Analysis of Financial Statements, 3rd Edition

CHAPTER 4

Financial Analysis

Financial analysis is the selection, evaluation, and interpretation of financial data, along with other pertinent information, to assist in assessing the risk and return associated with an investment. Financial analysis may be used to evaluate the efficiency of operations, the effectiveness of credit policies, and the creditworthiness of a company, among other things.

The analyst draws the financial data needed in financial analysis from many sources. The primary source is the data provided by the company itself in its annual report and required disclosures. The annual report and the 10-K filing include the income statement, the balance sheet, and the statement of cash flows, as well as footnotes to these statements.

Besides information that companies are required to disclose through financial statements, other information is readily available for financial analysis. For example, information such as the market prices of securities of publicly traded corporations can be found in the financial press and the electronic media daily. Similarly, information on stock price indices for industries and for the market as a whole is available in the financial press.

Another source of information is economic data, such as the Gross Domestic Product (GDP) and Consumer Price Index (CPI), which may be useful in assessing the recent performance or future prospects of a company or industry. Suppose you are evaluating a company that owns a chain of retail outlets. What ...