Chapter 8 went into detail on the analysis of financial statements, including th

Question

Chapter 8 went into detail on the analysis of financial statements, including the various pieces of information stakeholders look for in these statements. This assignment lets you fine-tune your knowledge of financial statements and their uses.

Address each of the following as completely as possible, using examples and citations when necessary.

1. Why are ratios useful? What three groups use ratios, and for what reasons?

2. What qualitative factors should analysts look for when evaluating a company’s likely future financial performance? Explain.

3. You are training a new financial analyst who lacks experience. What are the most critical steps of financial analysis? Why are these steps critical and what will you hope to find?

Please answer the questions as accurately as possible!

Explanation / Answer

1. Financial ratios along with financial statements give a deep insight into a company's performance. Financial ratios add further depth when we analyze or compare companies of varying sizes. For example, if one is contemplating to invest in a company and wants to study performance, that person may be misguided by the size of a company. This is where financial ratios help in bringing various companies to an even playing field and thus enable personnel in taking apt decisions. The main groups of ratios are

1. Liquidity ratios, which talk about a company's immediately available assets that can be used to solve short term debt issues

2. Profitability ratios, which talk about the efficiency of the company in earning profits which is the ulterior motive of any organization.

3. Solvency ratios, which talk about the business range in long term view. How a business can sustain using various financial elements.

2. Qualitative factors are those things which cannot be measured. Talking of such factors for financial analysis, they do play a huge role when bigger decisions are involved. A few such factors to be considered are

Industry concentration, Industry geographic dispersion, barriers of entry, firm size, Industry diversification.

But a few empirical researches have had a different opinion on firm size and diversification part, stating that they play no significant role in determining a company's financial performance.

3. For a novice in financial analysis, we can lay a set of steps which can be termed as most critical.

1. Collecting historical data that can be best utilized for analysis purpose, which can take into account various seasonal and other hidden effects into account. Ideally a 5 year data would do good.

2. Scrutinizing balance sheets for variations in assets and liabilities. A greater variation, either positive or negative, can signify instability.

3. Next step is scrutinizing income statements that will provide insights on trends.

4. Concentrating on equity, to see how the stocks are being held and what retained earnings is witnessed.

5. Cash flow statements to be analyzed for cash flow from operation, finance and investments.

6. This collected data, with use of appropriate ratios, should be compared with industry figures and competitor's figures.

These outlined 6 steps cover most important features in analyzing statements. Though they are not exhaustive in nature, this guide line would be a right starting point for someone relatively new to finance.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.