All financial statements are essentially historically historical documents.

They tell what has happened during a particular period of time. However most users of financial statements are concerned about what will happen in the future. Stockholders are concerned with future earnings and dividends. Creditors are concerned with the company's future ability to repay its debts. Managers are concerned with the company's ability to finance future expansion. Despite the fact that financial statements are historical documents, they can still provide valuable information bearing on all of these concerns. Financial statement analysis involves careful selection of data from financial statements for the primary purpose of forecasting the financial health of the company. This is accomplished by examining trends in key financial data, comparing financial data across companies, and analyzing key financial ratios. Managers are also widely concerned with the financial ratios. First the ratios provide indicators of how well the company and its business units are performing. Some of these ratios would ordinarily be used in a balanced scorecard approach. The specific ratios selected depend on the company's strategy. For example a company that wants to emphasize responsiveness to customers may closely monitor the inventory turnover ratio. Since managers must report to shareholders and may wish to raise funds from external sources, managers must pay attention to the financial ratios used by external inventories to evaluate the company's investment potential and creditworthiness. Although financial statement analysis is a highly useful tool, it has two limitations. These two limitations involve the comparability of financial data between companies and the need to look beyond ratios. Comparison of one company with another can provide valuable clues about the financial health of an organization. Unfortunately, differences in accounting methods between companies sometime makes it difficult to compare the companies' financial data. For example if one company values its inventories by the LIFO method and another firm by average cost method, then direct comparisons of financial data such as inventory valuations are and cost of goods sold between the two firms may be misleading. Some times enough data are presented in foot notes to the financial statements to restate data to a comparable basis. Otherwise, the analyst should keep in mind the lack of comparability of the data before drawing any definite conclusion. Nevertheless, even with this limitation in mind, comparisons of key ratios with other companies and with industry averages often suggest avenues for further investigation. An inexperienced analyst may assume that ratios are sufficient in themselves as a basis for judgment about the future. Nothing could be further from the truth. Conclusions based on ratio analysis must be regarded as tentative. Ratios should not be viewed as an end, but rather they should be viewed as a starting point, as

indicators of what to pursue in greater depth. They raise may questions, but they rarely answer any question by themselves. In addition to ratios, other sources of data should be analyzed in order to make judgments about the future of an organization. They analyst should look, for example, at industry trends, technological changes, changes in consumer tastes, changes in broad economic factors, and changes within the firm itself. A recent change in a key management position, for example, might provide a basis for optimism about the future, even though the past performance of the firm may have been mediocre. Few figures appearing on financial statements have much significance standing by themselves. It is the relationship of one figure to another and the amount and direction of change over time that are important in financial statement analysis. How does the analyst key in on significant relationship? How does the analyst dig out the important trends and changes in a company? Three analytical techniques are widely used; dollar and percentage changes on statements, common-size statements, and financial ratios formulas. Rashid Javed is an Asian author. He writes about financial and managerial accounting articles, financial statement analysis, and accounting ratios. http://www.accountingformanagement.com

What is financial analysis?? This article defines financial analysis and describes common uses for different types of analysis. It considers the two main types of financial analysis: horizontal and vertical. Financial Analysis is just playing with numbers. In the hands of an expert and a motivated management, however, it can make the difference between the success and failure of a business. The key to success in financial analysis is to first assess the interest and needs of management by talking to them. Some owners and managers are looking simply to maintain current operations until retirement. Others hope to one day be the largest business in their industry. The more they are interested in growth, the more analysis they will want. Determine their interest by asking management the questions below. By understanding the answers to these questions, you will be able to determine the type of analysis, they would like.

What do they want from their business? What services are they hoping you'll provide?

What type of information do they expect to receive? Are they interested in ideas that will improve profitability? Do they want to be warned of troublesome trends? What financial comparisons, if any, would they like? Are there industries, or other companies, what they wish to benchmark with? Are they planning on budgeting/forecasting? There are two types of analysis that you may choose to use in a business: Horizontal and Vertical. The most common, and simplest, being Horizontal Analysis.

Horizontal Analysis
This method of analysis is simply comparing the same item in a company's financial statements from two or more comparable periods, and then calculating the difference. For instance, you may choose to compare the current month with the previous month, or with the same month last year. Another common horizontal comparison is to compare this year's year-to-date versus the same period last year. For example, let's imagine that your business had $531,275 in sales in the current year and $552,715 in sales the previous year. The reduction in sales would be $21,440. That was easy. Now, management would want to know "WHY". That's the analysis and that's our job. Once you understand the reason for the change in sales, you'll want to tackle Cost of Sales - then Expenses. Sometimes an increase or decrease in one account will explain the same or opposite impact in another account. For instance, an increase in Advertising Expense may be the reason for a complimentary increase in Sales (at least that's management's hope). Even understanding the change in Balance Sheet Accounts can be valuable to the owner. For instance, what's happening to Inventory, or to Accounts Receivable? An increase in either of these two accounts can have the same impact to the Cash Account as the purchase of a piece of equipment, and may result in a cash-poor company.

Vertical Analysis
This type of analysis illustrates the relationship of certain components compared to the whole, or the financial stability of a company. There are several different types of ratios or indexes that may help us determine where the company currently stands in relationship to where it wants to go. The most common form of Vertical Analysis is using percentages to show one account's relationship to another. For instance, often times we will include a column on the Income Statement showing each Cost and Expense, and the resulting Gross Profit and Net Income as a percentage of total Revenue. From this analysis we can determine how many pennies of each revenue dollar actually results in profit. This way we can compare one company's results with those of another, even though the size of the companies may vary significantly. If our company is profiting 10 cents for every sales dollar, and another company is getting only 4 cents it may indicate we're being more efficient.

On the Balance Sheet we might show each account balance as a percentage of Total Assets. This has lesser value, but occasionally shows trends that may or may not be enlightening. There are a host of other analyses that companies use in determining their financial position and effectiveness. Here's just a list of a few of the more common ones and their formulas: Working Capital Current Ratio Quick Ratio Debt to Equity Ratio Return on Investment Return on Equity Accounts Receivable Turnover Accounts Receivable Days on Acct Inventory Turnover Current Assets - Current Liabilities Current Assets / Current Liabilities Quick Assets / Current Liabilities Total Liabilities / Owner's Equity Net Profit / Total Assets Net Profit / Owner's Equity Sales on Account / Average Accounts Receivable 365 Days / Accounts Receivable Turnover Cost of Goods Sold / Average Inventory

The resulting numbers and ratios are useless unless you have something to compare them to. One effective use of these calculations is to compare them horizontally to identify improvements or failures in the company's system. For instance, a declining trend in Inventory Turnover could indicate that the company is purchasing too much inventory for the current level of sales. An additional source of information would be to compare one company's results with those from another company or industry average. Comparing them to another company may be difficult since most companies hold their financial data close to vest. On the other hand, libraries have reference books called 'financial abstracts' which contain industry specific financial data that is easy to compare to.