In this unit, you will be introduced to financial statement analysis and its main components. You will also be led through the discussion on how financial statement analysis aids management in decision-making process.
At the end of this unit, you should be able to:
- Explain financial statement analysis;
- Identify the main components of financial statement and the analysis; Discuss financial analysis as a tool for management decisions.
3.0 MAIN CONTENT
3.1 Financial Statement Analysis: An Overview
Financial statement is a statement that records financial activities of a particular business organisation (business enterprise). It is the book keeping and recording of source document from the early stage of business enterprise through journalizing to the ledger accounts, trial balance and then the final accounts.
In the early times, keeping financial statement analysis was not a priority because business transactions were undertaken by means of barter system where goods exchanged for goods. With the modern economy, all transactions were monetized and therefore there was the
need to keep records using money as a common denominator, hence financial recording known as financial statement.
Financial statement analysis is used for two purposes, namely: definitive purpose and information purpose. Where it is used for information purpose, it is for comparative analysis to be made within (intra) and between (inter) the industry.
Users of financial statement have further insight about financial strengths and weaknesses of the business enterprise if information (data) reported in the statement are properly analyzed. It is therefore incumbent on the management to have interest in knowing or developing enough passion for the state of the enterprise at any point in time. This shall be possible if management uses the financial report effectively to evaluate the performance of the business and ensure that the business is suitably organised along corrective measures.
Financial statement is also used for future plans of the enterprise. The present financial data of the business is compared with the past in order to project the likely outcome of activities in the future. It is also worthy of note that financial analysis is based on the data collected from financial statement which itself is the starting point (source) of making the plans before using same for forecasting. It is also good to note that the past financial record is a prerequisite for anticipating the future.
It therefore means that financial statement is the custodian of business activity from the beginning and the basis of financial analysis – which measures the business’s progress and viability. It contains financial information required to predict, compare and evaluate an enterprise’s earning ability. It is the basis for financial analysis, planning and decision-making. The financial statement analysis is used as managerial guide and aid. It is supported on the premise that money values provide a common denominator for the varied activities of an organisation. Financial statement is an accounting report.
Self Assessment Exercise 1
What is financial statement? Briefly explain its role in analysis of an enterprise.