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Skill: Financial Statement Analysis

Purpose

Build, validate, and interpret the three core financial statements — Income Statement (IS), Balance Sheet (BS), and Statement of Cash Flows (SCF) — so the founder always has a reconciled, trustworthy picture of profitability, resources, and cash. Includes constructing statements from a raw transaction log, cross-statement reconciliation, common-size recasting, and multi-year trend analysis.

When to Use

• "Turn my transactions/bookkeeping export into real financial statements."
• "Do my statements actually tie out / balance?"
• "What do my financials say about the business — what's the story?"
• "Show me the trend over the last 3 years / which cost lines are creeping up."
• Month-end or year-end close review; before a loan application, investor conversation, or valuation.
• As the upstream data-prep step feeding ratio analysis, cash diagnostics, or forecasting.

When NOT to Use

• You need ratios, benchmarks, or covenant flags → use financial-ratio-analysis.
• The question is "profitable but no cash, why?" → use cash-flow-diagnostic.
• You need forward-looking projections → use financial-forecast-builder.
• The task requires GAAP judgment calls, tax treatment, entity accounting, revenue-recognition rulings, or an audit opinion → escalate to an accountant/CPA. This skill organizes and interprets; it does not certify GAAP compliance.

Required Context

• Business type (product vs. service) and reporting basis (cash vs. accrual). Read from company.
• Chart of accounts or transaction log with beginning balances, OR pre-built statement figures. Read from finance.income_statement, finance.balance_sheet, finance.cash_flow, finance.accounts.
• Period definitions (month/quarter/year) and prior-period comparatives for trend work.
• Fixed-asset register with cost and useful life (for depreciation) if building from transactions.

Inputs

input:
  mode: enum[build_from_transactions, validate_existing, interpret, common_size, trend]  # what to do
  business_type: enum[product, service]        # service uses Cost of Services (salaries) not COGS
  reporting_basis: enum[accrual, cash]         # accrual assumed unless stated
  period: string                               # e.g. "2026-Q2" or "FY2025"
  beginning_balances:                          # required for build_from_transactions
    cash: number
    accounts_receivable: number
    inventory: number
    prepaid_expenses: number
    fixed_assets_gross: number
    accumulated_depreciation: number
    accounts_payable: number
    accrued_expenses: number
    short_term_debt: number
    long_term_debt: number
    common_stock: number
    retained_earnings: number
  transactions:                                # required for build_from_transactions
    - {date: string, description: string, amount: number, accounts_affected: list}
  statements:                                  # required for validate/interpret/common_size/trend
    income_statement: {revenue, cogs, opex{selling_marketing, g_and_a, r_and_d, depreciation}, interest_expense, tax}
    balance_sheet: {current_assets{...}, fixed_assets{gross, accum_dep}, current_liabilities{...}, long_term_debt, equity{common_stock, retained_earnings}}
    cash_flow: {operating, investing, financing}
  prior_periods: list                          # for trend mode: array of prior statements
  fixed_asset_register:                        # for straight-line depreciation
    - {asset: string, cost: number, useful_life_years: number, in_service_date: string}

Missing Information Protocol

• If beginning balances are missing for build_from_transactions, pull the prior period's ending balance sheet from finance.balance_sheet; if none exists, ask the founder for opening balances in ONE batch (list every account needed).
• If a transaction's account mapping is ambiguous, do NOT guess the accounting treatment — list the ambiguous items and ask the founder or route the classification question to the accountant.
• If useful life for depreciation is unknown, ask; never assume a life that changes reported income without confirmation.
• Never fabricate figures to force a balance. If the sheet will not balance, report the imbalance and its size (see Decision Rules), do not plug it silently.
• If reporting basis is unstated, assume accrual, state the assumption explicitly in the output.

Diagnostic Questions

1. Is the business profitable this period, and is profit rising or falling vs. prior periods?
2. Does the balance sheet balance (Assets = Liabilities + Equity), and does net income tie to the change in retained earnings?
3. Does ending cash on the SCF equal cash on the BS?
4. Which income-statement lines are growing faster/slower than revenue (common-size drift)?
5. Is the business generating positive operating cash flow, or funding itself from investing/financing?
6. What one transaction type or account is driving the biggest period-over-period change?

Analysis Framework

Uses the Balance Sheet Equation (BSE) construction engine and common-size/trend analysis.

A. Build-from-transactions (BSE grid). Lay out columns: Cash | A/R | Inventory | Prepaid | Fixed Assets (gross) | Accum. Dep. || A/P | Accrued | Short-term Debt | Long-term Debt || Common Stock | Retained Earnings. Post each transaction as offsetting entries so that after every row Assets = Liabilities + Equity still holds. Then extract:

• Income Statement = the Retained Earnings column entries (revenues positive, expenses negative).
• Balance Sheet = the ending (bottom) row of balances.
• Statement of Cash Flows = the Cash column entries, bucketed Operating / Investing / Financing.

B. Cash-flow bucketing rules. Operating = cash from customers; cash paid to suppliers, employees, rent, utilities, insurance, interest, taxes. Investing = purchase/sale of fixed assets and intangibles. Financing = owner contributions, dividends/withdrawals, and borrowing/repaying interest-bearing debt (loans, credit lines, credit cards). A/P and accrued expenses are Operating, NOT Financing.

C. Validation (three-way tie-out). (1) BS balances; (2) net income from IS equals change in retained earnings; (3) ending cash on SCF equals cash on BS.

D. Common-size. IS: every line ÷ Revenue. BS: every line ÷ Total Assets. Surfaces margin structure and cost creep normalized for size.

E. Trend. Place periods side by side, compute period-over-period growth and common-size deltas, flag lines drifting adversely (classic pattern: revenue up while net income down).

Calculations

Variable key: R = Revenue; COGS = cost of goods sold (service: Cost of Services = delivery salaries); Opex = operating expenses; D = depreciation; Int = interest expense; T = tax; NI = net income.

• Gross Profit = R − COGS. Gross Margin % = Gross Profit / R.
• Operating Income (EBIT) = Gross Profit − Total Opex.
• EBITDA = EBIT + D&A.
• EBT (pre-tax) = EBIT − Int.
• Net Income = EBT − T.
• Straight-line Depreciation = Asset Cost / Useful Life (years).
• Net Fixed Assets = Gross Fixed Assets − Accumulated Depreciation.
• Balance Sheet Identity = Assets = Liabilities + Owners' Equity (must hold per transaction and in total).
• Ending Retained Earnings = Beginning R/E + Net Income − Dividends.
• Operating Cash Flow (indirect) = NI + D ± ΔWorking-capital items (−ΔA/R, −ΔInventory, +ΔA/P, +ΔAccrued, −ΔPrepaid, +ΔUnearned).
• Change in Cash = Operating CF + Investing CF + Financing CF; Ending Cash = Beginning Cash + Change in Cash.
• Common-size IS line = Line / Revenue × 100. Common-size BS line = Line / Total Assets × 100.
• Period-over-period growth % = (Current − Prior) / Prior × 100.

Validation thresholds: balance imbalance must be exactly 0 (report any |imbalance| > 0). Rounding differences up to $1 are acceptable if all inputs were rounded; flag anything larger as an error, not a rounding artifact.

Decision Rules

• IF |Assets − (Liabilities + Equity)| > 0 → THEN the statements do NOT tie out; report the exact imbalance and the most likely offending account; do NOT plug it. Route to accountant if the cause is a classification/treatment question.
• IF NI (from IS) ≠ ΔRetained Earnings (excluding dividends) → THEN a revenue/expense item is miscategorized or a dividend is unrecorded; flag for correction.
• IF Ending Cash (SCF) ≠ Cash (BS) → THEN a cash transaction is mis-bucketed or omitted; reconcile before publishing.
• IF a cost line rises as a % of revenue across periods (common-size) → THEN flag it as cost creep and name the specific line.
• IF revenue grew but net income fell → THEN run common-size to identify which line (COGS or a specific opex) absorbed the growth; hand off to financial-ratio-analysis for margin diagnosis.
• IF Operating CF is negative while NI is positive → THEN hand off to cash-flow-diagnostic (profit ≠ cash).
• IF reporting basis is cash but the founder needs A/R, A/P, or accrual insight → THEN note that timing accounts are not captured and recommend accrual conversion or an accountant.

Procedure

1. Determine mode and business_type; confirm reporting basis (state assumption if unstated).
2. build_from_transactions: load beginning balances → post each transaction to the BSE grid, checking A = L + E after every row → compute period depreciation from the fixed-asset register → extract IS (R/E column), BS (ending row), SCF (cash column, bucketed).
3. validate_existing: run the three-way tie-out (balance, NI↔ΔR/E, ending cash↔BS cash). Report each check pass/fail with the numeric difference.
4. common_size: recast IS as % of revenue and BS as % of total assets.
5. trend: align periods, compute growth and common-size deltas, flag adverse drifts.
6. interpret: narrate the story — profitability, resource/funding mix, cash generation — citing the specific line or ratio behind each finding.
7. Write reconciled statements to finance.* (staged for approval — L1) and record findings in decisions.
8. Hand off to the appropriate downstream skill (ratios, cash diagnostic, forecast) as flagged.

Output

output:
  period: string
  reporting_basis: enum[accrual, cash]
  income_statement:
    revenue: number
    cogs: number
    gross_profit: number
    gross_margin_pct: number
    operating_expenses: {selling_marketing, g_and_a, r_and_d, depreciation}
    ebit: number
    ebitda: number
    interest_expense: number
    ebt: number
    tax: number
    net_income: number
  balance_sheet:
    current_assets: {cash, accounts_receivable, inventory, prepaid, other}
    fixed_assets: {gross, accumulated_depreciation, net}
    total_assets: number
    current_liabilities: {accounts_payable, accrued, short_term_debt, other}
    long_term_debt: number
    total_liabilities: number
    equity: {common_stock, retained_earnings, total}
    balances: boolean
  cash_flow:
    operating: number
    investing: number
    financing: number
    net_change: number
    ending_cash: number
  validation:
    balance_sheet_balances: boolean
    imbalance_amount: number
    ni_ties_to_retained_earnings: boolean
    ending_cash_ties_to_bs: boolean
  common_size: {income_statement: map, balance_sheet: map}   # optional
  trend_flags: list                                          # adverse drifts, each citing the line
  narrative: string                                          # cited interpretation
  handoffs: list                                             # downstream skills recommended

Recommendations

Recommendations are prioritized by (1) integrity first — any failed tie-out is fixed before interpretation is trusted; (2) materiality — the largest common-size drifts and period-over-period swings; (3) actionability — each flagged line pairs with a concrete next step (e.g., "COGS rose from 58% to 63% of revenue → investigate supplier pricing or mix; see financial-ratio-analysis"). Every finding cites the exact line/figure that triggered it.

Execution Opportunities

• Write reconciled statements into Business Memory finance.* (reversible, LOW — staged as L1 draft for founder confirmation).
• Create internal tasks for each unreconciled item or cost-creep flag (reversible, LOW).
• Update an internal financial dashboard with the period's statements and common-size view (reversible, LOW).
• Draft a plain-language monthly financial summary for the founder (reversible, LOW; sending externally requires approval).

Human Approval Requirements

• Analysis, construction, validation, and interpretation: always allowed (no money moves).
• Committing statements as the official/finalized record of the period requires founder confirmation.
• Any correction that changes reported income, tax basis, or an accounting treatment: hold for accountant/CPA review before it is treated as final.
• No action in this skill moves money, takes on debt, commits budget, or files anything — those are out of scope here and always require approval elsewhere.

Escalation Conditions

• GAAP treatment, revenue recognition, entity/tax accounting, or classification uncertainty → accountant/CPA.
• Statements will not tie out and the cause is not a data-entry error → accountant/CPA + founder.
• Suspected material misstatement or fraud indicators → founder immediately, then accountant.
• Low confidence in input data quality → surface uncertainty to founder; do not present unreliable statements as fact.

KPIs

• Three-way tie-out pass rate (target 100% before publishing).
• Balance imbalance = $0 on published statements.
• Time from transaction log to reconciled statements.
• Number of cost-creep/adverse drifts surfaced that the founder acts on.
• Downstream reuse: statements consumed cleanly by ratio/forecast skills without rework.

Monitoring

• Watch for period-over-period swings > 20% in any major line and re-flag.
• Re-run validation whenever underlying transactions change.
• Track whether flagged cost creep reverses or worsens in subsequent periods.

Follow-Up

• Run every close (monthly/quarterly/annual) and before any loan, investor, valuation, or budgeting exercise.
• Re-run immediately if bookkeeping data is corrected or a prior period is restated.

Related Skills

• financial-ratio-analysis (consumes these statements for ratios/benchmarks).
• cash-flow-diagnostic (when NI and operating cash diverge).
• working-capital-optimizer (uses A/R, inventory, A/P balances).
• financial-forecast-builder (uses the base period as its anchor).
• budget-builder (variance vs. actuals).

Guardrails

• Never plug an imbalance to force a tie-out; report it.
• Never assume account classifications, useful lives, or reporting basis that change reported results — confirm first.
• Do not certify GAAP compliance or issue anything resembling an audit opinion; this is management analysis.
• Treat low-quality/low-confidence inputs as uncertain and label them; do not present estimates as audited fact.
• Financial data is confidential; write only to permitted finance.* namespaces; writes are audited.

Example

Founder input: "Here are my Q2 opening balances and 30 transactions from my bookkeeping export — build my statements and tell me if they tie out." Business type: product, accrual. Opening cash $40,000; among the transactions: $120,000 credit sales, $70,000 COGS purchased on account, $12,000 cash collected on old A/R, $8,000 rent paid, $5,000 equipment bought for cash (5-yr life), $10,000 loan principal repaid.

Skill reasoning: Posts each to the BSE grid. Depreciation on the new $5,000 asset for the quarter = 5,000 / 5 / 4 = $250. Extracts: Revenue $120,000; COGS $70,000 → Gross Profit $50,000; less rent $8,000 and depreciation $250 → EBIT $41,750 (no interest/tax this simplified period). Cash column: +$12,000 collections, −$8,000 rent, −$5,000 equipment (Investing), −$10,000 loan repayment (Financing). Operating CF = NI $41,750 + Dep $250 − ΔA/R (rise $108,000 from $120k booked less $12k collected) + ΔA/P (rise $70,000) = −$36,000. Checks: BS balances (imbalance $0); NI $41,750 = ΔRetained Earnings; ending cash on SCF equals BS cash.

Output: reconciled IS/BS/SCF, all three tie-out checks pass, plus a flag: "Operating cash flow is −$36,000 despite $41,750 net income — driven by a $108,000 rise in A/R. Hand off to cash-flow-diagnostic."

Executed vs. approval: statements staged to finance.* and dashboard updated automatically (L1 draft); finalizing them as the official Q2 record held for founder confirmation.

Provenance

SOURCE. Derives from the Finance — Statements & Ratios knowledge (Balance Sheet Equation construction engine, three-statement definitions, cash-flow bucketing, common-size and trend frameworks) and the Forecasting/Cash knowledge (BSE transaction engine, statement reconciliation). Branding stripped and generalized to function per PROVENANCE_MAP.