Lecture 8: Financial analysis part 1

Question 1

What are the 3 different forms of financial statement analysis?

Answer 1

• Horizontal analysis (trend analysis)
• Vertical analysis
• Ratio analysis

Question 2

What are the 5 key areas of financial analysis?

Answer 2

• Profitability
• Liquidity
• Efficiency
• Solvency
• Investors return

Question 3

Why is financial analysis so important?

Answer 3

• Tells us about strengths and weaknesses of businesses
• Helps with investment decisions
• Help us look at the financial health of a business

Question 4

What are the 2 fundamental assumptions before investing into an entity?

Answer 4

1) Buying shares o the stock market is much more than just investments o a piece of paper, you are investing in the business

2) Before investing you should study and understand the business.

Question 5

Financial analysis for investment purposes - Key Considerations

Answer 5

• Objectives and business strategy of the organisation.
• Knowledge of the product/service being sold.
• Your level of trust in the senior management team and their vision
• PESTLE
• Firms’ reputation.

Question 6

What are 4 different user groups?

Answer 6

• Investors
• Customers
• Employees
• Lenders

Question 7

Investors (user group), motivations and information needs…

Answer 7

Motivations:
- Share price and potential growth

Information needs:
- ROI in relation to the risk being taken.

Question 8

Customers (user group), motivations and information needs…

Answer 8

Motivations:
- How fair are the prices which are being charged
- Does the firm have an overreliance on one supplier.

Question 9

Employees (user group), motivations

Answer 9

Is the company financially stable?

Question 10

Lenders (user group), motivations and information needs…

Answer 10

Motivations:
- If the firm will be able to pay them.

Information needs:
- Look at the liquidity of the firm.

Question 11

What is Horizontal analysis?

Answer 11

• Compares the data in financial statements line by line over several years.
• Year 1 provides the base figures, which are expressed as 100%.
• Subsequent years are expressed as a % of year 1’s figures.

Question 12

What are the advantages of horizontal analysis?

Answer 12

• Relative changes over time can be easily identified.
• Financial and economic trends can be identified.
• Easily graphed
• Abnormalities can be easily identified.

Question 13

What is the equation for percentage increase?

Answer 13

New - original/original X 100

Question 14

Financial analysis key points:

Answer 14

• Not just about calculations we can look at why the balance has moved, and how this then affects users economic decision making.
• How well has our performance been in comparison to other companies in the industry?

Question 15

What are the disadvantages of horizontal analysis?

Answer 15

• Time consuming
• Which year should be the ‘base’ year?
• Making comparisons within a year is difficult.

Question 16

What is vertical analysis?

Answer 16

• Compares figures within a year.

IMPORTANT AND I NEED TO KNOW:
- Everything in the statement of profit or loss is shown as a percentage of revenue.
- Everything in the statement of financial position is shown as a percentage of total assets.

• Revenue and total assets are the base figures, so they are the starting points so are expressed as 100%.
• Seeks patterns in the data on a year on year basis.

Question 17

Vertical analysis calc:

Answer 17

Number/ revenue X 100

Number/ total assets X 100

Question 18

What are the advantages of vertical analysis?

Answer 18

• Easily graphed
• Financial and economic trends can be identified
• Assists in the identification of risk.

Question 19

What are the disadvantages of vertical analysis?

Answer 19

• Obscures absolute balances, which may be important.
• Differences may be due to real economic factors such as scale.