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Step By Step Guide To Analyzing Your Financial Reporting Statements

The First 2 Steps Of Financial Reporting Analysis

As one of the popular online accounting services operating from Virginia, USA, we know that effectively analyzing a business’s financial statements is essential. For it, you need to be adept at:

  • Understanding the framework of the financial reporting statements.
  • Knowing the economic traits of the sector the business is in.
  • Grasping the strategies the business wields to stand out from the crowd.

Once you have mastered this art, you can then dive into financial statement analysis. The process requires 6 steps.

Economic characteristics of the sector.

The first step is always to identify the value chain of the industry the business operates in. The value chain is all the activities starting from designing a product or service ending at the product/service distribution. You can use Porter’s Five Forces to analyze economic attributes.

  • Strategies of the business.

The second step is to determine the strategies of the business.

For this, you must take an in-depth look at the product or service and understand:
  • What makes it unique?
  • What is the level of profit margin?
  • How to control costs?
  • How to build brand loyalty?

You will also need to investigate:

  • supply chain integration
  • geographic diversification
  • industry diversification

Assessing The Financial Statements And Profitability Of The Business

Review the critical financial statements.

The third step of financial statement analysis of any business  is examining the balance sheets for issues like:

  • Recognition
  • Valuation
  • Classification

The balance sheet should give you a complete picture of the business’s economic condition. When assessing the income statement, evaluate the quality of earnings. And finally, the cash flow statement must give you an understanding of:

  • Where funds come from?
  • Where do they go?
  • What is the overall liquidity?

Scrutinize risk and profitability.

As a business owner, you can perform the first 3 steps. For the fourth, an accountant is your best bet because it involves analyzing:

  • Liquidity
  • asset management
  • profitability
  • debt management/coverage
  • risk/market valuation

This step requires determining how profitable your business is relative to the assets and how profitable it is in terms of equity holders. It also necessitates financial statement ratios comparative analysis, i.e., comparing the current ratios with that of an earlier time or with the industry average.

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Making an estimated financial statement.

The next step of financial statement analysis is forecasting the industry's future and the business and how that impacts funding and cash flow. During this stage, you will have to rely on Pro-forma financial statements. These are prepared through methods like the percent of sales approach.

Valuing the business.

The last step is the valuation of the business. The methodology you can use for it is discounted cash flow using:

  • projected dividends
  • free cash flows to equity holders

A few other approaches to valuation include accounting-based measures or relative valuation. 

Preparing and analyzing financial reports is a challenge. It is also not the end of the road. Once the financial statements are complete, you need further questions answered. That’s why it is advised to hire online accounting service providers to conduct the analysis. Professionals will be faster, better, and more accurate than you diving in on your own.

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