A basic method of financial statement analysis using accounting ratios is called the parsimony method. You start by constructing a pie chart by dividing up your total assets, liabilities, ownership interest and net worth into separate categories. Then calculate the difference between your top category and your bottom category. This is called your effect on assets/liabilities.
Another common method of financial statement analysis using accounting ratios is called DuPont analysis. DuPont refers to the equity as well as the debt. Construct a line connecting the top category and the bottom category, which represent the value of equity. The value of equity is equal to the equity minus the total debt of each category. The debt component is called DuPont Debt when it exceeds the value of equity. The DuPont ratio can be calculated by dividing the difference between total equity and debt by equity/total debt.
Other methods of financial statement analysis that can help you understand ratios alone are variance analysis, absolute differences, relative differences among multiple comparables. All these can be used to get a clearer picture of how changes in one category can affect the other categories. Variance analysis uses arithmetic data to analyze trends in prices, inventories and other related variables. Absolute differences determine whether prices and inventories move in different directions. Relative differences help determine if markets tend to move in the same direction or vary according to the economy.
A variety of financial statements, such as the balance sheet, income statement of cash flows help managers make decisions about their business. Managers must also make sure that they have a complete and accurate picture of their company’s financial position at the end of a year. To do this, they use several types of financial reports. One type is the statement of cash flows. Other reports that are needed along with financial statements are balance sheets, income statements and loan and lease-based financial reports.
A variety of strategies can be used in financial statement analysis. The most common types are horizontal and vertical analysis. A financial statement may be prepared for any number of years. The horizontal analysis compares historical information across years. The vertical analysis looks at the overall trend over time.
A variety of financial statements are compared in the context of the company’s overall financial position. This includes both the current and long-term financial statements. Long-term data is more appropriate because it represents the future income of equity holders, the portion of the company’s stock owned by equity holders and the value of retained earnings. These data are reported in earnings per share (EPS), profit and loss statement (LHES), and other comprehensive income reports. Companies prepare financial statement analyses for tax purposes and to comply with regulations.
Financial statements are prepared based on information obtained through the financial statements and data. Auditors perform an analysis of those financial statements using internal procedure and report the results to management. Those internal procedures are referred to as accounting principles. The primary objective of accounting is to meet the requirements of the US GAAP (Generally Accepted Accounting Principles). To meet GAAP criteria, a company must prepare its financial statements according to Generally Accepted Accounting Principles (GAAP). To provide transparency and accurate data, financial reporting companies usually apply audit management techniques that include data manipulation and database calibration.