Financial

Statement
Analysis

K R Subramanyam
John J Wild

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
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Overview of Financial
Statement Analysis

1
CHAPTER
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Business Analysis

Evaluate Prospects Evaluate Risks

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Information Sources for Business

Analysis
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New Trend in Corporate Reports

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Credit Analysis
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Credit Analysis
Credit worthiness: Ability to honor credit obligations
(downside risk)

Liquidity Solvency
Ability to meet short- Ability to meet long-
term obligations term obligations
Focus: Focus:
• Current cash flows • Long-term profitability
• Make up of current • Capital structure
assets and liabilities
• Liquidity of assets
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Equity Analysis
Assessment of downside risk and upside potential

Technical analysis / Fundamental Analysis

Charting Determine Intrinsic value without
• Patterns in price or reference to price e.g Discounted
value
volume history of a
• Analyze and interpret key factors
stock
– Economy
• Predict future price – Industry
movements – Company
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Accounting Analysis

Process to evaluate and adjust financial

statements to better reflect economic reality

Accounting
Risk
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Financial Analysis

Process to evaluate financial position and

performance using financial statements

Profitability analysis — Evaluate return

on investments Common tools

Risk analysis ——— Evaluate riskiness

& creditworthiness Cash
Ratio
flow
analysis
analysis
Analysis of — Evaluate source &
cash flows deployment of funds
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Prospective Analysis
Process to forecast future payoffs

Business Environment
& Strategy Analysis

Accounting Analysis

Financial Analysis

Intrinsic Value
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Dynamics of Business Activities

Business Activities Time
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Business Activities

Financing activities
• Owner (equity)
• Nonowner (liabilities)
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Business Activities

Investing activities
• Buying resources
• Selling resources

Investing = Financing
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Business Activities

Operating Activities
Revenues and expenses from providing
goods and services
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Financial Statements Reflect Business Activities

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Financial Statements
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Statement of Financial Position

Total Investing = Total Financing

= Creditor Financing + Owner Financing
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Income Statement
Revenues – Cost of goods sold = Gross Profit
Gross profit – Operating expenses = Operating Profit

Colgate’s Profitability
(in $billions)

$12.238 - $5.536 = $6.701 Gross Profit

$6.701 - $4.5411 = $2.160 Operating profit
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Statement of Cash Flows

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Additional Information
(Beyond Financial Statements)
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Analysis Preview

Comparative Analysis

Purpose: Evaluation of consecutive financial

statements
Output: Direction, speed, & extent of any
trend(s)
Types:  Year-to-year Change Analysis
 Ratio-Number Trend Analysis
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Analysis Preview
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Analysis Preview
Common-Size Analysis

Purpose :  Evaluation of internal makeup

of financial statements
 Evaluation of financial statement
accounts across companies
Output: Proportionate size of assets,
liabilities, equity, revenues, &
expenses
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Analysis Preview
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Analysis Preview
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Analysis Preview
Ratio Analysis
Purpose : Evaluate relation between two or
more economically important items
(one starting point for further analysis)
Output: Mathematical expression of relation
between two or more items
Cautions:  Prior Accounting analysis is important
 Interpretation is key - long vs short term
& benchmarking
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Analysis Preview
Valuation
Valuation - an important goal of many types
of business analysis

Purpose: Estimate intrinsic value of a

company (or stock)
Basis: Present value theory (time value of
money)
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