The Tools of Financial Statement Analysis

We can use the following tools to analyze a company's financial statements:

(1) vertical analysis.
This includes the common-size income statement (each line item is expressed as a percentage of sales) and the common-size balance sheet (each line item is expressed as a percentage of total assets)

(2) horizontal analysis.
This includes a trend income statement and a percentage change income statement/balance sheet

(3) cause-of-change analysis.
We can understand why net income changed from one period to the next by separately identifying the individual effects of a change in sales, a change in margins, a change in a specific expense account, etc.

(4) ratio analysis.
This can tell us how quickly a company sells its inventory, collects cash from customers, and pays suppliers. We can analyze the company's profit margins, rate of return, short-term liquidity, long-term solvency, and efficiency.

(5) DuPont analysis.
We can disaggregate ROA and ROE into their component parts to learn why (a) the company's performance is improving or deteriorating and/or (b) why the company is outperforming/underperforming its competitors.

(6) quality of earnings.
We can assess the likelihood the company has manipulated its financial statements to overstate sales and/or earnings.
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