In this article, we told you about the three financial analysis tools you can use to analyse your financial statements, to identity successes or failures before it's too late.
Now we're going to tell you about three important limitations to financial statement analysis you must bear in mind.
Revealed: Three limitations to financial statement analysis
#1: According to the Practical Accountancy Loose Leaf, financial information is always historic. But, sometimes history is a poor predictor of the future. It's important to bear in mind that trends and ratios may change over time.
#2: Because you may need to estimate amounts, financial information may be inaccurate.
It's almost impossible to have 100% accurate information in your financial statements; it may be useful to double check information from different sources.
#3: Trends will only become apparent over time. In some cases it's tempting to see a trend in your analysis that could really be a random occurrence. Try to allow sufficient time before calling something a trend.
It's a good idea to compare your financial statements to those of other companies
The best way to analyse your business is to compare your business with competitors in your industry.
This way, you'll be able to benchmark your business's performance against your competitors. And you'll be able to see your relative strengths and weaknesses.
In addition, viewing industry averages allows you to set tangible goals for your business's financial performance.
The Loose Leaf says you'll analyse your financial statements by comparing two pieces of financial information, for example total sales and net profit.
Compare percentages between different businesses of different sizes to understand the financial information in the context of the industry as a whole.
For example, comparing the net profit of Pick'n Pay to that of a local corner café, would only reveal that Pick'n Pay is substantially bigger than the corner café. Comparing the net profit percentage between the different companies reveals more about how the two companies operate.
Where do you get this type of information?
Listed companies (companies whose shares can be bought and sold on a stock exchange) are obliged to publish their audited financial information every year.
You can find this information on financial websites like www.jse.co.za and www.sharenet.co.za.
Knowing the limitations associated with financial statement analysis will help ensure you analyse your financial statements correctly.
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