Financial analysis is the process of evaluating financial and other information for decision-making. A six-step approach includes identifying the purpose, providing a corporate overview and industry analysis, applying financial analysis techniques, conducting a detailed accounting analysis, performing a comprehensive analysis, and making a decision or recommendation. Industry analysis considers factors like competition, barriers to entry, and buyer/supplier power. A company's business strategy, such as cost leadership or product differentiation, is also analyzed in the context of industry characteristics. Quantitative financial analysis systematically evaluates key elements like ratios, cash flows, and models to identify "red flags" requiring in-depth examination.

1. Chapter 1
What is Financial
Analysis?

2. Defining Financial Analysis
 Financial analysis is the process of
evaluating financial and other
information for decision-making.
 A six-step approach is suggested for
systematic financial analysis.

3. Six-step Process
 Identify purpose of financial analysis
 Corporate overview
 Financial analysis techniques
 Detailed accounting analysis
 Comprehensive analysis
 Decision or recommendation

4. Corporate Overview
 Industry analysis– key economic
characteristics, historical context,
profit drivers, business risks
 Firm’s business strategy–
competitive strategy given the
industry characteristics

5. Industry Analysis
 Competition– growth rates,
concentration ratios, degree of
product differentiation, economies of
scale (& relative fixed & variable
costs), substitute products
 Legal barriers– patent & copyrights,
licensing, regulation
 bargaining power of buyers (&
suppliers) & price sensitivity

6. Industry Analysis Criteria
 What is the industry?
 Relative size & significance
 Largest companies
 Geographic presence
 Business cycle effects
 Future potential

7. Business Strategy
 Cost leadership: low cost producer,
economies of scale, efficient
production, low input prices
 Product differentiation: specific
attributes that customers value (e.g.,
quality, variety, service, delivery
time), brand name
 Importance of core competencies

8. Business Strategy Criteria
 Historical perspective
 Primary focus of operations
 Most important strategy
 Major operating segments
 Corporate outlook/ forecast

9. Qualitative Analysis– Dell Computer
 Industry– high tech, competitive (e.g.,
Gateway, IBM, Apple, others), changing
products, high growth rates, low barriers of
entry
 Business strategy– (1) cost leadership
strategy: direct selling, made-to-order
manufacturing, early on the internet, low
receivables; (2) product differentiation?? [IBM
clones, Intel & Microsoft components]
 Economic slowdown– what is the impact
(PCs are durable goods)?

10. Quantitative Financial Analysis
 Systematic analysis of key elements
based on analysis context
 Ratios, cash flows, common-size,
time series, comparative (e.g.,
specific firms, industry, all firms),
models (e.g., DuPont, Altman’s)
 In-depth analysis for “red flag” items

11. Quantitative Financial Analysis
 Financial Statements
 Common-size Analysis
 Financial Ratios
 Growth/trend Analysis
 Quarterly analysis
 DuPont Model

12. Detailed Accounting Analysis
 Does accounting information capture
the underlying business reality?
 Identify areas of “accounting flexibility”
& evaluate accounting policies
(choices) & disclosures; e.g., MD&A
 Evaluate earnings management
potential
 Recast accounting numbers when
necessary

13. Comprehensive Analysis
 Summarize key points: what is
particularly important for decision
making?
 “Red flags” are particularly important
 Consider a written executive
summary
 Consider a rating scale, such as 1-10

14. Financial Analysis Decision
 Based on Elliott’s “value chain of
information”: this is the $1,000 per
hour stage
 The purpose of financial analysis is
to arrive at an informed
recommendation or decision

15. End of
Chapter 1
What is Financial
Analysis?