Lecture 8: Financial analysis part 1 Flashcards
What are the 3 different forms of financial statement analysis?
- Horizontal analysis (trend analysis)
- Vertical analysis
- Ratio analysis
What are the 5 key areas of financial analysis?
- Profitability
- Liquidity
- Efficiency
- Solvency
- Investors return
Why is financial analysis so important?
- Tells us about strengths and weaknesses of businesses
- Helps with investment decisions
- Help us look at the financial health of a business
What are the 2 fundamental assumptions before investing into an entity?
1) Buying shares on the stock market is much more than just investments on a piece of paper, you are investing in the business
2) Before investing you should study and understand the business.
Financial analysis for investment purposes - Key Considerations
- 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.
What are 4 different user groups?
- Investors
- Customers
- Employees
- Lenders
Investors (user group), motivations and information needs…
Motivations:
- Share price and potential growth
Information needs:
- ROI in relation to the risk being taken.
Customers (user group), motivations and information needs…
Motivations:
- How fair are the prices which are being charged
- Does the firm have an overreliance on one supplier.
Employees (user group), motivations
Is the company financially stable?
Lenders (user group), motivations and information needs…
Motivations:
- If the firm will be able to pay them.
Information needs:
- Look at the liquidity of the firm.
What is Horizontal analysis?
- 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.
What are the advantages of horizontal analysis?
- Relative changes over time can be easily identified.
- Financial and economic trends can be identified.
- Easily graphed
- Abnormalities can be easily identified.
What is the equation for percentage increase?
New - original/original X 100
Financial analysis key points:
- 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?
What are the disadvantages of horizontal analysis?
- Time consuming
- Which year should be the ‘base’ year?
- Making comparisons within a year is difficult.
What is vertical analysis?
- 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.
Vertical analysis calc:
Number/ revenue X 100
Number/ total assets X 100
What are the advantages of vertical analysis?
- Easily graphed
- Financial and economic trends can be identified
- Assists in the identification of risk.
What are the disadvantages of vertical analysis?
- Obscures absolute balances, which may be important.
- Differences may be due to real economic factors such as scale.
