(1) are sales growing or in decline?
(2) is the company profitable?
(3) does the company have a lot of debt?
(4) from what sources does the company obtain cash?

Going a bit deeper into the financial statements (e.g., by performing ratio analysis) allows you to answer questions such as:
(a) how long does it take the company to sell its inventory?
(b) for every $100 in sales, how much profit does the company earn?
(c) is the company spending more on R&D (research and development) as a percentage of sales relative to its competitors?

An advanced analysis of the financial statements can tell you:
(i) why is ROA (or ROE) increasing or decreasing?
(ii) why did the company's net income increase or decrease?
(iii) did the company manipulate its financial statements?

We can use the following tools to analyze the financial statements:
-vertical analysis (common-size financial statements)
-horizontal analysis (trend and percentage change financial statements)
-cause-of-change analysis
-ratio analysis
-DuPont analysis for ROA/ROE
-quality of earnings (detecting manipulation)
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