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Summary of Financial Analysis Techniques

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Extracts (in part) from : Robinson et al (2009) International Financial Statements Analysis CFA Institute, Wiley, New Jersey, 2009, Chapter 7.

Financial Analysis applies analytical tools to assess a company's performance over time and trends in that performance to assist in decision making by investors etc.

How has the company performed relative to its own past performance and to its competitors?

Some pertinent questions in assessing present and future performance might include:

* How has it performed and is expected to perform in the context of its business and economic, political environment etc.?

* What changes in its environment may have special impact on it given the nature of the industry within which it operates?

* How has the financial crisis and its attendant implications for the level and nature of economic activity, local and global, affected and is expected to continue to affect the company in the forseeable future?

* What changes in the company's structures, if any, have been made and how might these impact on performance?

Some reasons for financial statements analysis include:

* Valuing shares

* Assessing credit risk

* Potential acquisition

The focus of analysis will depend on its purpose.

Objectives of the analysis:

* What is the purpose and what questions it will answer?

* What level of detail will be needed?

* What data are available?

* What factors will influence it?

* What are the analytical limitations and how would these limitations impair the analysis?

Analyst must then select the appropriate analytical techniques.

An effective analysis encompasses both computations and interpretations. A well-reasoned analysis differs from a mere compilation of various pieces of information, computations, tables and graphs by integrating the data collected into a cohesive whole.

To achieve this, the analyst may address the following key questions:

1. What aspects of performance are critical for successful competition in the industry?

2. How well did the company's performance meet these critical aspects (compare with the company's ,competitor's and industry benchmarks)?

3. What were the key causes of this performance and how does it reflect the company's strategy?

A forward looking analysis will include:

* Assessing the likely impact of a trend;

* The response of management;

* Impact of industry and economy trends;

* Recommendations of the analyst arising from interpretation and forecasting of results ; and

* Highlighting of risks through evaluation of major uncertainties in the forecast.

The analyst should communicate findings in a report which should include:

1. The purpose of the report

2. Relevant aspects of the business context:

Economic environment (sector, country international)

Financial and other infrastructure

Legal and regulatory environment

3. Evaluation of corporate governance

4. Assessment of financial and operational data

5. Conclusions and recommendations ( including risks and limitation to the analysis)


Get Financial statements, past and present, including current interim statements and reports and data bases.

Get other relevant data - industry reports, credit rating reports, economic data etc.

Choose the appropriate tool (e.g. current ratio)

Measure it (calculate the current ratio)

Compare result with that of the company in the past (time and trend analysis) and with other firms (cross section analysis)

Evaluate by benchmarking with company, competitor etc.)

Express results of evaluation

Express limitations.

Predict future trend.

Some limitations to ratio analysis are:

* The different composition of the company's operating activities

* Consistency of results

* Need for judgment

* Use of different accounting methods.

Analyses may be:

* Common Size Analysis - using assets or revenue as a base as the case may be;

* Cross- Sectional Analysis- comparison with other companies; or

* Trend Analysis- comparison over time periods.

The broad categories of ratios are:

* Liquidity

* Activity

* Profitability

* Solvency

* Valuation.

Financial ratios can only be interpreted in the context of other information including benchmarks.

Evaluation should be based on:

* Company goals and strategy

* Industry norms

* Economic conditions.





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