A describe tools and techniques used in financial analysis, including their uses and limitations;

Question 1

Ratio Analysis (ratios express relationships among data to derive and communicate the values of companies and securities)(A ratio tells WHAT happened, not WHY. Therefore, it is an INDICATOR not an answer)

Answer 1

relationships among data facilitate analysis, internally to evaluate changes in the firm and industry over time and against competitors Used in earnings and CF forecasts To evaluate whether a firm is ‘flexible’ enough to grow its operations and meet unexpected obligations. To ensure a top performing management …But ratios are only Informative in comparison (comparable firms or own historical performance), not isolation. Varied accounting treatments complicate intra-company comparison (esp. US to foreign) or when a firm varies it’s operating sectors across multiple geographies. All ratios and their conclusions are held in relative view Target or comparison values require a range of acceptable values (contains an element of subjectivity) *Understand ‘consistency’ as some analysts define ratios differently, and know that reasonable values of ratios can differ among industries. Conclusions cannot be made from viewing one set of ratios as all ratios must be viewed relative to one another in order to make meaningful conclusions. It can be difficult to find comparable industry ratios, especially when analyzing companies that operate in multiple industries. still… There is not a great deal of subjectivity involved in calculating ratios. The mechanical formulas for the calculations are fairly standard and objective for the activity, liquidity, solvency, and profitability ratios

ratios reduce the effect of size (thus rendering economies of scale as meaningless in ratio analysis, where econs of scale usually would employ the likes of absolute terms), which enhances comparisons between companies and over time.

Question 2

Common Size Financial Statements (ex) (vertical)

Answer 2

A quicker and easier comparative view of ratios and trends in costs and profit margins allows easier comparison of performance across firms (cross sectional analysis: Comparing a company’s ratios with those of its competitors) and for a single firm over time (time series analysis) Normalize a BS, BS Line Item / Total Assets Normalize an IS, IS line item / % of Sales

Question 3

Charts (visual performance presentation in comparison and over time)

Answer 3

Bar: Changes in items from year to year Line: Lines

Question 4

General logical stuff

Answer 4

Evaluation of company data requires comparisons in order to clarify the basis of performance as ‘good’,’bad’,’neutral’ *Draw comparisons to other companys and over time *Ratios and common size can remove size as a factor and enable a more relecant comparison Trailing 12 month data achieves comparability for differences in fiscal year ends Accounting standards can limit comparability, too

Question 5

Tools and Techniques used to convert financial statement data into formats that facilitate analysis

Answer 5

Ratio analysis Common-size analysis Graphical Analysis Regression Analysis - Used to identify relationships between variables and often used for forecasting

Question 6

Horizontal common-size balance sheet or income statement (displays apparent trends in growth and value)

Answer 6

Useful to analyze trends over time. Divisor is the base year (usually the first year), thus standardized to 1.0 Each line item is divided by its base year value

Question 7

Prior to beginning any financial analysis, the analyst should clarify the purpose and context, and clearly understand the following:

Answer 7

■ What is the purpose of the analysis? What questions will this analysis answer? ■ What level of detail will be needed to accomplish this purpose? ■ What data are available for the analysis? ■ What are the factors or relationships that will influence the analysis?

■ What are the analytical limitations, and will these limitations potentially impair the analysis?

Having clarified the purpose and context of the analysis, the analyst can select the set of techniques (e.g., ratios) that will best assist in making a decision.