CHAPTER 1

OVERVIEW OF FINANCIAL
STATEMENT ANALYSIS
OBJECTIVES

• Identify and discuss overview and function of

financial statement analysis.
• Explain business analysis and its relation to
financial statement analysis.
• Identify the relevant analysis information beyond
financial statements.
• Explain the part of accrual accounting in financial
statement analysis.
INTRODUCTION
• What is Financial Statement Analysis?
– an analysis of the financial reports of a company in a certain
period of time by evaluating the company’s economic prospects
and risks.
– Relies on the past accounting data in order to predict about the
future of the firm. and identify problem areas.
– Includes analysis of company’s business environment,
strategies and its financial position and performance.
– Fundamentals of financial planning and analysis applicable to
both for profit-seeking and for non-profit-seeking organizations.
– Financial statement structure and analysis is discussed, with the
objective of arriving at a financial model for an organization such
as:
• Operating activities
• Investing activities
• Financing activities
– Financial statement analysis is also employed as a tool to
predict the financial results based on a firm's strategic plans and
objectives.
• What are financial statements?
– The medium by which a company discloses
information concerning its financial performance.
– Financial statements consist of:
• Income statement,
• Balance sheet, and
• Statement of Cash flow
• How to analyze financial statements?
– The most commonly-used approaches across the
industries are:
• Ratio analysis
• Cash flow analysis
• Common size analysis
• Index trend analysis
• Equity analysis and Valuation
• Why do we analyze the financial statements?
– To identify the state of the company in terms of their
risk and return. Therefore, the results from the
analysis will shed light as to the performance of the
company.
• Who analyze the financial statements?
– Investors
– Creditors
– Government
BUSINESS ANALYSIS

• Business analysis is process of evaluating company’s

prospects and risks for the purpose of making business
decisions. These business decisions extend to equity and
debt valuation, credit risk assessment, earning predictions,
audit testing, etc.
• It’s an aids in making informed decision by helping
structure the decision task through an evaluation of a
company’s business environment, its strategies, and its
financial position and performance.
 BUSINESS ANALYSIS

EXTERNAL FACTOR INTERNAL FACTOR

Technology Competitors Regulation Financial Statement

Information Information Information
Business Analysis

Evaluate
EvaluateProspects
Prospects •• Evaluate
EvaluateRisks
Risks
Information Sources for
Business Analysis
Credit Analysis
 Credit Analysis
Credit
Creditworthiness:
worthiness:Ability
Abilityto
tohonor
honorcredit
creditobligations
obligations
(downside
(downsiderisk)
risk)

Liquidity
Liquidity Solvency
Solvency
Ability
Abilityto
tomeet
meetshort-
short- Ability
Abilityto
tomeet
meetlong-
long-
term
termobligations
obligations term
termobligations
obligations
Focus:
Focus: Focus:
Focus:
••Current
Currentcash
cashflows ••Long-term
flows Long-termprofitability
profitability
••Make
Makeupupofofcurrent ••Capital
current Capitalstructure
structure
assets
assetsand
andliabilities
liabilities
••Liquidity
Liquidityof
ofassets
assets
 Equity Analysis

Assessment
Assessmentof
ofdownside
downsiderisk
riskand
andupside
upsidepotential
potential

Technical
Technicalanalysis
analysis/ / Fundamental
FundamentalAnalysis
Analysis
Charting
Charting Determine
DetermineIntrinsic
Intrinsicvalue
value
••Patterns
Patternsin
inprice
priceor
or without
volume withoutreference
referenceto to
volumehistory
historyof
ofaa price
price
stock
stock
••Predict ••Analyze
Analyzeand
andinterpret
Predictfuture
futureprice
price interpret
movements key
keyfactors
factors
movements
–– Economy
Economy
–– Industry
Industry
–– Company
Company
Accounting Analysis

Process to evaluate and adjust financial

statements to better reflect economic reality
Financial Analysis

Process to evaluate financial position and

performance using financial statements

Profitability analysis — Evaluate return

on investments Common tools

Risk analysis ——— Evaluate riskiness

& creditworthiness Cash
Ratio
flow
analysis analysis
Analysis of — Evaluate source &
cash flows deployment of funds
Prospective Analysis

Process
Processto
toforecast
forecastfuture
futurepayoffs
payoffs

Business
BusinessEnvironment
Environment
&&Strategy
StrategyAnalysis
Analysis

Accounting
AccountingAnalysis
Analysis

Financial
FinancialAnalysis
Analysis

Intrinsic
IntrinsicValue
Value
Business Activities
Business Activities

Financing
Financingactivities
activities
• •Owner
Owner(equity)
(equity)
• •Nonowner
Nonowner(liabilities)
(liabilities)
 Business Activities

Investing
Investingactivities
activities
• •Buying
Buyingresources
resources
• •Selling
Sellingresources
resources

Investing
Investing==Financing
Financing
Business Activities

Operating
OperatingActivities
Activities
Revenues
Revenuesand
andexpenses
expensesfrom
fromproviding
providing
goods
goodsand
andservices
services
Financial Statements Reflect Business Activities
FINANCIAL STATEMENT

• A financial statement is a transaction that flow

through business activities.
• Each transaction or exchange, for example, the
sale of a product or the use of a rented building,
contributes to the whole picture.
 2
1

Balance Sheet Capital

Supplied

ASSETS LIABILITIES
• Current • Current Debt
(Short-term) •Long-term
•Fixed
(Long-term)
•Other Shareholder’s Stock
EQUITY

Cash Flow Retain Return

3

Sell Equity
Issue Debt
Buy Assets
4
Buy Inventory
Make Sales
Retain profits or
Pay Costs
“repay” debt-holders
Pay Taxes
(with interest) and
Pay Interest
stockholders (with
Pay Dividends
dividend)
ACCRUAL ACCOUNTING

• Accrual basis accounting - record both revenues

and expenses when they occur. Accrual basis
accounting is the method of accounting most
businesses and professionals are required to use
by law.
• In cash basis accounting, revenues are recorded
when cash is actually received and expenses are
recorded when they are actually paid