Chapter 1. Overview of Financial Statement Analysis. Dr. Uday

Transcription

1 Chapter 1 Overview of Financial Statement Analysis Dr. Uday

2 Meaning and Definition of financial analysis The term financial analysis is the process of determining financial strengths and weaknesses of the firm by establishing strategic relationship between the items of balance sheet, profit and loss account and other operative data.

3 Types of financial analysis On the basis of materials used: External analysis Internal analysis On the basis of method of operation: Horizontal analysis Vertical analysis

4 Methods or Tools of financial analysis Comparative statements Common-size statements Ratio Analysis Trend Analysis Cash flow analysis Cost-Volume-Profit analysis

5 Advantages of financial statement analysis It helps the management in decision-making It helps the shareholders to analyse the strengths and weaknesses of the company It helps the investors to decide on whether to invest in the company or not It helps the bankers and other creditors to assess the credit worthiness of the firm It helps the government to assess the tax on the company It helps the financial analysts to assess the financial position of the firm

6 Limitations of financial analysis Financial analysis is based on only monetary information and non-monetary factors are ignored It is only the study of interim reports It does not consider the changes in price level It has all the limitations of financial statements Changes in accounting procedure by a firm may often make financial analysis misleading

7 FINANCIAL STATEMENTS Statement of Financial Position (Balance Sheet) Income Statement Statement of Comprehensive Income Statement of Change in Equity Statement of Cash Flows Notes to the Financial Statements

8 Shareholder s Equity (SHE) and its Components Consists of, -the accumulated earnings of the company, - prior period adjustment for errors, - dividends declared/paid, - effect of changes in accounting policy - appropriated retained earnings.

9 STATEMENT OF COMPREHENSIVE INCOME Comprehensive income consists of recognized gains and losses that are not included in the income statement but are found in the equity section of the SFP or more clearly at the statement of changes in equity.

10 STATEMENT OF CASH FLOW The summary of the operating, investing and financing activities of the firm is presented in the statement of cash flows. The ending balance of the statement of cash flows is the same as the cash balance presented in the balance sheet. This statement shows the movements (receipts and disbursements) of cash for one whole period, generally one year.

11 Cash flows and its Classification Cash flows refer to the movement of cash. It could be in an inflow of cash which pertains to the receipts of cash or an outflow which means disbursement of cash. Operating activities. These are activities related in the generation of the principal revenue of the firm. Principal revenue means the main source of revenue or income of the company

12 Investing activities. These are cash flows from purchasing or selling long-term assets and other long-term investments. These are cash flows from sale or purchase transactions wherein non-operating assets(assets other than inventory) are involved. Financing activities. These are the company s cash inflows or outflows involving its owners (equity financing) and creditors (debt financing). The borrowings included under this category are non-trade payables. Non-trade payable are those we get from borrowings from bank or other financial institutions. These are not from purchases of inventory or company office or store supplies.

13 NOTES TO THE FINANCIAL STATEMENTS There are bits or sets of information that cannot be disclosed on the face of the financial statements. These information maybe quantitative or qualitative in nature and may have a bearing on how the financial statements may be interpreted.

14 Objectives of Financial Statement Analyses Profitability. This pertains to the ability of the firm to yield a sufficient amount of return on company sales assets and invested capital. Liquidity and Stability. Liquidity is also referred to as working capital position. Asset utilization or Activity. This pertains to how efficient the company is in managing its resources. Debt-utilization or Leverage. This pertains to the overall debt status of the company. It measures the degree of how the firm is financed.

15 Practical Steps Proposed in Analyzing Financial Statements 1. The analyses done may cover not only the subject firm but could involve other firms belonging to the same industry. It would be wise to learn about the past, present and future conditions of the company. 2. Get to know the firm you are analyzing. Know their mission and vision. 3. Know their strategic plans. Know where the company wishes to be. 4. Know their current status in the industry. Know company financial projections. Know all things about the firm which you consider relevant and may have a bearing on your analysis.

16 5. ASSESS/ANALYZE the financial statements. Horizontal Analysis or also known as dynamic measure or trend ratios. This involves the comparison and measurement of financial statements of two or more periods. This includes statements showing both absolute (monetary amounts) and relative (percentage) changes, financial trends for successive statements, and special analysis of absolute changes in the financial statements. Vertical analysis or also known as static measure or structural ratios. This includes a comparison of financial data for only one period. It involves comparing and establishing the relationship of the components of the financial statements.

17 6. After finishing computing the trends and ratios, comes the more important task. INTERPRET the results of the computations and ratios. 7. Draw CONCLUSIONS from the interpretations made in step six. The conclusions must take into consideration the objectives you have set up.

18 Basic Financial Statements Three types of financial statements are mandated by the accounting and financial regulatory authorities: 1. Income statement how much money you made last year? Revenue, expense, profits over a year or quarter. 2. Balance sheet What s your current financial situation? a snap shot on a specific date of Assets (value of what the firm owns), Liabilities (value of firm s debts), and Shareholder s equity (the money invested by the company owners) 3. Cash flow statement How did the cash come and go? cash received and cash spent by the firm over a period of time FIN3000, Liuren Wu 18

19 Why Study Financial Statements? 1. Assess current performance through financial statement analysis Next chapter provides more tools for the analysis. 2. Monitor and control operations, and Both insiders (such as managers, board of directors) and outsiders (such as suppliers, creditors, investors) use the statements to monitor and control the firm s operations. 3. Forecast future performance. Financial planning models are typically built using the financial statements FIN3000, Liuren Wu 19

20 Three Accounting Principles 1. The revenue recognition principle: Revenue should be included in the income statement for the period in which: Its goods and services were exchanged for cash or accounts receivable; or The firm has completed what it must do to be entitled to the cash. 2. The matching principle: Expenses are matched with the revenues they helped produce. For example, employees salaries are recognized when the product produced as a result of that work is sold, and not when the wages were paid. 3. The historical cost principle: Most assets and liabilities are reported in the financial statements at historical cost, i.e., the price the firm paid to acquire them. The historical cost generally does not equal the current market value of the assets or liabilities. FIN3000, Liuren Wu 20