INTERPRETING FINANCIAL STATEMENTS THROUGH RATIO ANALYSIS

Financial statement analysis should not be limited to the assessment of sources and uses of funds. Another tool used to gauge the financial health of a business is financial ratio analysis. Essentially, a financial ratio is the comparison of different figures which appear on a balance sheet or an income statement. This comparison is usually expressed in terms of a ratio or a percentage.

Business managers, owners, or creditors do not look only at the makeup of financial statements, that is, the "cosmetics." Just because balance sheets are prepared by renowned accounting firms, does not mean that a business is in a healthy position. A person who knows how to read financial statements can readily detect whether a business is financially sound or suffers from financial anemia. Just like a medical doctor, trained to look at X-rays to detect whether patients are healthy or not, a person can also be trained to read financial statements and to draw meaning from them.

After reading through this subject, you will be in a position to analyse a balance sheet and an income statement and, in a matter of minutes, be able to gauge the financial soundness and profitability of any business. Financial ratio analysis helps analysts assess the financial structure and profitability of businesses by answering such basic questions as:

Let's analyze financial statements in depth, showing how to meaningfully compare numbers appearing on balance sheets and income statements. Here are a few examples of the comparisons that can be made: