Finance: Capital Markets, Financial Management, and Investment Management

CHAPTER 3

Basics of Financial Analysis

Financial analysis involves the selection, evaluation, and interpretation of financial data and other pertinent information to assist in evaluating the operating performance and financial condition of a company. The information that is available for analysis includes economic, market, and financial information. But some of the most important financial data are provided by the company in its annual and quarterly financial statements.

The operating performance of a company is a measure of how well a company has used its resources to produce a return on its investment. The financial condition of a company is a measure of its ability to satisfy its obligations, such as the payment of interest on its debt in a timely manner. An investor has many tools available in the analysis of financial information. These tools include:

• Financial ratio analysis

• Cash flow analysis

• Quantitative analysis

Cash flows provide a way of transforming net income based on an accrual system to a more comparable basis. Additionally, cash flows are essential ingredients in valuation because the value of a company today is the present value of its expected future cash flows. Therefore, understanding past and current cash flows may help in forecasting future cash flows and, hence, determine the value of the company. Moreover, understanding cash flow allows the assessment of the ability of a firm to maintain current dividends and its current capital expenditure policy without ...