Financial Statement Analysis
The information needs of various entity users in relation to financial statements vary. Some core groups include investors (RoI, profitability, solvency, risk), lenders (risk), employees (profitability, liquidity), audtors (trends, accounting policies), analysts, management (performance).
External information includes government publications (e.g., statistics), trade journals, etc and internal information includes the chairman's report, director's report, balance sheet, income statement, equity statement, cash flow statement, accounting policy, notes, auditor's report.
Financial statements need to be comparable over time and consistent in the measurement and display of transactions and events.
Trend analysis involves choosing a base year, assigning a value of 00 and calculating the relationship of other years to the base year. The choice of an appropriate base year is vital. If the base year is not typical subsequent analysis can be very misleading.
Common-size statement express all items in a financial statement as a percentage of one significant item (e.g., total assets in a balance sheet). It allows fro a fast review and detection of significant changes.
When conducting ratin analysis consider relative size of entities, comparison to industry norms, geographical location of the entity and similar accounting policies and periods.
Accounting ratios are comparisons between quantity A and quantity B: R = A / B or A = R * B or R:1
Accounting ratios that assess profitability include return on assets, return on ordinary shareholder's equity, net and gross profit margins, asset turnover and earnings per share.
Efficiency ratios include inventory and debtor turnover ratios, and the total asset turnover.
Ratios that assess short-term solvency include the current ratio, the quick ratio and the cash flow from operating activites as a percentage of current liabilities.
The ratios tha address long-term solvency include the debt to equity ratio, debt to total assets, leverage and interest coverage ratio and the cash flow from operating activities as a percentage of total liabilities.
The Efficient Market Hypothesis suggests that share prices accurately reflect publically available information.