Financial analysis is a practice used to disseminate information from a company's financial statements. This analysis can be done through a variety of methods. By taking an analytical approach to financial statements, accountants and financial analysts can glean information to help make important business decisions.
Common sizing refers to an analysis method of converting a financial statement line item to a percentage of a common reference point. Common sized income statements often reference the line items of the report to net sales. Common sized balance sheets reference the line items of the report to either net assets or net liabilities and owner's equity. The goal of common sizing is to be able to compare the financial statements from different companies or different time periods.
Organizations must research the reasons behind financial variances in their financial statements to ensure accuracy and consistency. Benchmarking is a process in which each line item of a financial statement is given a dollar amount, called a benchmark. For a benchmarking program to be successful, the information used to set the benchmarks must be accurate. If an actual financial statement line item varies from its benchmark, the finance team should research the cause of the variance to determine its root cause.
Analysts use ratio analysis to compare financial statements from company to company or time period to time period. A ratio by itself imparts little knowledge about the business. However, when ratios from multiple companies or time periods are compared, analysts can determine trends and research the causes behind them. Common financial ratios include the current ratio, accounts receivable turnover and days sales outstanding. Each of these ratios uses information taken directly from the financial statements, making ratio analysis a simple method to use.
Analysts and auditors are aware that financial statement line items from month to month should be relatively similar. Substantive analysis refers to the method of financial statement analysis that is based upon this theory. It uses various methods, from simple schedules to advanced financial models, to arrive at conclusions based upon the data harvested from the financial statements. Variances in financial statement line items from comparative time periods should be thoroughly researched to determine the root cause of the discrepancy.
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