How to do financial statement analysis
Collect Financial Statements:
Obtain the company's financial statements, including the balance sheet, income statement, and cash flow statement. These statements provide crucial information about the company's financial condition, profitability, and cash flow.
Understand the Structure of Financial Statements:
Familiarize yourself with the structure and content of the balance sheet, income statement, and cash flow statement. Understand the definitions and relationships of different items, aiding in a deeper understanding of the company's financial position.
Perform Horizontal and Vertical Comparisons:
Horizontal Comparison: Compare the company's financial performance over several accounting periods to identify trends and changes.
Vertical Comparison: Compare different items within the same financial statement, such as comparing changes in assets and liabilities in the balance sheet or comparing revenue and expenses in the income statement.
Calculate Financial Ratios:
Use financial ratios to measure various aspects of performance. Important financial ratios include:
Current Ratio: The ratio of current assets to current liabilities, assessing short-term solvency.
Quick Ratio: The ratio of quick assets to current liabilities, measuring short-term solvency without considering inventory.
Gross Margin Ratio: The ratio of gross profit to revenue, assessing profitability from production or sales.
Net Profit Margin: The ratio of net profit to revenue, measuring overall profitability.
Analyze the Balance Sheet:
Focus on Asset Structure: Analyze the company's asset structure to understand the composition of different asset categories and assess asset quality.
Examine Liability Structure: Analyze the company's liability structure, especially long-term liabilities, to evaluate financial stability.
Analyze the Income Statement:
Focus on Profit Drivers: Study the company's operating revenue, costs, and expenses to understand the main profit drivers and their variations.
Calculate Profit Growth Rate: Compute the average annual growth rate of net profit to evaluate profitability and growth potential.
Analyze the Cash Flow Statement:
Monitor Cash Flow Situation: Review the company's cash flow statement to understand the impact of operating, investing, and financing activities on cash flow.
Evaluate Free Cash Flow: Calculate free cash flow to assess the amount available for investment, dividends, or debt repayment.
Refer to Notes and Management Discussion and Analysis (MD&A):
Read the notes to the financial statements and the MD&A section, as they provide a deeper understanding of the company's operations and can explain the reasons behind financial performance.
Comprehensive Analysis:
Integrate the results of the above analyses to form a comprehensive assessment of the company's overall financial condition, profitability, and risks. Consider industry and macroeconomic factors in forming expectations for the company's future potential.
