World Library  
Flag as Inappropriate
Email this Article

Financial statement analysis

Article Id: WHEBN0006184541
Reproduction Date:

Title: Financial statement analysis  
Author: World Heritage Encyclopedia
Language: English
Subject: Investment management, Overtrading, Net operating assets, Economist, NOPAT
Collection: Management Accounting
Publisher: World Heritage Encyclopedia
Publication
Date:
 

Financial statement analysis

Financial statement analysis (or financial analysis) is the process of reviewing and analyzing a company's financial statements to make better economic decisions. These statements include the

  • [1] SFAF - the French Society of Financial Analysts
  • [2] ACIIA - Association of Certified International Investment Analysts
  • [3] EFFAS - European Federation of Financial Analysts Societies

Associations

  • Investopedia
  • Beginner's Guide to Financial Statements by SEC.gov

External links

  1. ^ a b c
  2. ^ New York Times,August 16, 1998 Gretchen Morgenson – Market Watch MARKET WATCH; A Time To Value Words of Wisdom“ … Security Analysis by Benjamin Graham and David Dodd, the 1934 bible for value investors.”
  3. ^ New York Times, January 2, 2000 Business Section Humbling Lessons From Parties Past By BURTON G. MALKIEL “BENJAMIN GRAHAM, co-author of "Security Analysis," the 1934 bible of value investing, long ago put his finger on the most dangerous words in an investor's vocabulary: "This time is different." Burton G. Malkiel is an economics professor at Princeton University and the author of "A Random Walk Down Wall Street" (W.W. Norton).
  4. ^ a b
  5. ^ Accountingtools.com - Financial Statement Analysis
  6. ^ Perceptual Edge-Jonathan Koomey-Best practices for understanding quantitative data-February 14, 2006
  7. ^ Accountingtools.com - Financial Statement Analysis
  8. ^ Investopedia-Financial Statement Analysis
  9. ^ Investopedia – Digging Into The Dividend Discount Model

References

See also

Financial analysts typically have finance and accounting education at the undergraduate or graduate level. Persons may earn the Chartered Financial Analyst (CFA) designation through a series of challenging examinations.

Certifications

Recasting financial statements requires a solid understanding of accounting theory. Once the cash flow in future years is projected, a discount rate or interest rate will be applied to measure the value of the company and its stock or debt.[1]}

Investors typically are attempting to understand how much cash the company will generate in the future and its rate of profit growth, relative to the amount of capital deployed. Analysts may modify ("recast") the financial statements by adjusting the underlying assumptions to aid in this computation. For example, operating leases (treated like a rental transaction) may be recast as capital leases (indicating ownership), adding assets and liabilities to the balance sheet. This affects the financial statement ratios.[1]

Recasting financial statements

Financial statement analyses are typically performed in spreadsheet software and summarized in a variety of formats.

A Dividend discount model (DDM) may also be used to value a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.[9] In other words, it is used to value stocks based on the net present value of the future dividends.

DuPont analysis uses several financial ratios that multiplied together equal return on equity, a measure of how much income the firm earns divided by the amount of funds invested (equity).

  • Liquidity ratios are used to determine how quickly a company can turn its assets into cash if it experiences financial difficulties or bankruptcy. It essentially is a measure of a company's ability to remain in business. A few common liquidity ratios are the current ratio and the liquidity index. The current ratio is current assets/current liabilities and measures how much liquidity is available to pay for liabilities. The liquidity index shows how quickly a company can turn assets into cash and is calculated by: (Trade receivables x Days to liquidate) + (Inventory x Days to liquidate)/Trade Receivables + Inventory.
  • Profitability ratios are ratios that demonstrate how profitable a company is. A few popular profitability ratios are the breakeven point and gross profit ratio. The breakeven point calculates how much cash a company must generate to break even with their start up costs. The gross profit ratio is equal to (revenue - the cost of goods sold)/revenue. This ratio shows a quick snapshot of expected revenue.
  • Activity ratios are meant to show how well management is managing the company's resources. Two common activity ratios are accounts payable turnover and accounts receivable turnover. These ratios demonstrate how long it takes for a company to pay off its accounts payable and how long it takes for a company to receive payments, respectively.
  • Leverage ratios depict how much a company relies upon its debt to fund operations. A very common leverage ratio used for financial statement analysis is the debt-to-equity ratio. This ratio shows the extent to which management is willing to use debt in order to fund operations. This ratio is calculated as: (Long-term debt + Short-term debt + Leases)/ Equity.[8]

Financial ratios are very powerful tools to perform some quick analysis of financial statements. There are four main categories of ratios: liquidity ratios, profitability ratios, activity ratios and leverage ratios. These are typically analyzed over time and across competitors in an industry.

Financial ratio analysis

Vertical analysis is a proportional analysis of financial statements. Each line item listed in the financial statement is listed as the percentage of another line item. For example, on an income statement each line item will be listed as a percentage of gross sales. This technique is also referred to as normalization[6] or common-sizing.[7]

Horizontal analysis compares financial information over time, typically from past quarters or years. Horizontal analysis is performed by comparing financial data from a past statement, such as the income statement. When comparing this past information one will want to look for variations such as higher or lower earnings.[5]

Horizontal and vertical analysis

The Graham and Dodd approach is referred to as Fundamental analysis and includes: 1) Economic analysis; 2) Industry analysis; and 3) Company analysis. The latter is the primary realm of financial statement analysis. On the basis of these three analyses the intrinsic value of the security is determined.[4]

Benjamin Graham and David Dodd first published their influential book "Security Analysis" in 1934.[2] [3] A central premise of their book is that the market's pricing mechanism for financial securities such as stocks and bonds is based upon faulty and irrational analytical processes performed by many market participants. This results in the market price of a security only occasionally coinciding with the intrinsic value around which the price tends to fluctuate.[4] Investor Warren Buffett is a well-known supporter of Graham and Dodd's philosophy.

History

Contents

  • History 1
  • Horizontal and vertical analysis 2
  • Financial ratio analysis 3
  • Recasting financial statements 4
  • Certifications 5
  • See also 6
  • References 7
  • External links 8
    • Associations 8.1

Common methods of financial statement analysis include fundamental analysis, DuPont analysis, horizontal and vertical analysis and the use of financial ratios. Historical information combined with a series of assumptions and adjustments to the financial information may be used to project future performance. The Chartered Financial Analyst designation is available for professional financial analysts.

It is used by a variety of stakeholders, such as credit and equity investors, the government, the public, and decision-makers within the organization. These stakeholders have different interests and apply a variety of different techniques to meet their needs. For example, equity investors are interested in the long-term earnings power of the organization and perhaps the sustainability and growth of dividend payments. Creditors want to ensure the interest and principal is paid on the organizations debt securities (e.g., bonds) when due.

[1]

This article was sourced from Creative Commons Attribution-ShareAlike License; additional terms may apply. World Heritage Encyclopedia content is assembled from numerous content providers, Open Access Publishing, and in compliance with The Fair Access to Science and Technology Research Act (FASTR), Wikimedia Foundation, Inc., Public Library of Science, The Encyclopedia of Life, Open Book Publishers (OBP), PubMed, U.S. National Library of Medicine, National Center for Biotechnology Information, U.S. National Library of Medicine, National Institutes of Health (NIH), U.S. Department of Health & Human Services, and USA.gov, which sources content from all federal, state, local, tribal, and territorial government publication portals (.gov, .mil, .edu). Funding for USA.gov and content contributors is made possible from the U.S. Congress, E-Government Act of 2002.
 
Crowd sourced content that is contributed to World Heritage Encyclopedia is peer reviewed and edited by our editorial staff to ensure quality scholarly research articles.
 
By using this site, you agree to the Terms of Use and Privacy Policy. World Heritage Encyclopedia™ is a registered trademark of the World Public Library Association, a non-profit organization.
 


Copyright © World Library Foundation. All rights reserved. eBooks from Project Gutenberg are sponsored by the World Library Foundation,
a 501c(4) Member's Support Non-Profit Organization, and is NOT affiliated with any governmental agency or department.