An overview of financial statement analysis
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AN OVERVIEW OF FINANCIAL STATEMENT ANALYSIS. CHAPTER 1. …OBJECTIVE. 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.

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…OBJECTIVE

  • 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.


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Case 1.1

Financial Statement Analysis is a process of reviewing, analyzing, interpreting the basic financial reports using the analytical tools such as comparative and trend index analysis, common size analysis, ratio analysis or cash flow analysis. It includes the analysis of the profitability of a company (based on the net profit), worth of the company (asset own), its risk associated to debt they own (liability), capital structure (equity vs. debt own) and cash flows of the company (its sources and uses of funds). The tools used to do the analysis can be c

The objectives of financial statement analysis are to identify the strength and the weaknesses of the company. At the same time it measures the ability of the company to sustain in the business or market and be able to create wealth to the shareholders or pay principal and interest to the creditors.

Exercise:

Find other explanation and your opinion about financial statement analysis and why does it important for one organization


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….BUSINESS ANALYSIS

BUSINESS ANALYSIS ANALYSIS

EXTERNAL FACTOR

INTERNAL FACTOR

Technology Information

Regulation Information

Competitors Information

Financial Statement

BUSINESS ACTIVITIES:

Planning

Financing

Investing

Operating


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Case 1.2

The goal of business analysis is to improve business decisions by evaluating available information about a company’s financial situation, its management, its plan and strategies, and its business environment. Business analysis involved scanning the environment. This is done by examining the environment related to competitors, technology, regulation or changes in government policy as well as customer needs and demand. This type of analysis is called external analysis. Business analysis 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 is the evaluation of a 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.

Exercise

Discuss on the importance of business analysis


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FINANCIAL STATEMENT – The System

  • Step 1 : Shareholders and lenders supply capital (cash) to the company.

  • Step 2: The capital suppliers have claims on the company. The balance sheet is an updated record of the capital invested in the business. On the right-hand side of the balance sheet, lenders hold liabilities and shareholders’ hold equity. The equity claim is "residual", which means shareholders own whatever assets remaining after deducting liabilities.

  • The capital is used to buy assets, which are itemized on the left-hand side of the balance sheet. The assets are current, such as inventory, or long-term, such as a manufacturing plant.

  • Step 3: The assets are deployed to create cash flow in the current year (cash inflows are shown in green, outflows shown in red). Selling equity and issuing debt start the process of raising cash. The company then "puts the cash to use" by purchasing assets in order to create (build or buy) inventory. The inventory helps the company make sales (generate revenue), and most of the revenue is used to pay operating costs, which include salaries.

  • Step 4: After paying the costs (and taxes), the company can do three things with its cash profits.

    • It must pay interest on its debt,

    • It may pay dividends to shareholders at its discretion, and

    • It may retain or re-invest the remaining profits. The retained profits increase the shareholders' equity account (retained earnings). In theory, these reinvested funds are held for the shareholders' benefit and reflected in a higher share price.


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….ACCRUAL ACCOUNTING

  • In accrual basis accounting, income is reported in the fiscal period it is earned, regardless of when it is received, and expenses are deducted in the fiscal period they are incurred, whether they are paid or not. In other words, using accrual basis accounting, you 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 (no matter when they were actually invoiced).


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…SUMMARY

  • Financial statement analysis is a very powerful tool used by analysts to evaluate and predict the performance and the risk of a company. As the name implies, financial statement analysis relies on the accounting data contained in a set of financial statements. However, as financial statements are prepared by corporate managers, the information that is disclosed may not reflect the “true” underlying nature of the firm as the managers have discretion on the amount of detail and the types of information that are to be disclosed.

  • In theory, the idea behind accrual accounting should make reported profits superior to cash flow as a gauge of operating performance. But in practice, timing issues and classification choices can paint a profit picture that is not sustainable. Our goal is to capture normalized earnings generated by ongoing operations. To do that, we must be alert to timing issues that temporarily inflate (or deflate) reported profits


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