Analysis of Financial Statements, Essay Example

Financial statements are the summary of an organization’s affairs as well as their transactions represented in a manner that is discernible as well as logical. The financial affairs of an organization presented in a simple manner form the financial statements (BPP 2009). A proper research and analysis of an entity’s financial statements gives insight into the actual status of the organization. Management therefore ought to analysis and closely scrutinise such information that is presented in the financial statements of an entity to determine whether an entity is performing well or it is not. There are various benefits to be gained from analysis of these financial statements.

First by analysing such financial statements management can perform ration analysis that will assist them determine various comparable performance rations of the organization. Among them the management is able to determine the financial performance indicators which can be compared with the organization’s performance in the prior year as well as with the performance of comparable entities that are in direct competition with the entity. First the management is able to compare profits in the current period against budget as well as against prior periods. This way they can verify whether they were able to meet the budget as well as whether they have made significant progress. The analysis of the financial statements also enables the management to determine whether they have cost effective practices (BPP 2009)

The analysis of financial statements gives a clear guide on the ongoing affairs of an entity. This enables the management (as investors) to make informed decisions on the organizations financial health (Harper 2010). The investors can therefore through clear research establish the current status of various vital rations such as gearing which helps establish the organization’s debt ratio. They can also establish whether the organization has a good return on capital employed (ROCE) as well as good earnings per share. Finally a good research as well enables the company to establish whether they have a healthy liquidity ratio and accounts payable period.

The research and analysis of the various ratios mentioned above helps the company to arrive at a decision whether the company is doing well financially or not and whether it is headed in the right direction or not. The management is therefore able to overcome the risks involved when decisions are made based on the profit figure only. For example, a company might have a good profit but be highly geared.  Analysis of such an entity would enable the management to determine that it is not safe to enter into a credit agreement to fund expansion. Similarly a company with low earnings per share would be indicative for the management to reduce the share capital.

The management should make decisions based on their analysis of financial statements. All analysts insist on users of financial information doing their homework (Harper 2010). This is because there are creating accounting techniques that if not well investigated can leave the management believing that a company is doing well while in reality it is tottering on the brink of collapse. The management also needs to look comparatively at the cost of sales and compare net profit margin to gross profit margin and therefore determine whether they need to institute cost cutting measures to improve their performance.

Present value and future value analysis seeks to establish the expected value of a present day asset in a specified period in the future. This also seeks to measure the expected cash inflows from a current day asset or otherwise known as capitalization. The management also seeks to factor in the predicted impact of inflationary trends on the financial wellbeing of the company. The future value of present assets therefore will enable the management predict the organization’s financial strength in the future as well as predict future cash flows. The management is therefore able to discern the financing as well as the investment options that are workable as well as determine how to deal with the current problems. If for example the company expects to receive a lot of money in future as dividends this is a future value of present day investment which can affect their decision.

References

BPP Learning Media (2009). Performance Management. London: BPP publishers.

Harper D (2010). Financial statements. Retrieved 2 May 2010. Available. http://www.investopedia.com/university/financialstatements/default.asp