Techniques (Tools) of Financial Statement Analysis

Several tools are available for analysing financial statements. The Odisha +2 Commerce syllabus for this chapter concentrates on three of them — comparative statements, common-size statements and trend analysis — while ratio analysis and cash flow analysis are studied as chapters of their own. It helps to see all the tools together first, so that each one's job is clear.

• Comparative statements — the financial statements of two or more periods are set side by side, and the absolute change and the percentage change in each item from one period to the next are computed. This is a form of horizontal analysis, because the eye moves across the years for each item. It shows the direction and size of change in each figure.
• Common-size statements — every item in a statement is expressed as a percentage of a common base (net revenue from operations for the income statement, total assets or total of equity and liabilities for the balance sheet). This is a form of vertical analysis, because within one year the items are related down the statement to a common total. It shows the internal composition of the statement and makes firms of different sizes comparable.
• Trend analysis — one item (or a few key items) is tracked over a run of years, with the earliest year taken as the base year = 100 and every later year expressed as a percentage (a trend percentage) of that base. It shows the long-run direction of an item — steadily rising, steadily falling, or fluctuating.
• Ratio analysis — meaningful relationships between two related figures are expressed as ratios or percentages (for example, current assets to current liabilities). (Studied as a separate chapter.)
• Cash flow analysis — the sources and uses of cash during the period are examined through the Cash Flow Statement. (Studied as a separate chapter.)

Two ways of describing the same tools — horizontal vs vertical analysis