Financial Statement Analysis Notes: Meaning, Importance, Formats (2023)

Financial Statement Analysis refers to the process of reviewing and analyzing a company’s financial statements. It is primarily done to make better financial decisions and devise plans for the company to earn more income in the future. Financial Analysis meaning as well as procedure is important both for the accounting exam point of view as well as for practical purposes.

    • Different types of financial statements are the income statement, statement of cash flow, balance sheet, notes to accounts, statement of changes in equity, and so on.
    • A few common types of financial statements analysis are Horizontal Analysis, Vertical Analysis, Liquidity Analysis, Profitability Analysis, Variance Analysis, Valuation Analysis, and Scenario and Sensitivity Analysis.
    • Comparison, analysis, and rearrangement, and interpretation of data are the major steps involved in financial statement analysis.
    • The activity of analysis of financial statements is primarily done to measure the company’s profitability and evaluate its operational efficiency.

In the following Financial Statement Analysis study notes, let’s discuss all of these and other significant aspects of the topic. Accounting aspirants are suggested to go through the following study material on Financial Statement Analysis carefully for a better preparation.

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What is Financial Statement Analysis?

The term ‘Financial Statement Analysis’ refers to the systematic numerical representation of the relationship of one financial aspect with the other. The activity of financial statement analysis is undertaken to analyse the company on the basis of its profitability, solvency, operational efficiency, and growth prospects.

Financial Analysis chiefly involves bifurcating the financial records on the basis of a definite plan, arranging them in sections, and presenting them in a user-friendly manner.

Purpose of Financial Statement Analysis

Now that we are clear about the Financial Analysis meaning and definition, let us learn about its purpose or the need of undertaking such an activity. Following is the list of purpose of financial statement analysis:

    • To measure the financial standing of the business
    • To evaluate the profitability (earning capacity) of the business
    • To make comparisons within the firm (intra-firm) and with other firms (inter-firm)
    • To find out the business’ capability of paying interest, dividend, etc.
    • To judge the performance of the management
    • To measure the firm’s short-term and long-term solvency

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Types of Financial Analysis

The main types of financial statement analysis are as follows:

Horizontal Analysis
  • It refers to the analysis of financial statement figures that are dynamic in nature.
  • It compares one item with another in a different time period.
  • It analyses the business’s finances from one year to the next.
Vertical Analysis
  • The relationship between various items on a financial statement is analyzed.
  • For instance, one item is measured against another during an accounting period.
  • The relationship is expressed in percentage.
Liquidity Analysis
  • It uses ratios to determine whether or not a company will be able to pay back any debts or other expenses.
  • It is helpful for businesses as they can predict financial troubles in future.
  • This analysis is helpful for lenders, creditors, etc. who want some insight into the business’ financial standing before giving them any loans or credit.
Profitability Analysis
  • In this, the company’s rate of return is analyzed.
  • As every business seeks profits, using the profitability analysis to measure its cost and revenue over a given period can be highly beneficial.
  • A company is considered profitable if its revenue exceeds the costs.
  • Margin Ratios and return Ratios are the two main types of profitability analysis.
Variance Analysis
  • It refers to the process of evaluating any differences between a business’ budget and the actual costs incurred.
  • For instance, if a business budgeted their sales of INR 10,000 but actually sold goods worth INR 4,500, then the variance analysis would be with a difference of INR 5,500
Valuation Analysis
  • It analyzes the business’ present value and can be utilized for various instances such as mergers and acquisitions.
  • Once the company’s present ratios are determined, they can be compared to the past ratios, competitor’s ratios, etc.
  • There are different types of valuation ratios such as price/ earnings and price sales.
Scenario and Sensitivity Analysis
  • The value of an investment is measured based on the current scenarios and changes.
  • Scenario and sensitivity analysis is helpful to predict outcomes based on different variables.

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Importance or Uses of Financial Statement Analysis

Now that we know what is the meaning of financial statement analysis and its types, let’s understand its importance as well.

There are various uses of financial statement analysis for different users like investors, creditors, management, government, and so on, mentioned as below:

UsersAreas of Interest
For ManagementTo know the company’s profitability, liquidity, and solvency.

To measure the effectiveness of the decisions taken and to take corrective actions ahead.

For InvestorsTo know the business’ earning capacity and its future growth prospects and evaluate the safety of their investment and a reliable return.
For CreditorsTo know the liquidity and solvency position of the business.
For GovernmentTo know the profitability position required for taxation purposes and to take decisions about price regulations.
For CustomersTo know about the longevity of the business.
For EmployeesTo know about the progress of the company for evaluating bonus, increase in wages, job stability, etc.

Tools of Financial Statement Analysis

The various tools of financial statement analysis help in evaluating and interpreting the company’s financial statements for planning, investment, and performance.

(Video) FINANCIAL STATEMENT ANALYSIS- Meaning and It's Types

The most commonly used tools of financial analysis are comparative statement (comparison of financial statements), common size statement (vertical analysis), ratio analysis (quantitative analysis), cash flow analysis, and trend analysis. Let’s quickly learn about these tools.

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Comparative Statement

Financial Statements of two years are compared and differences in absolute as well as percentage terms are calculated. It is a form of horizontal analysis.

The comparative analysis is done through a Comparative Income Statement and Comparative Balance Sheet.

Format of Comparative Income Statement

Financial Statement Analysis Notes: Meaning, Importance, Formats (1)

The above statement shows in percentage terms the total of income earned and the expenses incurred during two or more accounting periods.

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Format of Comparative Balance Sheet

Financial Statement Analysis Notes: Meaning, Importance, Formats (2)

The above statement shows the business’ assets and liabilities for two or more accounting periods. It also presents the percentage change in the monetary value of those assets and liabilities.

Common Size Statement

The figures of financial statements are converted into percentages with respect to a common base.

Just like comparative analysis, the common size statement analysis is also done through an income statement and a balance sheet.

Format of Common Size Income Statement

Financial Statement Analysis Notes: Meaning, Importance, Formats (3)

The above Common Size Income Statement shows the sales figure to be 100 and all other figures expressed as a percentage of sales.

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Format of Common Size Balance Sheet

Financial Statement Analysis Notes: Meaning, Importance, Formats (4)

The common-size balance sheet shows the total of assets or liabilities to be assumed as 100 and the figures are expressed as a percentage of the total.

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Ratio Analysis

It studies the relationship between various items in the financial statements.

Cash Flow Statement

It shows the inflow and outflow of cash and cash equivalents during a particular period. Such an analysis helps find out the causes of changes in the cash position between the two balance sheets at two different dates.

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That’s all on Financial Statement Analysis meaning and other important factors for accounting exam preparations. For more such interesting study resources and guides, do check out our Testbook App today itself! Our app contains hundreds of revision tests, mock tests, practice sets, live coaching, study note pdfs, and so on. Get it now and avail exciting deals!

Financial Statement Analysis FAQs

Q.1What is financial statement analysis?


Financial Statement Analysis refers to the process of reviewing and analyzing a company’s financial statements.

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Q.2Who are the users of financial statement analysis?


The management, government, employees, customers, and investors are the users of financial statement analysis.

Q.3What are the tools of financial analysis?


The most commonly used tools of financial analysis are comparative statement (comparison of financial statements), common size statement (vertical analysis), ratio analysis (quantitative analysis), cash flow analysis, and trend analysis.

Q.4What are the types of financial statement analysis?


(Video) Topic 6 - Financial statement analysis

These include horizontal analysis, vertical analysis, liquidity analysis, profitability analysis, variance, and valuation analysis.

Q.5Why is financial statement analysis done?


It is done to understand the financial position, solvency, and profitability of the business, and to make better financial decisions in future.

  • 3

(Video) FINANCIAL RATIOS: How to Analyze Financial Statements


What is the importance of financial statement notes? ›

The notes to the financial statements communicate information necessary for a fair presentation of financial position and results of operations that is not readily apparent from, or not included in, the financial statements themselves.

What are the 3 most important financial statements in financial analysis? ›

The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.

What are the 5 components of financial analysis? ›

5 Key Elements of a Financial Analysis
  • Revenues. Revenues are probably your business's main source of cash. ...
  • Profits. If you can't produce quality profits consistently, your business may not survive in the long run. ...
  • Operational Efficiency. ...
  • Capital Efficiency and Solvency. ...
  • Liquidity.

Can you explain the importance notes to the financial statements and what is included in these notes? ›

Notes to the financial statements disclose the detailed assumptions made by accountants when preparing a company's: income statement, balance sheet, statement of changes of financial position or statement of retained earnings. The notes are essential to fully understanding these documents.

What are the example of notes to financial statements? ›

Examples can include unexpected changes from the previous year, required disclosures, adjusted figures, accounting policy, etc. Footnotes may also contain notable future activities that are expected to have a significant impact on the company's future.

What are the 4 important types of financial statement? ›

For-profit businesses use four primary types of financial statement: the balance sheet, the income statement, the statement of cash flow, and the statement of retained earnings.

What 7 items must financial statements consist of? ›

Revenues and expenses are included in the income statement. Changes in these elements are noted in the statement of cash flows.
The main elements of financial statements are as follows:
  • Assets. ...
  • Liabilities. ...
  • Equity. ...
  • Revenue. ...
  • Expenses.
Jan 20, 2023

What are the five 5 basic financial statements? ›

Five elements of financial statements (Balance sheet, income statement, cash flow statement, equity statement, and notes) Five elements of the financial statement include the balance sheet, income statement, statement of cash flow, statement of changes in equity, and the notes to the financial statements.

What are 2 most important financial statements sheets? ›

Financial statements help you analyze your company's financial position and performance. They are comprised of four main components, of which the balance sheet and income statement are essential. Ascertain whether financial statements have been prepared for external or internal use.

What are the 12 types of financial analysis? ›

The most common types of financial analysis are vertical analysis, horizontal analysis, leverage analysis, growth rates, profitability analysis, liquidity analysis, efficiency analysis, cash flow, rates of return, valuation analysis, scenario and sensitivity analysis, and variance analysis.

What are the 7 key components of financial planning? ›

A good financial plan contains seven key components:
  • Budgeting and taxes.
  • Managing liquidity, or ready access to cash.
  • Financing large purchases.
  • Managing your risk.
  • Investing your money.
  • Planning for retirement and the transfer of your wealth.
  • Communication and record keeping.

What are the 10 key elements that make up all the financial statements? ›

This chapter defines 10 elements of financial statements: assets, liabilities, equity (net assets), revenues, expenses, gains, losses, investments by owners, distributions to owners, and comprehensive income.

Are notes required in financial statements? ›

The notes to the financial statements are a required, integral part of a company's external financial statements. They are required since not all relevant financial information can be communicated through the amounts shown (or not shown) on the face of the financial statements.

What is GAAP notes to financial statements? ›

The notes to the financial statements are used to give additional company information to financial statement users. Generally Accepted Accounting Principles (GAAP) are the guidelines that accountants use to determine how things are reported in the financial statements.

What are the 4 types of notes? ›

We're going to learn four types of notes and rests; whole, half, quarter and eighth.

What are notes to financial statements called? ›

The notes to the financial statements (sometimes called footnotes) are also an integral part of the overall picture.

What are financing notes? ›

Understanding Notes

A note is a debt security obligating repayment of a loan, at a predetermined interest rate, within a defined time frame. Notes are similar to bonds but typically have an earlier maturity date than other debt securities, such as bonds.

What are the financial statement formats? ›

They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders' equity. Balance sheets show what a company owns and what it owes at a fixed point in time.

What are the six 6 basic financial statements? ›

These include the working capital ratio, the quick ratio, earnings per share (EPS), price-earnings (P/E), debt-to-equity, and return on equity (ROE). Most ratios are best used in combination with others, rather than singly, for a comprehensive picture of company financial health.

What are the four 4 main financial documents in accounting? ›

But if you're looking for investors for your business, or want to apply for credit, you'll find that four types of financial statements—the balance sheet, the income statement, the cash flow statement, and the statement of owner's equity—can be crucial in helping you meet your financing goals.

What are the 8 general features of financial statements? ›

IAS 1 explains the general features of financial statements, such as fair presentation and compliance with IFRS, going concern, accrual basis of accounting, materiality and aggregation, offsetting, frequency of reporting, comparative information and consistency of presentation.

What are the 9 steps in preparing financial statements? ›

The Nine Steps in the Accounting Cycle
  1. Step 1: Analyze Business Transaction. ...
  2. Step 2: Journalize Transaction. ...
  3. Step 3: Posting To Ledger Account. ...
  4. Step 4: Preparing Trial Balance. ...
  5. Step 5: Journalize & Post Adjustments. ...
  6. Step 6: Prepare Adjusted Trial Balance. ...
  7. Step 7: Prepare Financial Statements.
Sep 28, 2016

What are the 4 financial statements required by GAAP? ›

The four main financial statements include: balance sheets, income statements, cash flow statements and statements of shareholders' equity. These four financial statements are considered common accounting principles as outlined by GAAP.

What are the 6 components of general purpose financial statement? ›

These statements include the income statement, balance sheet, statement of cash flows, statement of shareholders' equity, and any accompanying disclosures. If the financial statements have been audited, then they should also include the audit report.

What are the 6 financial documents? ›

List of 6 Financial Documents Every Organization Should Create
  • Profit & Loss Statement or Income Statement. ...
  • Balance Sheet. ...
  • Cash Flow Statement. ...
  • Tax Returns. ...
  • Accounts Receivable/Accounts Payable or Aging Reports. ...
  • Notes to Accounts or Notes to Financial Statements.

What are the 3 most important things on a balance sheet? ›

1 A balance sheet consists of three primary sections: assets, liabilities, and equity.

What are the 2 basic techniques in financial statement analysis *? ›

Vertical and Horizontal Analysis

Vertical analysis is the process of reading down a single column in a financial statement. Whereas horizontal analysis is used to identify trends over time, vertical analysis is used to determine how individual line items in a statement relate to another item in the report.

What are the 3 major elements of statement of financial position or balance sheet? ›

The main elements of a statement of financial position are assets, liabilities and equity.

What are the six 6 parts of the financial system? ›

1.1Six Parts of the Financial System. The financial system can be broken down into six main parts: money, financial instruments, financial markets, financial institutions, regulatory agencies, and central banks. We will talk about each of these parts in turn.

What are the most common tools of financial analysis? ›

Commonly used tools of financial analysis are: Comparative statements, Common size statements, trend analysis, ratio analysis, funds flow analysis, and cash flow analysis.

What are the most commonly used techniques of financial analysis? ›

The three most commonly practised methods of financial analysis are – horizontal analysis, vertical analysis, and ratio and trend analysis.

What are the 4 pillars of financial planning? ›

Four Pillars of Financial Planning
  • Managing Cash Flow and Financial Resources. This critical first pillar focuses on making sure you and your loved ones are provided for. ...
  • Accumulating Wealth. ...
  • Managing Income Taxes. ...
  • Planning for Retirement.

What are the 4 A's of financial management? ›

Any good cash management plan revolves around the four A's — Accounting, Analysis, Allocation, and Adjustment.

What are the 8 components of profit and loss statement? ›

Structure of the Profit and Loss Statement
  • Revenue (or Sales)
  • Cost of Goods Sold (or Cost of Sales)
  • Selling, General & Administrative (SG&A) Expenses.
  • Marketing and Advertising.
  • Technology/Research & Development.
  • Interest Expense.
  • Taxes.
  • Net Income.
7 days ago

How do you write a note format? ›

Top ten tips for writing notes
  1. Date your notes and make the main topic visible. ...
  2. Don't write everything down – write down the important points. ...
  3. Make short notes of the examples given. ...
  4. Use colour. ...
  5. Use illustrations and drawing. ...
  6. Use headings and sub-headings. ...
  7. Keep your sentences short.

Are notes required by GAAP? ›

In addition to the amounts that are reported on the face of the financial statements, US GAAP requires that additional information be provided as notes to the financial statements. To alert the readers of these important disclosures, each financial statement is required to make reference to them.

Why do we use notes of accounts and examples? ›

Notes to the accounts detail and comment on the information presented in the Balance sheet, Income statement, and Cash flow statement. Notes to the accounts reflect the accounting principles and the facts that can have a significant impact on the judgment of the reader of accounting information.

What is GAAP format? ›

Generally accepted accounting principles, or GAAP, are standards that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.

What is the level of importance of the notes as compared to other financial statement reports? ›

Notes, also known as footnotes, are important in accounting because they provide additional information regarding methodology, valuation, time period and myriad other calculation nuances.

What is the purpose of notes and disclosure requirements? ›

Note disclosures are an integral part of financial statements. Users rely on them to understand the financial statements and reach conclusions about the operating performance and stewardship of government resources.

What is the purpose of the notes to financial statements quizlet? ›

— Notes to financial statements are used to report information that does not fit into the body of the statements in order to enhance the understandability of the statements.

Which notes to the financial statements you think are important but may often be overlooked? ›

The cash flow statement is one of the most important but often overlooked components of a firm's financial statements. In its entirety, it lets an individual, whether they are an analyst, investor, credit provider, or auditor, learn the sources and uses of a company's cash.

What are the different types of note disclosures? ›

There are three common types: an income statement, a balance sheet, and a statement of cash flows.

Which is the first item in presenting the notes to financial statements? ›

The first note to the financial statements is usually a summary of the company's significant accounting policies for the use of estimates, revenue recognition, inventories, property and equipment, goodwill and other intangible assets, fair value measurement, discontinued operations, foreign currency translation, ...

What is the normal order of presenting the notes to the financial statements? ›

The standard requires a complete set of financial statements to comprise a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of changes in equity and a statement of cash flows.

What role is played by the notes in the financial reporting process? ›

It provides information on the extent to which resources were obtained and used in accordance with the approved budget; Notes to the Financial Statements - which assist in understanding the principal financial statements. The Notes comprise a summary of significant accounting policies and other explanatory information.


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