ANALYSIS OF FINANCIAL STATEMENT

WHAT IS FINANCIAL ANALYSIS?

Assessment of Firm’s Past, Present and Future financial performance

OBJECTIVES OF FINANCIAL PERFORMANCE

  1. Capitalize on the strengths
    Explanation: Financial analysis helps a company recognize areas where it's performing well so it can build on them.
    Example: If a company sees that its online sales are growing rapidly, it can invest more in e-commerce to boost profits even further.

  2. Take remedial action to improve upon weaknesses
    Explanation: It identifies weak areas, allowing management to fix them before they affect the business.
    Example: If a firm has rising inventory costs, it may find ways to reduce waste or negotiate better deals with suppliers.

  3. To standardize financial information for comparison purposes
    Explanation: Standard formats (like income statements and balance sheets) make it easier to compare performance.
    Example: Two companies in the same industry can compare their profit margins because their financials are reported in the same structure.

  4. To evaluate current operations of the company
    Explanation: It helps management understand how the business is performing right now.
    Example: A company may use this to see if its new product line is profitable by checking current revenue and expenses.

  5. To compare the present performance with the past performance
    Explanation: It tracks progress or decline by comparing financial results over time.
    Example: A retailer may compare this year's sales with last year's to see if its marketing strategy worked.

  6. To compare the performance of the company with other firms or industry standards
    Explanation: Helps determine if the company is keeping up with or outperforming its competitors.
    Example: If a business's profit margin is 8% but the industry average is 12%, it may need to investigate why it's underperforming.

  7. To assess the efficiency of operations
    Explanation: Analyzes how well resources are used to generate profits.
    Example: A company with high output but low labor costs shows strong operational efficiency.

  8. To assess the risk of operation
    Explanation: Identifies potential financial or operational threats that could impact the company.
    Example: A firm heavily dependent on a single supplier might face higher risk if that supplier fails.

TYPES OF FINANCIAL RATIO

LIQUIDITY RATIO

This is talking about liquidity ratios, which help us understand how well a company can pay off its short-term debts (like bills or loan payments due soon).

  • These ratios compare what the company owns short-term (like cash, inventory, or money others owe the company) to what it owes short-term (like bills and loans due soon).

  • If the ratio is high, it means the company has enough resources to pay its debts on time — this is called being “liquid.”

  • If the ratio is low, the company might struggle to pay its creditors, which can lead to problems.

  • So, higher ratios = better ability to pay short-term obligations.