- A financial statement is a document in which an organization lifts the veil on many operating factors, ranging from solvency and cash movements to profitability and shareholders' investments. Though it is usually shrouded in secrecy, the preparation and analysis of corporate financial statements offer a window into how the firm records and reports performance data. To prevent insider trading, regulators require companies to keep their operating results secret before publication, and only publish them once. For example, a U.S.-based public company that is listed on multiple stock exchanges around the world must report its financial statements simultaneously. Financial data summaries include an income statement, a statement of shareholders' equity, a statement of cash flows and a balance sheet.
- Various groups analyze corporate reports to differentiate struggling companies from healthy institutions. These include portfolio managers, traders, investors and credit-rating specialists. Regulators also pore over corporate accounting statements to make sure companies do not break the law.
- Securities-exchange players analyze a firm's accounting reports horizontally to see how well senior executives performed over a specific period of time, such as one, five or 10 years. For example, a company's senior management asks department heads to examine whether corporate strategies are effective over a two-year period. The company's revenues and expenses for both years are as follows: $10 million and $8 million in Year 1, and $15 million and $10 million in Year 2, respectively. As a result, department heads calculate that revenues increased by $5 million, or $15 million minus $10 million, resulting in an uptick of 50 percent.
- Analyzing corporate financial statements vertically indicates to investors whether top management's initiatives go far enough toward ensuring long-term profitability. Vertical analysis allows companies to review the evolution of specific items based on a benchmark. To illustrate, an accounting manager wants to review the corporate balance sheet, focusing on how the company uses its resources to expand. The supervisor notes current-year data as follows: $10 million in revenues, $7 million in expenses and $3 million in net income. The benchmark is the revenue amount. A vertical analysis of the firm's income statement shows that revenues equal 100 percent, or $10 million divided by $10 million multiplied by 100 percent, and expenses equal 70 percent, or $7 million divided by $10 million multiplied by 100 percent. The analysis also indicates that net income equals 30 percent, or $3 million divided by $10 million multiplied by 100 percent.