Chapter 13 … Analyzing Financial Statements
Basics of Analysis -- Transforming data into useful information for decision making.
Purpose of Analysis
To help users (both internal and external) make better business decisions. 1.
Internal users (managers, officers, internal auditors, consultants, budget officers, and market researchers) make the strategic and operating decisions of a company. 2.
External users (shareholders, lenders, directors, customers, suppliers, regulators, lawyers, brokers, and the press) rely on financial statement analysis to make decisions in pursuing their own goals. 3. The common goal of all users is to evaluate:
Past and current performance.
Current financial position.
Future performance and risk.
Building Blocks of Analysis
The four areas of inquiry or building blocks are:
Liquidity and efficiency—ability to meet short-term obligations and to efficiently generate revenues. 2.
Solvency—ability to generate future revenues and meet long-term obligations. 3.
Profitability—ability to provide financial rewards sufficient to attract and retain financing. 4.
Market Prospects—ability to generate positive market expectations.
Information for Analysis
Most users rely on general purpose financial statements that include: a.
Statement of changes in stockholders' equity (or statement of retained earnings) d.
Statement of cash flows
Notes related to the statements
Financial reporting—is the communication of financial information useful for making investment, credit, and other business decisions. Includes information from SCE 10-K or other filings, press releases, shareholders' meetings, forecasts, management letters, auditor's reports, and Webcasts.
Standards for Comparisons
Used to determine if analysis measures suggest good, bad, or average performance. Standards can include the following types of comparisons: 1.
Intracompany—based on prior performance and relationships between its financial items. 2.
Competitor—compared to one or more direct competitors (often best). 3.
Industry—published industry statistics (available from services like Dun & Bradstreet, Standard and Poor's, and Moody's). 4.
Guidelines (rules-of-thumb)—general standards developed from past experiences. E. Tools of Analysis – includes horizontal, vertical and ratio analysis.
Horizontal Analysis -- Tool to evaluate changes in financial statement data across time. This analysis utilizes:
Comparative Statements -- reports financial amounts for more than one period placed side by side in columns on a single statement. 1.
Computation of Dollar Changes and Percentage Changes—usually shown in line items. a.
Dollar change = Analysis period amount minus Base period amount. b. Percent change = Analysis period amount minus Base period amount divided by Base period amount times 100. Notes:
(1) When a negative amount appears in the base period and a positive amount in the analysis period (or vice versa)— a meaningful percentage change cannot be computed. (2) When there is no value in the base period—percentage change is not computable. (3) When an item has a value in the base period and zero in the next period—the decrease is 100 percent. 2.
Comparative balance sheets
Consist of balance sheet amounts from two or more balance sheet dates arranged side by side. b.
Usefulness is improved by showing each item’s dollar change and percent change to highlight large changes. 3.
Comparative income statements
Amounts for two or more period are placed side by side.
Additional columns are included for dollar and percent changes.
Trend Analysis -- used to reveal patterns in data across successive periods. Involves computing trend percents (or index number) as follows: 1.
Select a base period and assign each item in the base period a weight of 100%. 2.
Express financial numbers as a percent...
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