The Complete CPA Reference

CHAPTER 6

Financial Statement Analysis

Financial statement analysis is an appraisal of a company's previous financial performance and its future potential. The CPA is often involved in analyzing the financial statements of an existing client, prospective client, or targeted company for a potential acquisition. Financial statement analysis aids the CPA in determining what areas to audit and in appraising the overall health of the business. A going-concern problem may be identified. After the CPA completes the financial statement analysis, he or she should consult with management to discuss their plans and prospects, identify problem areas, and offer possible solutions.

This chapter covers:

• Analytical techniques to be followed in appraising the balance sheet and income statement
• Indicators of prospective business failure

Introduction

Why analyze the financial statement?

The CPA analyzes the financial statement of a client for a number of important reasons:

• The financial statement indicates areas requiring audit attention. The CPA can look at the percentage change in an account over the years or relative to some base year to identify inconsistencies. Example: If the ratio of promotion and entertainment expense to sales was 2 percent last year and shot up to 16 percent this year, the auditor would want to uncover the reasons. This increase would be especially disturbing if other companies in the industry still had a percentage relationship of 2 percent. The auditor might suspect ...