Strategy analysis enables the analyst to understand the underlying economics of the firm and the industry in which the firm competes. Involves 3 key steps:
What economic factors drive the industry choice? Impact on profitability? 2.Competitive strategy
How has the company positioned itself in the industry?
Can the company create value across the range of its business? (Ability to exploit synergies, minimisation of transaction costs,
There are a number of benefits to developing this knowledge before performing any financial statement analysis.
1.Strategy understanding provides a context for evaluating a firm’s choice of accounting policies and hence the information reflected in its financial statements (e.g. revenue recognition and cost capitalization policies)
2.Strategy analysis highlights the firm’s profit drivers and major areas of risk and provides an indication about whether these are likely to change (important for forecasting).
3.Strategy analysis makes it possible to understand a firm’s financial policies and whether they make sense.
In summary, understanding a firm’s business, the factors that are critical to the success of that business, and its key risks are critical to effective financial statement analysis.
2.Accounting analysis enables the analysts to ‘undo’ any accounting distortion by recasting a firm’s accounting numbers. Sound accounting analysis improves the reliability of conclusions from financial analysis.
3.Financial analysis seeks to use financial data to evaluate the performance of a firm. The outcome from financial analysis is incorporated into prospective analysis, the next step in financial statement analysis.
4.Prospective analysis synthesises the insights from business strategy analysis, accounting analysis, and financial analysis in order to make predictions about a firm’s future.
A2 Your brother,...