Definition: Financial statement analysis is the use of analytical or financial tools to examine and compare financial statements in order to make business decisions. In other words, financial statement analysis is a way for investors and creditors to examine financial statements and see if the business is healthy enough to invest in or loan to.
What Does Financial Statement Analysis Mean?
Financial statement analysis takes the raw financial information from the financial statements and turns it into usable information the can be used to make decisions. The three types of analysis are horizontal analysis, vertical analysis, and ratio analysis. Each one of these tools gives decision makers a little more insight into how well the company is performing.
For instance, horizontal analysis is the comparison of business performance over time. Investors can use the performance trends to predict future performance.
Vertical analysis compares the company performance to a base number. In a sense, vertical analysis is like benchmarking.
Ratio analysis is probably the most common form of financial statement analysis. Ratio analysis compares different financial statement accounts. For instance, the debt to equity ratio compares the company’s debt to the total equity. This ratio inversely shows investors how much the assets are worth that they own after all the liabilities are paid off.
Ratio analysis cannot only be used horizontally to chart intercompany trends; it can also be used to compare different companies. For example, a small and large company can’t be compared on a pure dollar value. It wouldn’t be fair. Instead ratios are used.
Financial statement analysis is used by all investors and creditors to gauge the performance of a company and help predict future performance to base financial decisions on.