CFI Jeff Schmidt - Analysis of Financial Statements

Analysis of Financial Statements
Guide to analyzing financial statements for financial analysts
Written by CFI Team

Updated July 14, 2022
Reviewed by Jeff Schmidt
Guide to Financial Statement Analysis

One of the main tasks of an analyst is to perform an extensive analysis of financial statements. In this
free guide, we will break down the most important methods, types, and approaches to financial
analysis.
This guide is designed to be useful for both beginners and advanced finance professionals, with the
main topics covering: (1) the income statement, (2) the balance sheet, (3) the cash flow statement,
and (4) rates of return.
1. Income Statement Analysis

Most analysts start their financial statement analysis with the income statement. Intuitively, this is
usually the first thing we think about with a business… we often ask questions such as, “How much
revenue does it have?” “Is it profitable?” and “What are the margins like?”
In order to answer these questions, and much more, we will dive into the income statement to get
started.
There are two main types of analysis we will perform: vertical analysis and horizontal analysis.
Vertical Analysis
With this method of analysis, we will look up and down the income statement (hence, “vertical”
analysis) to see how every line item compares to revenue, as a percentage.
For example, in the income statement shown below, we have the total dollar amounts and the
percentages, which make up the vertical analysis.
As you see in the above example, we do a thorough analysis of the income statement by seeing each
line item as a proportion of revenue.
The key metrics we look at are:
Cost of Goods Sold (COGS) as a percent of revenue
Gross profit as a percent of revenue
Depreciation as a percent of revenue
Selling General & Administrative (SG&A) as a percent of revenue
Interest as a percent of revenue
Earnings Before Tax (EBT) as a percent of revenue
Tax as a percent of revenue
Net earnings as a percent of revenue
To learn how to perform this analysis step-by-step, please check out our Financial Analysis
Fundamentals Course.
Key Highlights
One of the main tasks of a financial analyst is to perform an extensive analysis of a
company’s financial statements. This usually begins with the income statement but also
includes the balance sheet and cash flow statement.
The main goal of financial analysis is to measure a company’s financial performance

over time and against its peers.
This analysis can then be used to forecast a company’s financial statements into the
future.
Horizontal Analysis
Now it’s time to look at a different way to evaluate the income statement. With horizontal
analysis, we look at the year-over-year (YoY) change in each line item.
In order to perform this exercise, you need to take the value in Period N and divide it by the
value in Period N-1 and then subtract 1 from that number to get the percent change.
For the below example, revenue in Year 3 was $55,749, and in Year 2, it was $53,494. The
YoY change in revenue is equal to $55,749 / $53,494 minus one, which equals 4.2%.
To see exactly how to perform this horizontal analysis of financial statements, please enroll in
our Financial Analysis Fundamentals Course now!
2. Balance Sheet and Leverage Ratios

Let’s move on to the balance sheet. In this section of financial statement analysis, we will evaluate
the operational efficiency of the business. We will take several items on the income statement and
compare them to accounts on the balance sheet.
The balance sheet metrics can be divided into several categories, including liquidity, leverage, and
operational efficiency.
The main liquidity ratios for a business are:
Quick ratio
Current ratio
Net working capital
The main leverage ratios are:
Debt to equity
Debt to capital
Debt to EBITDA
Interest coverage
Fixed charge coverage ratio
The main operating efficiency ratios are:
Inventory turnover
Accounts receivable days
Accounts payable days
Total asset turnover
Net asset turnover
Using the above financial ratios, we can determine how efficiently a company is generating revenue
and how quickly it’s selling inventory.
Using the financial ratios derived from the balance sheet and comparing them historically versus
industry averages or competitors will help you assess the solvency and leverage of a business.
In our course on Analysis of Financial Statements, we explore all the above metrics and ratios in
great detail.
3. Cash Flow Statement Analysis

With the income statement and balance sheet under our belt, let’s look at the cash flow
statement and all the insights it tells us about the business.
The cash flow statement will help us understand the inflows and outflows of cash over the time
period we’re looking at.
Cash flow statement overview
The cash flow statement, or statement of cash flow, consists of three components:
Cash from operations
Cash used in investing
Cash from financing
Each of these three sections tells us a unique and important part of the company’s sources and uses
of cash over a specific time period.
Many investors consider the cash flow statement the most important indicator of a company’s
performance.
Today, investors quickly flip to this section to see if the company is actually making money or not
and what its funding requirements are.
It’s important to understand how different ratios can be used to properly assess the operation of an
organization from a cash management standpoint.
Below is an example of the cash flow statement and its three main components. Linking the 3
statements together in Excel is the building block of financial modeling. To learn more, please see
our online courses to learn the process step by step.
4. Rates of Return and Profitability Analysis
In this part of our analysis of financial statements, we unlock the drivers of financial performance. By
using a “pyramid” of ratios, we are able to demonstrate how you can determine the profitability,
efficiency, and leverage drivers for any business.
This is the most advanced section of our financial analysis course, and we recommend that you
watch a demonstration of how professionals perform this analysis.
The course includes a hands-on case study and Excel templates that can be used to calculate
individual ratios and a pyramid of ratios from any set of financial statements.
The key insights to be derived from the pyramid of ratios include:
Return on equity ratio (ROE)

Profitability, efficiency and leverage ratios
Primary, secondary and tertiary ratios
Dupont analysis
By constructing the pyramid of ratios, you will gain an extremely solid understanding of the business
and its financial statements.
Enroll in our financial analysis course to get started now!
More Analysis of Financial Statements

We hope this guide on the analysis of financial statements has been a valuable resource for you. If
you’d like to keep learning with free CFI resources, we highly recommend these additional guides to
improve your financial statement analysis:
How to Link the 3 Financial Statements
Guide to Financial Modeling
How to be a World-class Financial Analyst
Interactive Career Map

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Analysis of Financial Statements

Guide to analyzing financial statements for financial analysts

Written by CFI Team

Guide to Financial Statement Analysis

1. Income Statement Analysis

The key metrics we look at are:

Cost of Goods Sold (COGS) as a percent of revenue

Gross profit as a percent of revenue

Depreciation as a percent of revenue

Selling General & Administrative (SG&A) as a percent of revenue

Interest as a percent of revenue

Earnings Before Tax (EBT) as a percent of revenue

Tax as a percent of revenue

Net earnings as a percent of revenue

The main goal of financial analysis is to measure a company’s financial performance

2. Balance Sheet and Leverage Ratios

The main liquidity ratios for a business are:

Net working capital

The main leverage ratios are:

Fixed charge coverage ratio

The main operating efficiency ratios are:

Accounts receivable days

Accounts payable days

Total asset turnover

Net asset turnover

3. Cash Flow Statement Analysis

Cash flow statement overview

Cash from operations

Cash used in investing

Cash from financing

The key insights to be derived from the pyramid of ratios include:

Return on equity ratio (ROE)

Primary, secondary and tertiary ratios

Enroll in our financial analysis course to get started now!

More Analysis of Financial Statements

How to Link the 3 Financial Statements

Guide to Financial Modeling

How to be a World-class Financial Analyst

Interactive Career Map

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