Financial Statement Analysis What do internal users use it for? Planning, evaluating and controlling company operations What do external users use it for? Assessing past performance and current financial position and making predictions about the future profitability and solvency of the company as well as evaluating the effectiveness of management
Financial Statement Analysis Information is available from – Published annual reports (1)Financial statements (2)Notes to financial statements (3)Letters to stockholders (4)Auditor’s report (Independent accountants) (5)Management’s discussion and analysis – Reports filed with the government Taxation Department, SECP.
Financial Statement Analysis Information is available from – Other sources (1)Newspapers (e.g., The News) (2)Periodicals (e.g. The Economist, Fortune) (3)Financial information organizations (4)Other business publications
Methods of Financial Statement Analysis Horizontal Analysis Vertical Analysis Common-Size Statements Trend Percentages Ratio Analysis
Horizontal Analysis Example horizontal analysis The management of ABC Company provides you with comparative balance sheets of the years ended December 31, 2009 and 2010. Management asks you to prepare a horizontal analysis on the information.
Horizontal Analysis Example Calculating Change in Dollar Amounts Since we are measuring the amount of the change between 2010 and 2009, the dollar amounts for 2009 become the “base” year figures. Dollar Change Current Year Figure Base Year Figure =–
Horizontal Analysis Example Calculating Change as a Percentage Percentage Change Dollar Change Base Year Figure 100% = ×
$12,000 – $23,500 = $(11,500) Horizontal Analysis Example
Ratios Ratios can be expressed in three different ways: 1. Ratio (e.g., current ratio of 2:1) 2. % (e.g., profit margin of 2%) 3. $ (e.g., EPS of $2.25) “Using ratios and percentages without considering the underlying leads to incorrect conclusions.”
Categories of Ratios Liquidity Ratios Indicate a company’s short-term debt-paying ability Equity (Long-Term Solvency) Ratios Show relationship between debt and equity financing in a company Profitability Tests Relate income to other variables Market Tests Help assess relative merits of stocks in the marketplace
Important Considerations Need for comparable data – Data is provided by different companies. – Must compare by industry l Influence of external factors u General business conditions u Seasonal nature of business operations l Impact of inflation