Financial statement analysis is the process whereby investors and creditors evaluate the Financial Health of the business. It is also used by internal decision makers like owners and managers. we will look in detail at ways to analyze a set of financial statements to gain new perspective on the performance and financial health of the company. There are three general tools or techniques used to complete financial statement analysis: horizontal analysis, vertical analysis and ratio analysis. These techniques should be used together to aid in the evaluation of the financial health of a business. The focus of this video will be an introduction to ratio analysis. There are a number of ratios that are used to analyze a company. So it is important to remember that no single one ratio tells us very much about a business.
We need to use them all together in order to begin to understand a company. Additionally, it's helpful to have data to compare. Sometimes will make comparisons within a company, from one year to the next. This is called intracompany comparison. It's like comparing apples to apples. Sometimes we compare separate companies, which we call the intercompany comparisons. This is like comparing apples to oranges. Finally, we may make comparisons to industry averages. That's like comparing apples to the entire produce section. Generally there are five categories that all ratios fall into. The categories are liquidity ratios, efficiency ratios, solvency ratios, profitability ratios, and something I'm calling marketability ratios. liquidity ratios measure a company's short term ability to meet its obligations.
The primary users of this financial data are short term creditors. you can see some of the common ratios listed on the slide. Efficiency ratios measure how efficient a company is at utilizing its assets, as well as how it manages its liabilities. The primary users of this Financial Data are shareholders, as they have provided the capital management is using to operate the business. Shareholders want an organization to be managed efficiently. And you can see some of the common ratios listed on the slide. Solvency ratios measure the ability of a company to survive over a long period of time by analyzing its long-term debt. The primary users of this Financial Data are shareholders and bondholders, as they're concerned about a company's ability to pay off long-term debt. You can see some of the common ratios listed on the slide. Profitability ratios are often the easiest for students to understand. They measure the income or operating success of the company for a given period of time. The primary users of this financial data are shareholders because they have the most to gain when of business is profitable. And you can see some of the common ratios listed on the slide.
Marketability ratios evaluate the stock performance and attractiveness in the stock market. The primaries users of this financial data are shareholders and investors as they are the ones most interested in the market price of a corporation's common stock. Management is also very interested in these items because it's often how their job performance is evaluated. You can see some of the common ratios listed on the slide. when performing ratio analysis there are some red flags to watch for.
Like earnings problems, poor cash flow from operating activities, too much debt, receivables and inventory, or poor revenue trends. Remember that no one single ratio tells us everything we need to know about a company. For most companies some indicators will be strong and others might be weak. The whole package needs to be evaluated in order to arrive at an educated decision..