Financial statement analysis is a very important skill in a variety of occupations such as investment management, corporate finance, commercial lending, financial modeling, and other careers related to finance. Producing a standard spreadsheet on a company is a means rather than an end. In other words, genuinely valuable analysis begins only after all the usual questions have been answered: accurately measuring the profitability and financial condition of a company.
What are Financial Statements?
In your accounting class, you may have encountered the term business financials. It is actually another way of saying financial statements. Before you are told to do any calculating, you will be introduced to the most basics of Accounting reports which are the Financial Statements.
A financial statement is a report presenting a business’s financial position. Showing you a picture in a structured way of how a business uses its funding from investors or lenders, and other projections that serve as proof of a business’s financial standing. In other words, these financial statements are a collection of structured reports showcasing a business’s financial condition and results.
Standard Contents of Financial Statements
There are three reports in Financial statements – The Balance Sheet, Income Statement, and Statement of Cash Flows.
This is where you’ll see the Assets, Liabilities, and Equity of the entity as of the reporting date. Meaning, the data shown is as of a specific point in time. The format of the report shows that all Assets will be equal to the total of all the Liabilities and Equity; this is what we know as the basic Accounting Equation. The balance sheet is considered as the second most element in a financial statement since it showcases the liquidity ratios and capitalization structure of a business. Basically, a balance sheet represents as a summary of the values of all the assets owned by an enterprise. Though the true value of assets can be a bit elusive due to being subjective of what’s counted as an asset or not by the enterprise, users of financial statements should exercise judgment to draw sound conclusions through financial analysis.
In Accounting, the balance sheet utilizes the accounting equation: Assets = Liabilities + Shareholder’s Equity.
- Assets: represents all assets owned by the company such as cash in the bank and on-hand, materials but also larger assets such as Property, Plant and Equipment that are used as a resource used to generate revenue. Assets are split into two categories:
- Current Assets – these are assets that can be easily converted into liquidity within 1 year such as stocks and shares, account receivables, stocks about to sell for cash, etc.
- Fixed Assets – these are property assets which take longer to convert into cash such as large capital items like land, property, plant, and equipment, as well as nonphysical assets such as intellectual properties or goodwill.
- Liabilities: represents all debts owed which is categorized into current liabilities or short-term debt (due for payment within 1 year) and non-current liabilities or long-term debt. Both short-term and long-term debt can include positions of financial debt (e.g. mortgages, credit facilities) as the allocation depends on its maturity. Typical liabilities are payables, provisions, financial debt etc.
- Shareholder’s Equity: represents the book value what belongs to the owner/founder has after all the debt has been repaid. The book value normally reflects a going concern scenario of the business. The equity value can be very different in case the company would be liquidated or sold as then the valuation depends on a buyer willing to pay what it is worth to him.
Here’s an example of what a balance sheet report looks like:
The example above is the most basic format that is used when building a balance sheet from an accounting perspective. But there are cases where it can get complexed, especially when determining the true value of assets, liabilities, and shareholder’s equity since there are other factors that affect the result after a careful analysis. These cases could be regarding the return on equity, goodwill, and leveraged recapitalization which all can be construed in a different point of views of either an economist or a finance-related expert. Hence, resulting in a more subjective report rather than the “true value” of the components included in the balance sheet. However, you can utilize different methods/format of balance sheet reporting to at least come close to the true value, as well as exercise proper judgment when drawing sound conclusions.
This is where the Revenues or Sales, Expenses, and Profits or Losses presented, which is generated during the reporting period. Others call this statement as the Profit and Loss Account, which shows how it derived the net income of the business over a stated period. Basically, it projects all the business’s operations and financial activities, which is why this is considered as the most important of the financial statements since it showcases the operating results of a business. By simply observing an income statement, a reader can make several useful observations on whether the business was profitable or not as well as get a good sense of the business’ cost structure. In simpler terms, an income statement is essentially used to determine if a business is good, bad, or indifferent.
The income statement is usually more detailed than the other statements and is often the first thing to tackle when creating a financial model. The difference of an income statement compared to the other financial statements is that it refers to only one period. It doesn’t carry over the historical value, rather, each period starts fresh. Therefore, it is the most suitable tool to compare the current performance, tracking the performance of the business, and providing a basis from which you’ll create a forecast or a budget.
Another use for the income statement is to use its components to calculate for ratio analysis. Especially calculating the most useful ratio which is the profit margin (also known as return on sales or gross profit ratio) that is used to determine the company’s financial health. Profit margin is one of the many ratios that investors and creditors pay the most attention to.
Below is an example income statement report of a company with a solid working business plan.
With this income statement, you can tell that the company is assumed financially healthy in the upcoming years. A steadily growing profit margin ratio, well-managed and budgeted expenses resulting in positive EBITDA and EBIT, a positive value of Income before Tax and Net Income; these components are major points that determine the company is an attractive investment opportunity for investors and banks. But of course, a solid business plan is needed to back up the figures assumed, otherwise, a projection will only remain a projection and not actual.
Statement of Cash Flows
This is where all the Cash inflows and outflows caused by the business’s activities during the reporting period. All the changes of the business’s cash flows will be presented here and used to provide an in-depth explanation where cash has been generated or used (which is not visible in the income statement). To check whether if it is reflected or balanced in the amount of profit or loss reported during the stated time. Cash flow statement basically answers the questions; where the money came from and where it went. With this statement, it will help the business assess the amount, timing and predictability of cash flows which is used for budgeting and business planning.
The advantages of a cash flow statement correspond to the shortcomings of the income statement and more specifically, the concept of profit. In many instances where profit is used as a basis of comparison among companies, the one with minimal expenses is more attractive to investors since they generally seek to maximize the company’s reported net income. Therefore, creating a statement of Cash Flows became essential in financial reporting. However, one must not assume that profit and cash flow go hand in hand. The difference is that the previous signifies the underlying profitability of the business while the latter is the actual cash coming in and out of the business’ account. In other words, you could have a very profitable business, but in cases where you couldn’t pay for salary and other expenses for the business operation, the business won’t last at all. That is why managing the cash flow of a business is very critical so that the timing differences between the cash flow and profit will be monitored properly and mitigate any funding problems.
Another best use for a cash flow statement is to asses a company’s or business’ financial flexibility. Whether its capacity, in cases where the business in decline, to continue making expenditures that minimize its cost of capital and enhance its competitive position over the long term. By simply analyzing the cash flow report, one can take information such as:
- How safe is the company’s dividend?
- Is the company able to fund its needs internally if the capital from external source become non-existent or too expensive?
- Is the company still able to repay its obligations even though the business is failing?
Not every business and company will always prosper hence, in difficult times, cutting back on various expenses to conserve cash is often done. Basically, to salvage the business, management will have to go through difficult strategies and plans while considering their main concern which is to avoid damage to the business’ or company’s long-term health.
Here is an example of a cash flow statement report:
When building a cash flow projection, you will need the income statement to use as a base for making few key adjustments in order to calculate the cash flow. As shown in the example, you will need to calculate the net cash flow after deducting the operating expenses, venture expenses, other financing expenses, then add it all together to serve as the starting cash of the business. You will then outline the initial flows of cash from the beginning to use it as a reference for the next years to come after deducting the series of expenses again. You must take note that the starting position is critical since it will affect the entire statement. With an erroneous calculation of the beginning balance, you could turn into a deficit of cash or an overflow.
It is noted that when creating these basic financial statements, it is critical to add footnotes that provide more details and additional information to explain further how the business derived certain figures. This is so that in the future, you won’t have any problems with referencing and also be able to answer potential interested investors’ questions regarding your business operations.
Mere study of the financial statements never leads to a fully informed judgment about the issuer. There are cases where Financial statements cannot capture certain nonquantitative factors that may be essential to evaluation such as industry conditions, corporate culture, and management’s ability to anticipate and respond effectively to change. However, financial statements are still considered as a very important component in a financial model.
Uses of Financial Statements
Creating financial statements are critical for businesses, especially when gathering data and calculating numerical figures as part of properly analyzing financial statement. The known common reasons, significance, and uses of financial statements are the following:
- Determining the ability of a business to yield cash, where and how they derived with the cash and how the cash will be distributed.
- Determining whether the business is capable of paying back the liabilities incurred, not just in the present but also in the upcoming years.
- Determining where a business is in its life cycle, whether it is “taking off”, growing rapidly, maturing, or declining.
- Deriving financial ratios based on the financial statements that will show a business’s position and condition.
- Investigating the business’s transactions and all other projections.
- Organizing transactions and all financial projections in a readable and easy to understand way.
- Bases for decision-making when looking for potential and profitable investments and also when looking for funding from investors or getting a loan.
- Providing information about the results of operations, financial position, and cash flows of an organization. As such, each financial report has its own purpose:
- Income Statement – informs the reader about the ability of a business to generate profit and analyze trends according to the results of operations
- Balance Sheet – informs the reader about the current financial position of a business to determine its liquidity, funding, and debt position
- Cash Flow Statement – informs the reader about the nature of cash flows in and out of the business and as an additional report to back up the income statement
Aside from accounting rules, cash flows, and definitions of standard ratios, analysts must consider the motivations of corporate managers, as well as the dynamics of the organizations in which they work. Neglecting these factors will lead to false assumptions about the underlying intent of issuers’ communications with users of financial statements.
Financial Statement Template – Excel
In creating a business plan, financial statements are one of the most critical elements. Aside from ensuring the business’s condition, presenting the business financials will be one of the requirements needed to gather investors for more funding. Once issued for the outside users, it is critical to follow the format according to the standard accounting frameworks.
These frameworks are unique depending on which industry and what kind of business, hence, the statements will differ from the others. On the other hand, when used only internally, then following the structured and common base is enough as long as it serves its purpose – report of monthly results and ending financial condition. But, all in all, it is all preferably presented in Excel. Excel is a nifty tool for showing a systematic projection of computations and other variables in the financial statements.
All financial statements are expected to be created to report the results of a full fiscal year. Which means creating financial statements is not a one-time only thing. Some businesses hire financial experts just to create these for them but the ones who prefer to do it themselves will have to consume a lot of their time.
It is a good thing that nowadays, downloading a ready-made financial statement template Excel is easily acquired in a financial modeling platform such as eFinancialModels. Not only can you acquire financial statement templates but also a wide range of industry-specific financial model templates. These templates are made by experts and experienced finance professionals which have created the templates themselves when providing financial modeling services to different companies in different industries.
Often, the reason why it takes a lot of time to prepare the financial statements is that some users don’t know how to create one. Hence, learning how to create from scratch will take even more time and resources. The financial statement template excel is heaven sent to those in need of a base to start their financial report with and also to those who want to save time since the templates come with an automatic calculator and other graphs or charts to summarize the financials in a more readable and easier to understand option.
If you are interested and in need of a financial statement template Excel, you can check our website and choose from which business industry you prefer. Our financial model templates are utilized by users all over the world, such as in the US, UK, Canada, Australia, Japan, and many more countries that are in need of assistance with their financial modeling tasks.