How to conduct a financial statement analysis
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Financial Statements

  • Financial Statements are company-issued accounting reports with past performance information that a firm issues periodically (usually quarterly and annually).

  • Companies in the US are required to file their financial statements with the Securities and Exchange Commission (SEC) on a quarterly and annually basis.


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Financial Statements

  • The information in the annual report must also be sent to the shareholders every year.

  • Financial statements are important tools through which investors, financial analysts and other interested parties like the creditors obtain information about a corporation.


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Types of Financial Statements

  • Financial Statements are also useful for managers within the firm as a source of information for corporate financial decisions.

  • Every public company is required to produce four financial statements:

    • The Balance Sheet,

    • The Income Statement,

    • The Statement of Cash Flows and

    • The Statement of Stockholders’ Equity.


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Balance Sheet

  • A balance sheet of a company lists the firm’s assets and liabilities.

  • It provides a snapshot of the firm’s financial position at a given point of time.

  • The balance sheet includes the assets, the liabilities and the shareholders’ equity.


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Assets in a Balance Sheet

  • The assets of a company include the long term assets, current assets and expenses to be written off.

  • Long term assets include land, buildings, equipment, goodwill, patents, trademarks, etc.

  • Current assets include cash, accounts receivable, inventories, prepaid expenses, etc.


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Liabilities in a Balance sheet

  • The liabilities of a company include long term liabilities, current liabilities and share holders’ equity.

  • Long term liabilities include long term debt, capital lease obligations, deferred taxes and other long term liabilities.

  • Current liabilities include accounts payable, notes payable, current maturities of long term debt.


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Shareholders’ Equity

  • The sum of current liabilities and long term liabilities is total liabilities.

  • The difference between the firm’s assets and total liabilities is the shareholders’ equity.

  • It is also called the book value of equity. It represents the net worth of the company.


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Difference Market value and Book value

  • In the real world, this is a difficult proposition as the firm’s market value of the asset and liabilities differ from their book value.

  • The assets of the company are based on their historical cost rather than on their market value.

  • Same is the case with liabilities also.


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Market value and Book value contd

  • For these reasons the book value of equity is an inaccurate assessment of the actual value of the firm’s equity.

  • The market value of stock does not depend on the historical cost of the company’s assets.

  • Instead it depends on what investors expect those assets to produce in the future.


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Market value and Book value contd

  • This is not surprising that it will differ substantially from the amount investors are willing to pay for the equity.

  • The total market value of a company’s equity equals the market price per share times the number of shares, referred to as the company’s market capitalization.


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Balance Sheet Analysis

  • A great deal of useful of information from a firm’s balance sheet can be obtained.

  • These include Market to Book Ratio, Debt- Equity Ratio, Enterprise Value, etc.


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Income Statement

  • The Income Statement is a list of the company’s revenues and expenses over a period of time.

  • The last or the bottom line of the income statement shows the company’s net income, which is a measure of its profitability during the period.

  • The income statement is sometimes called a profit and loss statement and the net income is referred to as the company’s earnings.


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Statement of Cash Flows

  • The income statement provides a measure of the company’s profit over a given time period.

  • However, it does not indicate the amount of cash the firm earned.

  • There are two reasons that net income does not correspond to cash earned.


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Statement of Cash Flows

  • First, there are non-cash entries on the income statement, such as depreciation and amortization.

  • Second, certain uses of cash, such as the purchase of a building or expenditures on inventory, are not reported on the income statement.


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Statement of Cash Flows

  • The company’s statement of cash flows utilizes the information from the income statement and balance sheet.

  • This information is used to determine how much cash the company has generated and how that cash has been allocated, during a set period.


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Statement of Cash Flows

  • From the perspective of an investor attempting to value the firm, the statement of cash flows provides what may be the most important information of the four financial statements.

  • The statement is divided into three sections: operating activities, investment activities and financing activities.


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