Benefits of Financial Statements Analysis, Research Paper Example

The three main components of financial statements are balance sheet, income statement, and cash flow statement. In addition, financial statements are also accompanied by notes and management opinions which provide more details about individual elements in the financial statements. The supplementary information also helps reviewers understand the accounting policies and assumptions used in the preparation of financial statements.

It is important to thoroughly review financial statements because even though balance sheet, income statement, and cash flow statement each provide valuable information, the nature of information is often different which is why it is difficult to see the complete picture without reviewing and comparing them all. Balance sheet focuses on the assets and sources of assets, income statement focuses on the operating performance of the company, while cash flow statement addresses the liquidity position. Growth is important but it is also important to manage liquidity. Income statement may indicate high sales growth rate which would impress the reviewer but the balance sheet may reveal that much of the growth has been achieved through generous credit facility to consumers and has threatened short term liquidity. This example demonstrates the importance of a thorough review of financial statements. Many financial ratios which help us evaluate the financial strength of the company such as liquidity, efficiency, and profitability ratios (Griffin) require information that may be either in the financial statements or the accompanying notes.

If we don’t thoroughly review financial statements, we may overestimate the future prospects as well as underestimate the risk inherent in the company, resulting in poor investing decisions. We may also make mistakes in evaluating a particular’s company performance against its competitors if the companies under consideration have used significantly different accounting policies and assumptions to prepare their statements.

Reference

Griffin, D. (n.d.). Advantages of a Financial Statement Analysis. Retrieved October 2, 2012, from http://smallbusiness.chron.com/advantages-financial-statement-analysis-4124.html