Essential Tools for Financial Statement Analysis

Financial statement analysis is a valuable skill you can use in a variety of careers. This practice involves thoroughly analyzing a company's financial records and interpreting the data to get a clear view of the company’s financial health. Becoming familiar with financial statement analysis tools and techniques will help you better understand any company’s current position and future potential.

Different tools used to analyze financial statements offer multiple purposes. Some of them give you a glimpse into a company’s profitability, while others can help you understand how the company operates. Frequently-used tools for financial analysis include common size statements, comparative financial statements, ratio analysis, and benchmarking.¹

Keep reading to learn more about the most commonly used tools for financial analysis and how to use them.

Understanding Financial Statement Analysis

Before exploring financial performance analysis tools, it’s important to understand why you need to analyze financial statements. Whether your career goals involve working as a company’s chief financial officer or you’re interested in helping investors, you need to know how to analyze financial statements.

Financial analysis is also a valuable skill for management team members, entrepreneurs, and investors. The main financial statements you use in analysis include the following:²

• Income statements: summarize revenue earned over a specific time by listing revenue, expenses, gains, and losses
• Balance sheets: display a company’s assets, liabilities, and shareholders’ equity
• Cash flow statements: showcase a company’s cash activities from operating activities, investing activities, and financing activities

Components of financial analysis include the following:

• Revenue: A company's primary source of income 
• Profits: The money a company has left after deducting the cost of goods from revenues
• Operational efficiency: Shows how a company is using its resources to operate
• Liquidity: A company's ability to generate the cash needed to pay its bills

Tools for Financial Statement Analysis

An important financial statement analysis tool is ratio analysis. Ratio analysis helps you assess multiple financial metrics to identify trends and determine if a company is financially stable.³ Calculating various financial ratios also lets you quickly compare multiple companies. Common ratio analyses include those that follow here.⁴

Liquidity Ratios

Liquidity ratios tell you whether a company can pay its debts. You can use the quick ratio or current ratio to assess a company’s ability to pay short-term bills. This involves adding the value of quick assets, or assets a company can easily liquidate. You then divide the total by the company’s current liabilities.⁵ The current ratio also considers a company’s inventory and other assets.

Profitability Ratios

Profitability ratios help you predict a company’s ability to generate profits. They include the net profit margin and return on equity. The net profit margin shows a company’s earnings after they’ve paid all expenses and taxes.⁶ You calculate it by dividing net income by total revenue.

Efficiency Ratios

Efficiency ratios give you a glimpse into a company’s operations. Examples include inventory turnover and accounts receivable turnover. If a company can quickly turn its inventory over, it is likely making more money than a company with a longer turnaround time. You calculate this by dividing the cost of goods sold by the average inventory over a single time period.⁷ For example, you would calculate the cost of goods sold over a 30-day period along with the average inventory over the same 30 days.

Solvency Ratios

Solvency ratios show you if a company can pay its long-term debts with its cash flow. Common solvency ratios include the debt-to-income ratio, which compares a company’s outstanding debt to its assets, and the interest coverage ratio. This ratio gives you insights into a company’s ability to pay interest on its outstanding debts.⁸

Horizontal and Vertical Analysis

Horizontal and vertical analysis are financial statement analysis tools used to compare various aspects of a company’s performance.

Horizontal Analysis

Horizontal analysis involves comparing a metric or set of metrics over multiple time periods.⁹ Many companies perform a year-over-year analysis of their financial statements to benchmark their performance over the previous year.

For example, comparing your current net profit margin to the previous year will tell you if your business is growing or if you appear to be moving less inventory. If your net profit margin is substantially lower, you would investigate potential causes to get back on track and boost your earnings for the rest of the year.

Vertical Analysis

Vertical analysis involves assessing different line items in relation to another item.¹⁰ If you want to see how operating changes are impacting profitability, you would calculate line items on your income statement as a percentage of your gross sales. You could then compare how cost of goods sold impacted your gross profits for the year compared to the previous year.

Trend Analysis

Trend analysis is another tool of financial analysis that helps assess a company’s future potential.¹¹ Once you have calculated financial data from multiple years, you compare the data points to identify patterns.

Trend analysis helps you understand potential long-term performance, so you can develop budgets and strategic financial plans. It also gives you insights that guide your financial decisions. For example, if you notice seasonal spikes in profitability, you can save excess revenue for typical down periods.

Advanced Tools for Financial Statement Analysis

Delve deeper into a company’s finances with advanced financial statement tools such as the DuPont analysis. This tool breaks a company’s return on equity into net profit margin, asset turnover, and financial leverage.¹² DuPont analysis helps you understand how different aspects of a business affect its profitability. For example, you may learn that a company is not effectively using its assets (such as intellectual property) to make sales, which is lowering profitability.

You would use comparative analysis to benchmark a business against its competitors. Looking at financial statements side-by-side helps you see where a business is doing better than the competition and where it could improve.

Z-score analysis is a tool you can use to determine a company’s potential for bankruptcy. It involves analyzing and scoring multiple variables, such as working capital, total liabilities, and sales. Once you’ve calculated the required ratios, you compare them to a mean of industry scores to determine a company’s solvency.¹³

Technology in Financial Statement Analysis

Thanks to technological advances such as Excel, Tableau, QuickBooks, and other financial analysis software, you can spend less time crunching numbers and more time analyzing data. You may be familiar with Excel for graphing and spreadsheet management, but the program also offers features for financial analysis. Excel makes it easy to organize and manipulate data. It has many formulas that automatically calculate various ratios for you. It also has graphing capabilities and other data visualization tools that make analysis easy.

QuickBooks and Tableau are more advanced. QuickBooks runs multiple accounting functions and can automatically generate financial statements using your accounting data. You can quickly access historical data to make comparisons. Tableau saves you time by automatically consolidating data from Excel and other programs. It also lets you create graphs and other visualizations that make it easier to interpret complex information.¹⁴

Build Your Business Success on Financial Analysis Expertise

Learn how to use financial analysis tools to thrive in corporate finance, investment-focused organizations, or when starting your own business. Santa Clara University’s Online Master’s in Finance and Analytics offers a top-ranked program to prepare you for the exciting world of finance. Our curriculum covers all the skills you need to position yourself as a valuable asset to any company. You will also benefit from a powerful Silicon Valley network and training from our esteemed faculty.

Don’t wait to take the next step in your career. Contact an admissions outreach advisor today.