Steps in Understanding Financial Statements

by jon | February 4, 2019


What are the steps in understanding financial statements?

  1. Identify economic characteristics of industries
  2. Detect company strategies
  3. Analyze a firm’s financial statement
  4. Assessing risk and profitability
  5. Make reasonable assumptions on financial statements


Financial statements are the transcripts of every company. Understanding a financial statement is just like knowing what goes on in tax seminars in the Philippines, it requires one to have a certain understanding of these key areas in order to fully grasp what’s going on.

Before you understand what goes on at tax summits in the Philippines. Here are the basic prerequisites one needs to have to fully assess what’s going on in these intricate papers. A financial statements’ structure, the economic qualities of a certain industry/company, how a firm operates, and the strategies companies use in order to differentiate themselves from other brands/competitors. Let’s explore more below:


Identify Economic Characteristics of Industries

Knowing the chain of activities of a certain firm will tell you the whole story of what the company does and how their processes work. Determining a value chain analysis within a specific industry entails knowing how they manufacture, create, and distribute their products and how they manage their services. You can go about this by analyzing the economic attributes or characteristics of a firm through Industrial analysis. Implying the competitive forces model, SWOT analysis or the PEST analysis are the best forms of industry analysis.

The competitive forces model, popularly known as Porter’s 5 Forces, gives a precise impression of the industry and makes overall analysis much easier. The five forces that are studied in this method are the intensity of industry rivalry, the power of complementary good/service providers, the threat of substitute goods/services, bargaining power of suppliers, and the bargaining power of buyers.

The SWOT analysis gets its name by understanding the strengths, weaknesses, opportunities, and threats of an industry. This can be used to summarize and determine an industry’s implications for their business. The PEST analysis is used to analyze the external environment of an industry. It gets its name from forming an analysis based on four factors within a firm, political, economic, technological, and sociodemographics. You can use either of the three common analysis methods to identify an industry’s economic characteristics.


Detect Company Strategies

To identify the strategies a company implies in their system will be the next step to take. You must look into the nature of the products and services they offer. This includes knowing how unique their products are, their level of profit margins, how the firm controls their costs and the creation of brand loyalty.

When you have successfully determined these factors, you can easily integrate your knowledge on analysis to further strengthen your assumptions. Never leave out a firms’ other aspects such as their supply chain, geographic diversification, and industry diversification. These will all be useful and make your data more fruitful.


Analyze a Firm’s Financial Statement

In examining a firm’s financial statements, you should review every date with regards to the relevant standards of accounting. Proper evaluation involves examining balance sheets, determining issues such as recognition, classification, and valuation.

Every data acquired must revolve around the question of whether your analysis of the balance sheet is a comprehensive and precise representation of the company’s economic position. Then one must properly evaluate a company’s income statement.

By doing this, you can determine if the quality of a firm’s earnings is a complete representation of the firm’s financial performance. Assessment of a firm’s cash flow statement helps one to understand the bearing of a firm’s position of liquidity from the side of operations, to investments, and financial activities over a certain period. Basically, to know how funds circulate, where they go, and how it affects the overall liquidity of the firm.


Assessing Risk and Profitability

Assessing Risk and Profitability

Analyzing a firm’s financial statements is where you can really into full detail about a firm. Knowing the current status of risk and profitability of a company gives you an in-depth view of your evaluation of their financial statements. The most common analysis tools being used fall under ratio analysis; gathering data through the use of liquidity ratios, activity ratios, debt ratios, profitability ratios, and market ratios.

There are two questions that need to be asked when you talk about a company’s profitability: how profitable are the operations of the firm in relation to their assets? And how profitable is the company in terms of the equity shareholders? Keep in mind that it is essential to analyze every financial statement ratio in comparison to records from earlier periods or in relation to the average of the industry.


Make Reasonable Assumptions on Financial Statements

These are one of the most important assumptions a financial professional must make. This is one of the most challenging tasks one has to make. As their opinions must be reasonable about the future of a firm and in totality, the whole industry. These will determine the effect of the overall cash flow and funding of certain industries.


Key Takeaway

The value of a firm will rest on the hands of how one assesses a company’s financial statements. Understanding the structure of financial statements, cash flow, and the basics of economic analysis can give you a full grip on how a firm operates.

It’s just like knowing everything that goes on at tax seminars in the Philippines. When you know what goes on, you’ll understand what they talk about at Philippine tax summits. The same principle applies to firms and their financial statements.

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