Financial+analysis.docx

Financial+analysis.docx

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Financial+analysis

Financialanalysis（alsoreferredtoasfinancialstatementanalysisoraccountinganalysis）referstoanassessmentoftheviability,stabilityandprofitabilityofabusiness,sub-businessorproject.

Itisperformedbyprofessionalswhopreparereportsusingratiosthatmakeuseofinformationtakenfromfinancialstatementsandotherreports.Thesereportsareusuallypresentedtotopmanagementasoneoftheirbasesinmakingbusinessdecisions.Basedonthesereports,managementmay:

●Continueordiscontinueitsmainoperationorpartofitsbusiness;

●Makeorpurchasecertainmaterialsinthemanufactureofitsproduct;

●Acquireorrent/leasecertainmachineriesandequipmentintheproductionofitsgoods;

●Issuestocksornegotiateforabankloantoincreaseitsworkingcapital;

●Makedecisionsregardinginvestingorlendingcapital;

●Otherdecisionsthatallowmanagementtomakeaninformedselectiononvariousalternativesintheconductofitsbusiness.

Goals

Financialanalystsoftenassessthefirm's:

1.Profitability-itsabilitytoearnincomeandsustaingrowthinbothshort-termandlong-term.Acompany'sdegreeofprofitabilityisusuallybasedontheincomestatement,whichreportsonthecompany'sresultsofoperations;

2.Solvency-itsabilitytopayitsobligationtocreditorsandotherthirdpartiesinthelong-term;

3.Liquidity-itsabilitytomaintainpositivecashflow,whilesatisfyingimmediateobligations;

Both2and3arebasedonthecompany'sbalancesheet,whichindicatesthefinancialconditionofabusinessasofagivenpointintime.

4.Stability-thefirm'sabilitytoremaininbusinessinthelongrun,withouthavingtosustainsignificantlossesintheconductofitsbusiness.Assessingacompany'sstabilityrequirestheuseofboththeincomestatementandthebalancesheet,aswellasotherfinancialandnon-financialindicators.

Methods

Financialanalystsoftencomparefinancialratios（ofsolvency,profitability,growth,etc.）:

PastPerformance-Acrosshistoricaltimeperiodsforthesamefirm（thelast5yearsforexample）,

FuturePerformance-Usinghistoricalfiguresandcertainmathematicalandstatisticaltechniques,includingpresentandfuturevalues,Thisextrapolationmethodisthemainsourceoferrorsinfinancialanalysisaspaststatisticscanbepoorpredictorsoffutureprospects.

ComparativePerformance-Comparisonbetweensimilarfirms.

Theseratiosarecalculatedbydividinga（groupof）accountbalance（s）,takenfromthebalancesheetand/ortheincomestatement,byanother,forexample:

n/equity=returnonequity

Netincome/totalassets=returnonassets

Stockprice/earningspershare=P/E-ratio

Comparingfinancialratiosismerelyonewayofconductingfinancialanalysis.Financialratiosfaceseveraltheoreticalchallenges:

●Theysaylittleaboutthefirm'sprospectsinanabsolutesense.Theirinsightsaboutrelativeperformancerequireareferencepointfromothertimeperiodsorsimilarfirms.

●Oneratioholdslittlemeaning.Asindicators,ratioscanbelogicallyinterpretedinatleasttwoways.Onecanpartiallyovercomethisproblembycombiningseveralrelatedratiostopaintamorecomprehensivepictureofthefirm'sperformance.

●Seasonalfactorsmaypreventyear-endvaluesfrombeingrepresentative.Aratio'svaluesmaybedistortedasaccountbalanceschangefromthebeginningtotheendofanaccountingperiod.Useaveragevaluesforsuchaccountswheneverpossible.

●Financialratiosarenomoreobjectivethantheaccountingmethodsemployed.Changesinaccountingpoliciesorchoicescanyielddrasticallydifferentratiovalues.

●Theyfailtoaccountforexogenousfactorslikeinvestorbehaviorthatarenotbaseduponeconomicfundamentalsofthefirmorthegeneraleconomy（fundamentalanalysis）.

Financialanalystscanalsousepercentageanalysiswhichinvolvesreducingaseriesoffiguresasapercentageofsomebaseamount.Forexample,agroupofitemscanbeexpressedasapercentageofnetincome.Whenproportionatechangesinthesamefigureoveragiventimeperiodexpressedasapercentageisknowashorizontalanalysis.Verticalorcommon-sizeanalysis,reducesallitemsonastatementtoa“commonsize”asapercentageofsomebasevaluewhichassistsincomparabilitywithothercompaniesofdifferentsizes.

Anothermethodiscomparativeanalysis.Thisprovidesabetterwaytodeterminetrends.Comparativeanalysispresentsthesameinformationfortwoormoretimeperiodsandispresentedside-by-sidetoallowforeasyanalysis.

Balancesheet

Infinancialaccounting,abalancesheetorstatementoffinancialpositionisasummaryofthefinancialbalancesofasoleproprietorship,abusinesspartnershiporacompany.Assets,liabilitiesandownershipequityarelistedasofaspecificdate,suchastheendofitsfinancialyear.Abalancesheetisoftendescribedasa"snapshotofacompany'sfinancialcondition".Ofthefourbasicfinancialstatements,thebalancesheetistheonlystatementwhichappliestoasinglepointintime.

Astandardcompanybalancesheethasthreeparts:

assets,liabilitiesandownershipequity.Themaincategoriesofassetsareusuallylistedfirst,andtypicallyinorderofliquidity.Assetsarefollowedbytheliabilities.Thedifferencebetweentheassetsandtheliabilitiesisknownasequityorthenetassetsorthenetworthorcapitalofthecompanyandaccordingtotheaccountingequation,networthmustequalassetsminusliabilities.

Anotherwaytolookatthesameequationisthatassetsequalsliabilitiesplusowner'sequity.Lookingattheequationinthiswayshowshowassetswerefinanced:

eitherbyborrowingmoney（liability）orbyusingtheowner'smoney（owner'sequity）.Balancesheetsareusuallypresentedwithassetsinonesectionandliabilitiesandnetworthintheothersectionwiththetwosections"balancing."

Recordsofthevaluesofeachaccountorlineinthebalancesheetareusuallymaintainedusingasystemofaccountingknownasthedouble-entrybookkeepingsystem.

Abusinessoperatingentirelyincashcanmeasureitsprofitsbywithdrawingtheentirebankbalanceattheendoftheperiod,plusanycashinhand.However,manybusinessesarenotpaidimmediately;theybuildupinventoriesofgoodsandtheyacquirebuildingsandequipment.Inotherwords:

businesseshaveassetsandsotheycannot,eveniftheywantto,immediatelyturntheseintocashattheendofeachperiod.Often,thesebusinessesowemoneytosuppliersandtotaxauthorities,andtheproprietorsdonotwithdrawalltheiroriginalcapitalandprofitsattheendofeachperiod.Inotherwordsbusinessesalsohaveliabilities.

Incomestatement

Incomestatement,alsoreferredasprofitandlossstatement（P&L）,earningsstatement,operatingstatementorstatementofoperations,isacompany'sfinancialstatementthatindicateshowtherevenue（moneyreceivedfromthesaleofproductsandservicesbeforeexpensesaretakenout,alsoknownasthe"topline"）istransformedintothenetincome（theresultafterallrevenuesandexpenseshavebeenaccountedfor,alsoknownasthe"bottomline"）.Itdisplaystherevenuesrecognizedforaspecificperiod,andthecostandexpenseschargedagainsttheserevenues,includingwrite-offs（e.g.,depreciationandamortizationofvariousassets）andtaxes.Thepurposeoftheincomestatementistoshowmanagersandinvestorswhetherthecompanymadeorlostmoneyduringtheperiodbeingreported.

Theimportantthingtorememberaboutanincomestatementisthatitrepresentsaperiodoftime.Thiscontrastswiththebalancesheet,whichrepresentsasinglemomentintime.

Charitableorganizationsthatarerequiredtopublishfinancialstatementsdonotproduceanincomestatement.Instead,theyproduceasimilarstatementthatreflectsfundingsourcescomparedagainstprogramexpenses,administrativecosts,andotheroperatingcommitments.Thisstatementiscommonlyreferredtoasthestatementofactivities.Revenuesandexpensesarefurthercategorizedinthestatementofactivitiesbythedonorrestrictionsonthefundsreceivedandexpended.

Theincomestatementcanbepreparedinoneoftwomethods.TheSingleStepincomestatementtakesasimplerapproach,totalingrevenuesandsubtractingexpensestofindthebottomline.ThemorecomplexMulti-Stepincomestatement（asthenameimplies）takesseveralstepstofindthebottomline,startingwiththegrossprofit.Itthencalculatesoperatingexpensesand,whendeductedfromthegrossprofit,yieldsincomefromoperations.Addingtoincomefromoperationsisthedifferenceofotherrevenuesandotherexpenses.Whencombinedwithincomefromoperations,thisyieldsincomebeforetaxes.Thefinalstepistodeducttaxes,whichfinallyproducesthenetincomefortheperiodmeasured.

Usefulnessandlimitationsofincomestatement

Incomestatementsshouldhelpinvestorsandcreditorsdeterminethepastfinancialperformanceoftheenterprise,predictfutureperformance,andassessthecapabilityofgeneratingfuturecashflowsthroughreportoftheincomeandexpenses.

However,informationofanincomestatementhasseverallimitations:

Itemsthatmightberelevantbutcannotbereliablymeasuredarenotreported（e.g.brandrecognitionandloyalty）.

Somenumbersdependonaccountingmethodsused（e.g.usingFIFOorLIFOaccountingtomeasureinventorylevel）.

Somenumbersdependonjudgmentsandestimates（e.g.depreciationexpensedependsonestimatedusefullifeandsalvagevalue）.

Itemsonincomestatement

Operatingsection

●Revenue-Cashinflowsorotherenhancementsofassetsofanentityduringaperiodfromdeliveringorproducinggoods,renderingservices,or