What Should You Know to Analyze a Financial Statement?

What do you need to know to analyze a financial statement? The answer is a little complicated. Here are the things you should know:

A basic understanding of accounting. You need to be able to appreciate what the various components of a financial are, and where they come from. You need to understand the pitfalls of financial reporting, and the limitations of GAAP.

A good understanding of the tools of financial analysis, how they are used and what they reveal. Things like ratios, trend lines, scatter charts, and the like are important tools, if you know how to use them.

A good understanding of the industry. You need to know what is expected and what is unusual. Without some comparative information and background, your financial analysis of the company is in a vacuum, and probably meaningless.

A good understanding of the business. If you don’t know anything about the business except what you see in the financial statements, you don’t know very much. When I read an annual report, I spend far more time reading the explanatory material than actually looking at the financials. I do a web search on the company, try to understand what their products are, their operations and their plans. Look for news releases, articles, even yelp reviews.

If you have access to it, one of the best tools to help evaluate a company is its business plan. That gives you true insight into what was planned, what the goals were, and the planned execution. You can compare that to what you actually observe in the financials.

We have some excellent courses on financial analysis for small businesses at CEAnow.org.

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