Describe the importance and techniques of financial statement analysis
Importance of Financial Statement Analysis
Assessing Creditworthiness: Bankers use financial statement analysis to judge whether a borrower can repay a loan.
Understanding Financial Position: Financial statements show the true financial condition of a business by presenting its assets, liabilities, and net worth.
Measuring Profitability: The analysis helps determine whether the business is earning a satisfactory profit from its operations.
Evaluating Liquidity: A company’s ability to meet its short-term financial obligations can be assessed through financial statement analysis.
Identifying Trends: Comparing financial statements over different years helps identify changes in business performance.
Comparing with Competitors: Financial statement analysis makes it easier to compare a company’s performance with similar businesses in the industry.
Supporting Decision-Making: Investors, bankers, and management rely on financial statement analysis to make informed financial decisions.
Regulatory Assessment: Bangladesh Bank uses financial statement analysis under the CAMELS framework to evaluate the financial health of banks.
Importance of Financial Statement Analysis
Horizontal Analysis
- Compares financial data over two or more accounting periods.
- Shows the increase or decrease in each item.
- Helps identify growth, decline, and long-term trends.
Vertical Analysis
- Expresses each financial statement item as a percentage of a base figure.
- In the Balance Sheet, each item is shown as a percentage of total assets.
- In the Income Statement, each item is shown as a percentage of net sales.
- Makes comparison between companies easier.
Ratio Analysis
- The most common and useful method of financial statement analysis.
- It measures the relationship between two financial figures.
- Helps evaluate liquidity, profitability, efficiency, solvency, and repayment capacity.
Common ratios include:
- Current Ratio
- Quick Ratio
- Debt-to-Equity Ratio
- Net Profit Margin
- Return on Assets (ROA)
- Return on Equity (ROE)
- Interest Coverage Ratio
- Debt Service Coverage Ratio (DSCR)
- Inventory Days
- Receivable Days
