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FIN500 Mod 2p3 Basics of Financial Statement Analysis

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♪ Music playing in background ♪ Hi there! Welcome to the module on financial statement analysis. In this module we are going to cover the following topics: introduction to financial statement analysis, need for financial analysis, and we'll also look at some of the popular techniques of financial statement analysis. ♪ Music playing in background with text "Part 1" ♪ Financial statements provide a great deal of information to their users however to enable these users to make informed decisions statements on their own do not always provide sufficient information. For the financial statements to become more meaningful and useful to the users (both internal and external) the financial performance of a business has to be. evaluated not just for one year but across time periods and also in the context of the policies and accounting assumptions adopted by the business; such an attempt to get a better understanding of the present and expected future financial health of a company, is called financial statement analysis, or simply financial analysis. Financial statement analysis firstly dates comparison of financial data don't across the US, across companies in the same industry, and provides information to support informed decision making by the users. So financial statement analysis is essential for the following two reasons: first it helps diagnose profitability and financial soundness of a business. That is a financial statements help users assess liability, stability, and profitability of a firm. The second reason is that financial statement analysis helps users reliably forecast future performance of a business. ♪ Music playing in background with text "Check Your Understanding" ♪ [Question text: Policies adopted and the assumptions made to get a better understanding of the present and expected future financial health of a company is called_____________.] [Answer options: a. financial statement analysis b. financial policy analysis c. financial health analysis] ♪Beep♪ Answer a: financial statement analysis is highlighted. ♪ Music playing in background with text "Need for Financial Analysis" ♪ Financial analysis is usually done to diagnose or assess the following parameters of a company. First profitability of a company, that is the ability of a company to earn income and sustain the growth both in the long term and short term perspective. Second solvency, that is the ability of the company to pay obligations to creditors and third parties both in the short term and long term. Third liquidity, that is the ability of the company to maintain positive cash flows while meeting immediate obligations, or paying off immediate obligations. Fourth, stability, that is the ability to remain in business in the long run without having to sustain significant losses in the day to day operations. With the help of financial analysis investors can evaluate the financial condition or performance of the company. The CEO can decide what the immediate priorities for the future need to be. Managers working in the company can monitor whether the results achieved are in line with the budget. And market analysts can detect potential threats to the business. ♪ Music playing in background with text "Check Your Understanding" ♪ [Question text: The ability of a company to maintain positive cash flow while meeting immediate obligations is called_____________.] [Answer options: a. profitability b. solvency c. liquidity d. stability] ♪Beep♪ Answer c: liquidity is highlighted. ♪ Music playing in background with text "Techniques of Financial Analysis" ♪ So what are some other popular techniques used by companies to analyze financial statements? There are several popular techniques adopted, some of them are listed in your screen: horizontal analysis, also known as comparative statements, trend analysis, vertical analysis, ratio analysis, fund flow analysis, and cash flow analysis. Now in this module we will cover the first four techniques; fund flow and cash flow analysis will be discussed in the subsequent modules. So the first technique for analyzing financial statements is what is known as horizontal analysis. This is also popularly known as comparative statement analysis. In this technique two or more financial statements are placed side by side to facilitate comparison. Both profit and loss account and balance sheet can be prepared in the form of competitive financial statements. Now the comparative profit and loss statement on your screen shows the profit and loss account for a hypothetical company for two years: that is 2000 and 2001. The absolute increase or decrease and amounts of all the line items in the P&L account are shown. You can see that the sales has increased by two hundred rupees in 2001 compared to sales of 2000. The operating profit has also increased by 40 rupees in the year 2001 compared to the operating profit of the year 2000. The last column in the statement shows the percentage increase in line items of 2001 compared to profit and loss account in year 2000. So by looking at this comparative profit and loss statement we can conclude the following: first, sales and cost of goods sold have increased by the same percentage, so gross profit is also increased by the same percentage point. Second, there is no increase in administrative expenses, but selling expenses increased by 33% or 1/3. Operating profit has increased by 26.57% in the last two years. The CEO has to now check if the increased sales and operating profit is in line with the expectations of the investors. The increase of 1/3 in selling expenses also needs to be verified, and additional controls need to be put in place by the CEO or the top management, if these are much more than what had been originally planned for. The competitive balance sheet for the asset side of this hypothetical company is also shown on your screen. Similar to profit and loss account the balance sheet also contains the net increase or decrease in all line items in the balance sheet along with the percentage increase or decrease. We can see that there has been a huge increase in on current assets of the company but fixed assets except furniture have not increased, or have increased only marginally. The accountant should now highlight excess increase in debtors and stock to the top management, and asses whether this increase is again in line with the growth strategy of the company. Moving onto the second technique of financial statement analysis trend analysis. Trend analysis involves making a competitive study of financial statements over several years. The trend percentages are calculated in relation to a base year. All line items are projected in comparison to that base year by assuming each line item as 100. Trends are usually only tracked for the major and critical items in the financial statements, so that the important changes are highlighted to the top management. Now while using trend analysis the following points should be noted: accounting policies should have been consistently followed for the period being analyzed. If accounting policies change remember compatibility will be affected. There has to be a careful selection of base year. Trend analysis should also include comparison with absolute amounts, as increase in certain amounts might sometimes be misleading. For example - an expense might increase from 10 rupees to 30 rupees and show a 200% increase, but this amount is not significant enough to warrant an analysis. Let us now look at the trend analysis of an IT company. The absolute amounts are mentioned on the top half of the table, and the trend ratios in the rows below. As you can see in 2006-2007 all the amounts have been taken as hundreds so 2006-2007 is considered as the base year for calculating their trend ratios. You might notice that the revenue has almost doubled in the four years right? And the operating profit has also more than doubled. So clearly this company has excelled not only in increasing the sales but also in managing the operations efficiently to ensure that the profit increases in line with the increase in revenue. The third technique of financial statement analysis is what is known as vertical analysis, or common size financial statements. In this technique financial information is converted into percentages using some common base. In the profit and loss account the sales figure is assumed to be the common base and all figures are expressed as a percentage of this total. In the balance sheet the balance sheet totals are assumed to be the common base and all assets and liabilities of the company are expressed as a percentage of this amount. Since this analysis depends on the data for just one period this is conducive for a thorough analysis of a company's financial position. However, this technique does not show variations in financial items across time periods or across several years. One of the advantages to vertical analysis is that it is useful for studying comparative financial position of 2 or more businesses operating in the same industry. However, for the inter company comparison to be meaningful company's should follow the same accounting practices and policies. What you see on your screen is the profit and loss account of a company for 2 years. Vertical analysis will highlight the following points: sales has been considered as the base and all other items have been computed as a percentage of sales. Cost of goods sold for this company is approximately 75% of the total sales for the year. Administration expenses as a percentage of sales have decreased in year 2 compared to year 1; while selling expenses as a percentage of sales have increased marginally, leading to increase in operating profit percentage in year two compared to year 1. ♪ Music playing in background with text "Summary: Financial Statement Analysis" ♪ [Text: You have completed this video. You should be able to: * Explain financial statement analysis * Discuss the need for financial analysis * State popular techniques of financial statement analysis] ♪ Music playing in background with text "Thank You" ♪

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Duration: 12 minutes and 5 seconds
Country: Andorra
Language: English
License: Dotsub - Standard License
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Views: 11
Posted by: christineward on Feb 29, 2016

Basics of Financial Statement Analysis

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