Advantages & Disadvantages of Financial Statement Analysis - Example

Finance Name: Course Professor’s name University name City, State Date of submission Executive Summary The report presents a comprehensive study of the analysis of the financial statement in understanding the performance of companies. It is facilitated by critically evaluating the strengths and weaknesses of the analysis of the financial statement. The major objective of the report is to provide sufficient information to the newly appointed CEO about the judgment in preparation of the financial statements. This aims at providing required knowledge of accounting in making financial management decisions. The report is presented in three different parts. The first part presents a comprehensive introduction to the aspects of financial statement analysis through evaluation of major financial documents and indicators of financial health. The part also evaluates the important issues in understanding the financial statement. The second part presents the strengths of the analysis of the financial statement, which shows its strengths. The third part presents the weaknesses of the analysis of the financial statements, which shows its limitations. Keywords: Financial statements, Analysis, Performance, Decisions, and Judgment. Introduction The financial statement analysis is a significant element in a company that represents the function of the business finance. It involves providing comprehensive information that evaluates the historical, current and the future financial capabilities of a given company. The analysis of the financial statements is very important tool in the management of the company and it is used in making strategic decision. The most significant component that is enhanced by the financial statement analysis is creating an insightful understanding of the performance of companies[Joo07]. This is enhanced by critically understanding the data provided in the financial statements so as to facilitate the provision of valuable management decisions. In the analysis of the financial statement, there are two major documents that are mainly evaluated as source of data, and they include the balance sheet and the income statements. The balance sheet represents the financial tool that evaluates the physical and the financial resources of a given company and its major elements include liabilities and the assets. Its main function is to present companies resources making it a weak tool for analyzing the performance of the company. The income statement is a strategic document that provides information pertaining the performance of the company at a given period of time. Its main function is enhanced by various elements that include revenues, the incurred expenses, and generated profit and loss. The income statement is a strong financial tool for analyzing the performance since it provides the accomplishments of a company for a given period of time[Sin12]. The understanding of the performance of the companies is evaluated through the financial health reflected in analyzing the financial statements. This financial health is facilitated by evaluating three major financial components, which include profitability, leverage, and liquidity. These components enhance the internal measures and they are evident in the management structure of the company. The profitability reflects the management performance in a company through proper utilization of the business resources. It provides the actual state of the financial return in company hence reflecting the actual performance. The leverage can be explained as an important proportion of capital in a company that is contributed by both the creditors and the investors. It also reflects the extent which the company depends on the borrowing. The liquidity illustrates the capability of the company in paying their current expenses and bills [Kot06]. These three components are important in the analysis of financial statement since they help in understanding the performance of the companies. In order to enhance proper judgment in preparation of financial statement, there are various significant issues that one requires to know about the financial statement. First, the financial statements act like scorecards that reflect the operations of the companies. The stakeholders rely on the financial statement in order to know the quality of the company through evaluation of solid incomes, strong balance sheets, and positive cash flows. Second, the numbers behind the financial statements explain events and occurrence in the real world. These numbers create the actual visualization of the quantitative information that indicates the company’s performance. Third, the accounting aspect of the financial statement provides an act and not a science. This shows that the company position indicated in the financial statements is judgments, decision, and management of the company[Lot14]. Strengths of Analysis of the Financial Statements First, the analysis of the financial statement is very significant in the determination of the stability and health of a company. The data presented in the financial statement enhance a crucial understanding of how a given company conducts its business. This factor allows the stakeholders of a company to evaluate and understand how the management structure employs the company’s resources and whether it is done in a proper channel[Gri14]. Second, the technicality of the financial statements is enhanced through summarizing the accounting process and hence providing the tabulation of money and accounts titles. This helps in the communication of the financial decision in a company through reporting the relevant references for the business. Third, the analysis of the financial statements facilitates provision of the liquidity ratios, which shows the monetary worth of a company at a given period. This helps in setting the recommended financial reliability in a company. The current ratio is very useful and it shows how the current assets available in a business relate to meeting the company’s current obligations. The quick ratio helps a company in the calculation of those assets that can be easily converted to cash. This help in the evaluation of the relationship of the immediate working capital in the company hence determining the financial health. The efficiency ratio is also useful in a company especially in determining how a given company turns its inventory into revenue or sales. The function of the efficiency ratio is facilitated to be effective and efficient with the role of other adjacent ratios that include inventory turnover ratios and day sales inventory turnover[i]. Fourth, the financial statement provides the profitability ratio that evaluates the success of a company in generating of profit. A company that has a significant profit margin contains the ability to operate effectively under the challenges of adverse conditions and extreme competition. The return on assets provided in the profitability ratio shows the earned profits as compared to the assets, and it measures the management efficiency of creating profit return in a company from the assets. The net worth creates an insightful focus on the returns generated by a company by the invested capital from the owners[Jan14]. Fifth, the financial statement analysis is very important since it is useful in making decision-making and future planning indicated in the company’s budget. The budget outline presented in the statements is crucial revealing the recommended limits that a company can undertake in creating expansion and also advancing their operations. This help the company to have the exact estimates of available fund hence making the strategic decision to ensure it spends in accordance with the expectations[Jac141]. Sixth, the analysis of the financial statements reveals significant data that reveals the sales pattern of a given company. The increment and fluctuation of the sales pattern act as a significant indicator of showing the financial performance of the company. This helps the management in making the strategic decision and will uplift financial performance of the company in the future[Jan14]. Seventh, the analysis provided by the financial statements helps in the creation of a clear objective in a company. This helps the company in making the correct judgment about the company’s situation that includes the amount it earns and also the amount of debt. The factor is crucial for a company since it helps in making quantifiable and clear assessment on when to make various financial decisions related to costs, investment, and expansion[Joo07]. Eighth, the financial statement analysis is also significant in providing full disclosure of the company’s financial data. This helps in understanding the real value of the company in terms of resources and financial terms. The public companies are required by the exchange and securities commission to have a comprehensive financial disclosure in order to be fully listed. This is done by combining all the financial data that evaluates all the assumptions that create the visualization of the company[Den14]. Ninth, the analysis of the financial statements helps the company in enhancing the required compliance with the accounting standards and government agencies. The accounting standard requires a company to have a comprehensive presentation of the financial statement that indicates the financial position in order to be featured in a particular industry. This also helps in enhancing a strategic comparison of different companies. The government agencies through the internal revenue service utilize the analysis of the financial statements in making the decisions about how to collect company’s tax. This makes it a mandatory requirement for a company to have a well-prepared analysis of the financial statement[Fra09]. Tenth, the financial analysis is also important because it allow a company to present information in a simple and quick format. This allows a person to judge the operations of a company through the evaluation of few numbers instead of requiring massive reading of the financial statements. The factor is very significant especially in allowing different people to understand the performance of the company[Fra09]. Weaknesses of Analysis of the Financial Statements First, the analysis of the financial statements has limits that allow the manipulation of the numbers to hide the actual condition or state of the company. The accounting techniques utilized by a company may present different look on the papers. This may allow a company to use this techniques to alter and change the visibility of profit level and financial health. The financial management can use the accounting methods to indicate the company is performing well while it is in its worse condition[Bra14]. Second, the analysis of the financial statement may be disadvantageous in making the management decision since the data and figures evaluated are based on the market pattern at a given period of time. The market patterns always change in a span of time making it hard for the management to create an assumption of the future from previous financial statements[Gar14]. This shows that the financial analysis does not present the best merit for measuring the future performance of the company. Third, the analysis of the financial statement indicates how a company is doing in a given single period of time. This does not provide the actual comparison between the companies from one year to the other. This factor makes the financial statement to become a continuous analysis that requires evaluation of different period in order to develop an approved assumptions for the future performance[Hig00]. Fourth, the analysis of the financial statement does not provide all the relevant indicators that demonstrate the performance of the company. For example, it does not indicate the relevance of the recent trend that creates the company appeal to the market. Also, the financial statements base the decision making of a given company on financial documents eliminating the relevance of timing and intuition. This shows that the analysis may recommend taking a certain business judgment that is completely disapproved by management timing and intuition[i]. Fifth, the financial statements are evaluated through the ratio analysis that is hampered with various limitation on company’s performance. The analysis may include various errors and poor accounting management, which involves distort of information utilized to derive the financial ratios. This makes the company encounter poor performance especially when it is under poor oversight of external standards and internal management[Ham06]. Sixth, the numbers presented in the analysis of the financial statement might provide the company’s shareholders with a false sense of the company’s security, which may limit the expansion and performance of the business. This factor is facilitated when the analysis of the financial statement indicates stable profit and earnings but in the real sense there is poor performance. The sales and profits figures in a company may be as a result of unstable business model that present the poor indication. This may limit the company’s performance in the management decision-making will not be based on the real-time observations[Kha13]. Seventh, the analysis of the financial statements may provide wrong judgment especially when analyzed by individuals with poor skills and knowledge of accounting. Also, the company can make a poor decision when individual makes a bias conclusion in presentation of the analysis hence leading to poor performance[Wil09]. Eighth, the analysis of the financial statement presents only the quantitative data about the financial affair of the company. This may result in poor performance in a company since it does not evaluate crucial qualitative data. Some of the qualitative data include customer’s satisfaction, labor relation, and skills of the management. Ninth, the analysis of the financial statement might mislead the user on the company’s performance. The company relies on the financial preparation accuracy of the historical financial data. When there is a poor preparation, the analysis provides wrong performance information to the user[Hig00]. References Joo07: , (Joos & Beuselinck, 2007, p. 240), Sin12: , (Sinha, 2012, p. 37), Kot06: , (Kothari & Weber, 2006, p. 32), Lot14: , ( Loth, 2014), Gri14: , (Griffin , 2014), i: , (Accounting Explained , 2013), Jan14: , (Jane , 2014), Jac141: , (Jackson , 2014), Joo07: , (Joos & Beuselinck, 2007, p. 258), Den14: , (Dennis & Kozack, 2014), Fra09: , (Franco, et al., 2009, p. 14), Fra09: , (Franco, et al., 2009, p. 32), Bra14: , (Brayant , 2014), Gar14: , ( Gartenstein, 2014), Hig00: , (Higgins , 2000, p. 56), Ham06: , (Hammed & Chan, 2006, p. 129), Kha13: , (Khan, 2013), Wil09: , (Williams & Barth , 2009, p. 17), Hig00: , (Higgins , 2000, p. 9), Read More