Net Income is a part of Owners' Equity.
What Is Financial Statement Analysis?
Financial statement analysis is the process of analysing a company's financial statements for decision-making purposes. External stakeholders use it to understand the overall health of an organization as well as to evaluate financial performance and business value. Internal constituents use it as a monitoring tool for managing the finances.
Several techniques are commonly used as part of financial statement analysis.
Horizontal analysis compares data horizontally, by analysing values of line items across two or more years.
Vertical analysis looks at the vertical affects line items have on other parts of the business and also the business’s proportions.
Ratio analysis uses important ratio metrics to calculate statistical relationships.
The balance sheet is a report of a company's financial worth in terms of book value. It is broken into three parts to include a company’s assets, liabilities, and shareholders' equity.
Short-term assets such as cash and accounts receivable can tell a lot about a company’s operational efficiency.
Liabilities include its expense arrangements and the debt capital it is paying off.
Shareholder’s equity includes details on equity capital investments and retained earnings from periodic net income.
The balance sheet must balance with assets minus liabilities equalling shareholder’s equity. The resulting shareholder’s equity is considered a company’s book value. This value is an important performance metric that increases or decreases with the financial activities of a company.
The income statement breaks down the revenue a company earns against the expenses involved in its business to provide a bottom line, net income profit or loss. The income statement is broken into three parts which help to analyse business efficiency at three different points.
It begins with revenue and the direct costs associated with revenue to identify gross profit. It then moves to operating profit which subtracts indirect expenses such as marketing costs, general costs, and depreciation. Finally it ends with net profit which deducts interest and taxes.
Basic analysis of the income statement usually involves the calculation of gross profit margin, operating profit margin, and net profit margin which each divide profit by revenue. Profit margin helps to show where company costs are low or high at different points of the operations.
The cash flow statement provides an overview of the company's cash flows from operating activities, investing activities, and financing activities. Net income is carried over to the cash flow statement where it is included as the top line item for operating activities. Like its title, investing activities include cash flows involved with firmwide investments. The financing activities section includes cash flow from both debt and equity financing. The bottom line shows how much cash a company has available.
Ratio analysis can be used to isolate some performance metrics in each statement and also bring together data points across statements collectively.
Balance sheet: asset turnover, quick ratio, receivables turnover, days to sales, debt to assets, and debt to equity
Income statement: gross profit margin, operating profit margin, net profit margin, tax ratio efficiency, and interest coverage
Cash Flow: Cash and earnings before interest, taxes, depreciation, and amortization (EBITDA). These metrics may be shown on a per share basis.
Comprehensive: Return on assets (ROA) and return on equity (ROE). Also DuPont Analysis.
Financial Risk Management helps determining value creation by managing risks.
