The day-to-day work of a company’s financial department is not simple. Doing the Analysis of Financial Statements, then, is no joke. Knowing the step-by-step behind this process is essential to arrive at a complete diagnosis demonstrating the corporation’s situation.
It is from the Analysis of Financial Statements that data becomes information and can be used to support significant business decisions. Next, you will better understand this task’s objectives and learn a step-by-step guide on how to carry out the Analysis of Financial Statements.
What are the objectives of the Financial Statement Analysis?
Financial management and accounting are two pillars for a business to remain healthy. And the Analysis of Financial Statements, also called Analysis of Financial Statements, has as its primary objective to diagnose the actual asset, economic and financial situation of the analyzed company. That is, it demonstrates how the health of the analyzed company is going.
Reports generated by Accounting and other information deemed necessary for the analysis are used to carry out the Analysis of the Financial Statements. This is because some aspects may not be apparent only from the Accounting reports, and it is necessary to carry out a more in-depth study.
In addition, it is crucial to include studies other than accounting and financial statements to understand the scenario well, both for the organization and the market. Relative indexes from previous years and comparisons with competitors of the same size or in the same industry, for example, are common and recommended additions.
In the end, the product presented is a report that combines the analysis of the structure, equity composition, a set of financial indices and indicators, and the analyst’s conclusion.
1. Which financial statements should be analyzed?
The first step in carrying out the Financial Statement Analysis is data collection. At the start, you should gather the following documents:
- Three last financial statements of the analyzed institution:
- Balance Sheet (BP);
- Explanatory Notes to the Balance Sheet;
- Income Statement for the Year (DRE);
- Notification of Changes in Equity (DMPL);
- Statement of Accumulated Profits or Losses (DLPA);
- Statement of Cash Flows (DFC);
- Added Value Statement (DVA);
- Management Reports;
- Audit and Supervisory Board Opinions;
- Social Balance;
- Minutes of meetings and announcements of relevant facts.
2. Conference of collected data
The second step of the Analysis of Financial Statements is to check the data collected in the previous step. For this, check the structure and adequacy of current legislation. The bases for this conference should be:
- Law No. 6,406-76 or the Corporate Law;
- Income Tax Regulation;
- Rules issued by the Central Bank of Pak and the Real Estate Commission;
- Fundamental Accounting Principles.
At this stage, also verify that the statements analyzed
- Were audited;
- Converge to the international standard of the International Accounting Standards Board (IASB);
- They meet minimum information quality requirements;
- They have comments from the Supervisory Board;
- And if there were any relevant facts.
3. Data preparation and account reclassification
After collecting and collating data, the third part of the Financial Statement Analysis process is data preparation. First, after observing whether the collected information was standardized and obeyed the rules, you will need to adjust and reclassify everything unexpected.
In this step, you will also need to adjust for the effect of monetary variation. And finally, it is also necessary to reclassify some BP accounts between Resources and Origins. Amongst them:
- Discounted Duplicates: must be reclassified as Current Liabilities;
- Expenses for Next Year (AC) and Expenses for Future Years (ANC): must be reclassified as Shareholders’ Equity;
- Deferred: must be reclassified as Shareholders’ Equity;
- Income for Future Years: must be reclassified as Current Liabilities or Non-Current Liabilities if there is a possibility of return and as Shareholders’ Equity when there is no such possibility.
4. Data processing
With the information collected, checked, and reclassified, the analysis itself begins. During this stage, the data will be processed, and the calculations of the indicators will be carried out; from this, it will be possible to extract the indexes of the adjusted financial statements.
Some of the main economic-financial analysis techniques that you can use when doing your Financial Statement Analysis are:
- Vertical Analysis;
- Horizontal Analysis;
- Quotient Analysis;
- Capital Structure Analysis;
- Analysis of Activity Indicators;
- Dupont analysis;
- Fleuriet’s Dynamic Model Analysis;
- Liquidity Analysis;
- Analysis of Debt and Structure;
- Analysis of Profitability and Profitability;
- Analysis of Operational Activities.
And the data processing step can be divided into:
- Accounting Analysis: when reports and financial statements are analyzed to gather relevant information. It is subdivided into the analysis of structure, evolution, quotients, and by absolute differences;
- Financial Analysis: made through indicators for global analysis in the short, medium, and long term of the speed of the turnover of resources;
- Financial Leverage Analysis: measures the degree of use of third-party capital and its effects on the formation of the rate of return on equity;
- Economic Analysis: measures profitability, return on equity, net earnings per share, and return on operating investments.
5. Interpretation of indicators
After analyzing the data and calculating the indicators, the next step is to interpret their behavior in the analyzed period. This step aims to understand the behavior of equity, financial and economic indicators during the analyzed period, identifying trends and other bases for the diagnosis of the corporation.
6. Diagnosis of the Analysis of Financial Statements
The last step in the Analysis of Financial Statements is the diagnosis. At that moment, the analyst responds to questions and presents his conclusion. Some of the inquiries he must respond to are:
- Is the financial situation of the company normal or abnormal?
- Is the company’s economic situation normal or abnormal?
- What are the economic and financial strengths and weaknesses of this company?
- Is there a possibility of insolvency of this company?
In addition, the analyst must also relate the results to each other. He can also compare them with the performance indicators of other companies in the same sector or with standard indexes. These processes can lead to relevant inferences and insights for the final report.
The diagnosis of the Analysis of Financial Statements helps in making important decisions, such as:
- Invest in the company;
- Evaluate the solvency capacity of the company;
- Assess the risk of granting credit to the company;
- Detect strengths and weaknesses of the company and its competitors;
- Compare the performance of the analyzed company with that of competitors.