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Financial Statements Analysis: Definition and Introduction

A financial statement analysis is performed on the accounting reports prepared by a company, either internally or by auditors, and is vital to understanding the financial health of a company.

Financial statements are the accounting reports prepared by a company. They are the historical record of the finances of the company over a specified period. Investors use financial statement analysis as the basis for their investment opinion on a company. These statements can be prepared internally or by the company’s auditors (the outside accountants used by the firm).

Auditor’s Opinion vs. an Unqualified Opinion

“Audited” statements have been prepared and reviewed by an outside accountant. The outside accountant reviews the internal accounting of the subject company and provides an “Auditor’s Opinion” on their accuracy. An “unqualified opinion” means that the auditor did not encounter any significant problems or discrepancies in the company’s accounting. A “qualified opinion” points out problem areas to the outside parties reading the statements and is a significant flag to investors. Internal statements are called “unaudited”, meaning that a third party accountant has not verified them. Audited statements are provided on an annual basis under corporate law. Semi-annual statements are unaudited and do not have as much detail as the annual statements.

Selection and Importance

The selection of a company’s auditors is the responsibility of the board of directors. Usually the board will appoint a subcommittee known as the “Audit Committee” to choose the auditors and establish and review the accounting policies of the company. This process is very important to the investors in the company as it establishes how the company portrays its financial position. As “International Financial Reporting Standards” (IFRS) allow substantial latitude in how companies report their finances, companies are said to have “liberal” (loose) or “conservative” (tight) accounting policies. Companies have been known to change accounting firms when their accountants do not accept their version of financial reality.

Importance of Financial Statement Analysis for Auditors

As outsiders, it is difficult if not impossible for the auditors to know everything about a company’s financial situation. The auditors rely largely on the company’s internal accounting and records. They “sample” files, transactions and inventories to establish the reliability of the company’s accounting. Several fraud cases and bankruptcies have resulted in investors suing the auditors involved for not detecting the real underlying situation, which often have included outright fraud.

Modern industrial countries have very reliable accounting systems. The financial statement analysis of many “emerging” countries are far less reliable.