CHAPTER 1: OVERVIEW OF FINANCIAL STATEMENT ANALYSIS 🚩 : unnamed

1.2 Financial Statements - Basis of analysis

Business activities

Planning

Operating

Consist of company objectives& tactics, market demands, competitive analysis, sales strategies, managements performance and financial projections.

Methods that companies use to raise the money to pay its employees, market campaigns and RnD.

Sources of financing

Internal financing

1.1 Introduction to Business Analysis

FSA is part of business analysis (BA)

BA is the evaluation of a company's prospects and risks for the purpose of making business decisions.

Improve business decision by evaluating company financial's situation, its management, its plan & its business environment.

Types of Business Analysis

Credit Analysis

Equity Analysis

The evaluation of the creditworthiness of a company

Credit analysis (CA) is the ability of a company to pay its bills to creditors

A company’s primary source of earnings

Creditors can be classified into trade creditors and non trade creditors.

Trade creditor

Non Trade creditor

Provide goods or service.

Provide major financing

It also refers to carrying out the business plan

Mostly short term

5 possible components :

Mostly long term

R&D

Production

Marketing

Procurement

CA includes analysis of both liquidity and solvency.

Administration

Liquidity

Solvency

company's ability to raise cash in the short term to meet its obligation

company's long run viability and ability to pay long-term obligations

to access the upside potential ( uncertain possibility of gain)

to access the downside risk

Use technical analysis or fundamental analysis, or both.

Technical refers to charting & searches for pattern in the price or volume history of stock to predict future price movement.

Fundamental analysis is to determine instrintic value (IV) of company

Instrinsic value is the value of company determine through fundamental analysis without reference to its market value

Component of Business Analysis

Other Uses of Business Analysis

Buy stock when IV > MV. Sell stock when IV < MV

An analysist must forecast a company's earnings/ cashflow to determine IV

Managers

Mergers, acquisitions, and divestitures

Financial management.

Directors

Regulators

Labor unions.

Customers

Business Environment and Strategy Analysis

Industry Analysis

Strategy Analysis

Accounting
Analysis

Financial
Analysis

Profitability
Analysis

Analysis of Cash
Flows

Risk
Analysis

Prospective
Analysis

Cost of
Capital Estimate

Intrinsic Value

External financing

Creditors
(lenders)

Investing

A company's acquisition & maintenance of investments for :

Selling products & providing services

Investing excess cash

Equity investor (shareholders )

Example:

  • Earning reinvestment

Two types:

  • debt creditors
  • operating creditors

Major source

Financing

Financial Statements Reflect Business Activities

Additional information

Company’s acquisition and maintenance of investment for purpose of selling products and providing services, and for the purpose of investing excess cash.

To audit tax returns

To provide clues to strategic changes in operating, investing & financing activities.

To evaluate a competitor’s profitability & risk.

To evaluate relative strengths & weaknesses

To benchmark performance.

To identify targets & determine additional value

To protect shareholders’ interests.

To evaluate the impact of financing decisions, dividend policy, profitability & risk.

To check the reported amounts.

To determine the profitability of suppliers.

To negotiate.

MD&A

Management Report

Auditor Report

Explanatory Notes

Supplementary Information

Proxy Statements

Supplemental schedules to the financial statement notes

Operating assets

Financing assets

  • land
  • building
  • legal right (patents, license)

Financial statement analysis requires a review of the auditor's report to ascertain whether the company received an unqualified opinion.

  • equity stock
  • gov bonds
  • money market funds

Companies with publicly traded debt and equity securities are required by the Securities and Exchange Commission to file a MD&A.

Purposes of this report: 1) senior management's responsibilities for the company's financial and internal control system. 2)the shared roles of management, directors and the auditorin preparing financial statements.

Balance Sheet

Income Statement

Statement of changes in Shareholders’ Equity

Statement of cash flows

The technical nature of notes creates a need for a certain level of accounting knowledge on the part of financial statement analysts.

Contains information necessary for shareholders in voting on matters for which the proxy is solicited.

  • Accounting equation(also called the balance sheet identity is the basis of the accounting system
  • Assets = Liabilities + Equity
  • Measures a company's financial performance over a period of time
  • Earnings are determined using the accrual basis of accounting
  • Useful identifying reasons for changes in equity holders' claims on the assets of a company
  • Contributed capital called as share capital

Report cash inflows and outflows separately for a company’s operating, investing, and financing activities over a period of time

1.3 financial statement analysis preview

Analysis Tools

Common-size financial statement analysis

Ratio analysis

Comparative financial statement analysis

Cash flow analysis

1 year to year change analysis

index number trend analysis

Sources of financing (current liabilities, non-current liabilities & equity)

Composition of assets (current & non current assets)

Net Cash Flows from Operating Activities

Net Cash Flows from Investing Activities

Net Cash Flows from Financing Activities

Areas of Ratio Analysis

Credit (risk) Analysis

Profitability Analysis

Valuation

Liquidity

Capital structure and solvency

Return on investment

Operating performance

Asset utilization