Financial Statement Analysis

Document Type:Research Paper

Subject Area:Finance

Document 1

The key areas that can be reviewed include the debt levels of the company, the accounts receivable, cash, net profits, and gross margin for the company. Proportion analysis refers to the study of the financial statements of a company with the use of ratios. Investors use ratio analysis in comparing the performance of a company against other players in the same industry. An investor can identify an industry that he or she would like to invest. Once the sector is identified, there can be a list of several companies that can be analyzed to determine the most profitable company and the company that suits the financial desires of an investor. The investors may be current or potential investors. The investors have to get in-depth information about a company that they are about to put their money.

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The investors are the most affected by the financial performance of a company. The investors have to find out if the company that they are targeting has a potential of issuing dividends in the long term based on their past financial performance and the financial decisions arrived at by the management of a company. However, some investors are wealth oriented and those who are cash flow oriented. The methods that re sued include the horizontal and vertical analysis. Horizontal analysis refers to the analysis of the financial information that is available with the use of a series that runs on different reporting periods. Vertical analysis refers to an analysis method whereby the financial statements are analyzed in proportion to different line items that are found in the financial statement.

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The comparison is made in percentage form, and that helps in showing any form of increase or decrement (Casteuble, 2007). In the case of vertical analysis, every item that is in the income statement is shown as a percentage of the gross sales for the company under analysis. In most cases, the ratios are usually within the industrial averages. However, few ratios are not within the industrial averages. Such ratios raise red flags, and they need to be analyzed. The analysis will help in ensuring that the company changes the way it conducts its operations. There are different categories of ratios. The ratios show the ability of the management team to utilize the company resources that are available. The activity ratios include the accounts payable turnover.

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The ratio measures the speed with which a company pays its suppliers. It shows the number of days taken and the ability of a company to negotiate with suppliers for a longer repayment period. The other activity ratio is the receivable turnover ratio. The funding of a business is essential in determining the risk levels that are associated with a business. A company should be able to maintain a great combination of debt and capital to avoid any negativity that is associated with overlying with one type of funding. The debt service coverage ratio is a ratio that reveals the ability of a company to repay its debt obligations. The other leverage ratio that is available is the fixed charge coverage ratio.

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This ratio shows the ability of a company to pay off the fixed costs that are associated with the business operations. The ratio shows the ability of a company to convert its equity into profits (Higgins, 2010). The ratio shows the ability of a company to utilize the available equity and converting it into profits. It shows the efficiency with which a business uses the wealth of the investors. The return on net assets ratio shows the efficiency with which the assets of the company are used into creating profits. A company should be able to invest in assets that are technologically advanced to ensure that they cut on costs and increase the productivity of the company. Challenges that are associated with financial statement analysis Several challenges are associated with the preparation of the statement analysis.

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The issues that are associated with the use of financial statement analysis are the fact that the periods that are considered are different. There should be some ability to confirm the different accounting periods. However, there could be changes in the accounting system that is used, and it may have a difference in the financial results of a company. There are instances whereby some costs are reclassified. The operational information of different companies will determine the future profit levels of the company. There may be different proposals that will make a company either more stable or weaker. The other challenge that is associated with financial statement analysis is the fact that financial statements make use of historical information. There are sometimes when a company may be making financial information based on historical information (Helfert, 2007).

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