How to conduct a financial statement analysis


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How to conduct a financial statement analysis

  1. 1. How to conduct a Financial Statement Analysis<br /><br />
  2. 2. Financial Statements are company-issued accounting reports with past performance information that a firm issues periodically (usually quarterly and annually). <br />Companies in the US are required to file their financial statements with the Securities and Exchange Commission (SEC) on a quarterly and annually basis.<br />Financial Statements<br /><br />
  3. 3. The information in the annual report must also be sent to the shareholders every year. <br />Financial statements are important tools through which investors, financial analysts and other interested parties like the creditors obtain information about a corporation. <br />Financial Statements<br /><br />
  4. 4. Financial Statements are also useful for managers within the firm as a source of information for corporate financial decisions. <br />Every public company is required to produce four financial statements: <br />The Balance Sheet,<br />The Income Statement, <br />The Statement of Cash Flows and <br />The Statement of Stockholders’ Equity. <br />Types of Financial Statements<br /><br />
  5. 5. A balance sheet of a company lists the firm’s assets and liabilities.<br />It provides a snapshot of the firm’s financial position at a given point of time. <br />The balance sheet includes the assets, the liabilities and the shareholders’ equity. <br />Balance Sheet<br /><br />
  6. 6. The assets of a company include the long term assets, current assets and expenses to be written off. <br />Long term assets include land, buildings, equipment, goodwill, patents, trademarks, etc. <br />Current assets include cash, accounts receivable, inventories, prepaid expenses, etc. <br />Assets in a Balance Sheet<br /><br />
  7. 7. The liabilities of a company include long term liabilities, current liabilities and share holders’ equity. <br />Long term liabilities include long term debt, capital lease obligations, deferred taxes and other long term liabilities. <br />Current liabilities include accounts payable, notes payable, current maturities of long term debt. <br />Liabilities in a Balance sheet<br /><br />
  8. 8. The sum of current liabilities and long term liabilities is total liabilities. <br />The difference between the firm’s assets and total liabilities is the shareholders’ equity. <br />It is also called the book value of equity. It represents the net worth of the company. <br />Shareholders’ Equity<br /><br />
  9. 9. 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. <br />The assets of the company are based on their historical cost rather than on their market value. <br />Same is the case with liabilities also. <br />Difference Market value and Book value<br /><br />
  10. 10. For these reasons the book value of equity is an inaccurate assessment of the actual value of the firm’s equity. <br />The market value of stock does not depend on the historical cost of the company’s assets.<br />Instead it depends on what investors expect those assets to produce in the future.<br />Market value and Book value contd<br /><br />
  11. 11. This is not surprising that it will differ substantially from the amount investors are willing to pay for the equity. <br />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. <br />Market value and Book value contd<br /><br />
  12. 12. A great deal of useful of information from a firm’s balance sheet can be obtained. <br />These include Market to Book Ratio, Debt- Equity Ratio, Enterprise Value, etc.<br />Balance Sheet Analysis<br /><br />
  13. 13. The Income Statement is a list of the company’s revenues and expenses over a period of time. <br />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. <br />The income statement is sometimes called a profit and loss statement and the net income is referred to as the company’s earnings. <br />Income Statement<br /><br />
  14. 14. The income statement provides a measure of the company’s profit over a given time period. <br />However, it does not indicate the amount of cash the firm earned. <br />There are two reasons that net income does not correspond to cash earned.<br />Statement of Cash Flows<br /><br />
  15. 15. First, there are non-cash entries on the income statement, such as depreciation and amortization. <br />Second, certain uses of cash, such as the purchase of a building or expenditures on inventory, are not reported on the income statement. <br />Statement of Cash Flows<br /><br />
  16. 16. The company’s statement of cash flows utilizes the information from the income statement and balance sheet.<br />This information is used to determine how much cash the company has generated and how that cash has been allocated, during a set period. <br />Statement of Cash Flows<br /><br />
  17. 17. 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. <br />The statement is divided into three sections: operating activities, investment activities and financing activities. <br />Statement of Cash Flows<br /><br />
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