WEEK 7
CHAPTER 15 - FINANCIAL ANALYSIS: THE BIG PICTURE
3
15.1 - Basics of financial statement analysis
Analysing financial statements involves evaluating a company’s:
● Liquidity
2 ○ Indicates the ability of the borrower to pay obligations when they
come due
○ Short-term creditors (e.g. banks) are primarily interested in liquidity
-> evaluates safety of a loan
● Profitability and solvency
1 ○ Indicate the company’s ability to survive over a long period of time
○ Long-term creditors (e.g. bondholders) consider such measures as
the amount of a debt in the company’s capital structure and its
ability to meet interest payments
○ Shareholders consider these to assess the likelihood of dividends and
the growth potential of their investment
Comparative analysis
. Intracompany basis -> comparisons within a company
○ Useful to detect changes in financial relationships and significant
trends
○ e.g. company’s current year’s cash amount with prior’s shows an
increase or decrease
. Industry averages -> comparisons with industry averages
○ Provide information about a company’s relative position within the
industry
○ Companies can compare their financial data with industry averages
complied by financial ratings organisations
. Intracompany basis -> comparisons with other companies
○ Provide insight into a company’s competitive position
Tools for analysis:
, (1) Horizontal (trend) analysis = evaluates a series of financial statement
data over a period of time
● Primarily used in intracompany comparisons
● Determines the increase or decrease that has taken place
● Expressed as an amount or %
-> complications:
● If an items has no value in a base year or preceding year but has a value
in the next year, it cannot be computed as a & change
● If a negative amount appears in base or preceding period and a positive
amounts exists in following year (or vice versa), no % change can be
computed
Horizontal analysis in different financial statements:
CHAPTER 15 - FINANCIAL ANALYSIS: THE BIG PICTURE
3
15.1 - Basics of financial statement analysis
Analysing financial statements involves evaluating a company’s:
● Liquidity
2 ○ Indicates the ability of the borrower to pay obligations when they
come due
○ Short-term creditors (e.g. banks) are primarily interested in liquidity
-> evaluates safety of a loan
● Profitability and solvency
1 ○ Indicate the company’s ability to survive over a long period of time
○ Long-term creditors (e.g. bondholders) consider such measures as
the amount of a debt in the company’s capital structure and its
ability to meet interest payments
○ Shareholders consider these to assess the likelihood of dividends and
the growth potential of their investment
Comparative analysis
. Intracompany basis -> comparisons within a company
○ Useful to detect changes in financial relationships and significant
trends
○ e.g. company’s current year’s cash amount with prior’s shows an
increase or decrease
. Industry averages -> comparisons with industry averages
○ Provide information about a company’s relative position within the
industry
○ Companies can compare their financial data with industry averages
complied by financial ratings organisations
. Intracompany basis -> comparisons with other companies
○ Provide insight into a company’s competitive position
Tools for analysis:
, (1) Horizontal (trend) analysis = evaluates a series of financial statement
data over a period of time
● Primarily used in intracompany comparisons
● Determines the increase or decrease that has taken place
● Expressed as an amount or %
-> complications:
● If an items has no value in a base year or preceding year but has a value
in the next year, it cannot be computed as a & change
● If a negative amount appears in base or preceding period and a positive
amounts exists in following year (or vice versa), no % change can be
computed
Horizontal analysis in different financial statements:
