There are three main ways to analyze financial statements. They are ratio analysis, common size analysis and trend analysis. These three forms of analysis allow the firm's financials be compared to industry norms, to the firm's past performance and on a raw basis. By using these techniques, the analyst can gain a sense of where the firm stands today, where the firm has been in the past, and what the current trends of the business are.
Ratio analysis covers a wide range of ground, including liquidity, profitability, solvency and managerial efficiency (Leka, 2007). These ratios outline the financial condition the firm is in, and attempt to derive some understanding of how the firm got into that position. Trend and common-size analysis allow for better year-over-year comparison, while ratio analysis can facilitate analysis across different firms in the same industry.
In addition to performing these basic forms of analysis, it is critical to read the notes to the financial statements (Ribeiro, 2009). The numbers in the statements can hint at the types of operational changes that have affected firm performance; the notes are more explicit....
They outline in detail much of the information that goes into the financial statements. As such, the notes are a highly valuable source of insight into the company's operations.
I would, therefore, evaluate a firm's financial statements by first performing common size, trend and ratio analyses on them, and I would supplement this analysis with an examination of the notes to the financial statements.
Works Cited:
Friedman, M. (1970). The social responsibility of business is to increase its profits. New York Times Magazine. Retrieved December 15, 2009 from http://www.colorado.edu/studentgroups/libertarians/issues/friedman-soc-resp-business.html
Leka, M. (2007). How to analyze financial statements. E-Articles. Retrieved December 15, 2009 from http://e-articles.info/e/a/title/HOW-TO-ANALYZE-FINANCIAL-STATEMENTS/
Kolstad, I. (2007). Why firms should not always maximize profits. Journal of Business Ethics. Vol. 76, 2, 137-145.
Ribeiro, A. (2009). Understanding financial statements. Mint.com. Retrieved December 15, 2009 from http://www.mint.com/blog/finance-core/understanding-financial-statements/
