Understanding Financial Statements: Analysis and Key Reports
Financial Statement Analysis and Interpretation
1. Analysis
Analysis involves applying specific techniques based on relationships and comparisons to logically determine objectives within financial statements. These statements form the basis of the analysis.
Various relationships and comparisons are determined using basic arithmetic operations. These operations are applied to items within the financial statements, which may or may not belong to the same group of accounts or the same period. For example:
- Between two asset accounts
- Between two liability accounts
- Between an income statement item and equity
- Between an item referring to two distinct periods
Interpretation
Interpretation is a further, complementary, and indispensable task to the analysis. It involves a professional study of the results, diagnosing the company, issuing opinions, and reaching useful conclusions for users to make informed decisions. According to Newton, this requires:
- Obtaining conclusions from the review of financial statements.
- Identifying conclusions that could be refuted.
- Determining the types of information needed to improve the quality of conclusions.
- Identifying sources for obtaining additional information.
- Assessing if pursuing information will improve conclusions enough to justify the cost.
- Finding additional relevant information.
- Revising and extending the conclusions.
- Repeating steps b) to g) until completion.
- Examining significant information, using micro and macroeconomic knowledge, applying logic, and drawing necessary conclusions.
2. The Balance Sheet
The Balance Sheet briefly shows a company’s assets and liabilities structure at a specific date, stating:
- Assets
- Liabilities
- Minority Participation in Third-Party Controlled Companies
- Equity
This balance sheet serves as a basis for determining an entity’s financial and property situation using indicators like liquidity and solvency.
3. The Income Statement
The Income Statement summarizes the reasons for major economic changes through a summary of income and expenses. This statement allows us to determine the company’s financial capacity levels through indicators like profitability.
The Cash Flow Statement
The Cash Flow Statement provides information regarding the entity’s financial management. It shows the items that generated inflows of funds and those to which funds were assigned. It’s widely used to measure the capacity to evolve and generate investment funds according to the company’s revenue stream.
The Statement of Changes in Equity
The Statement of Changes in Equity shows opening balances, changes during the period, and closing balances for each item.
It is used for analyzing entrepreneurship and the evolution of profitability levels.