Financial Statement Analysis

Chapter 5How to Conduct a Financial Statement Analysis

Learning objectives

• Identify the appropriate steps to conduct a financial statement analysis.
• Identify the importance of time series and industry comparisons.
• Recognize the various sources of industry data.

Introduction

The purpose of this section is to provide general guidance on how to conduct a financial statement analysis and to discuss the importance of both time series and industry comparisons as critical components of that analysis. The success of that analysis is also dependent on the analyst’s awareness of the various sources of industry data as well as the problems inherent in the use of that data.

How to conduct an analysis of financial statements

• Determine what problems exist by comparing the company’s effect ratios to similar ratios for the company’s industry and to the same ratios for previous years.
• Take a cursory look at the causal ratios, comparing them to previous years and to industry averages.
• Determine which of the causal ratios are at fault by looking back at the balance sheet and income statement. Remember, the causal ratios can affect each other, so try to determine which one(s) is (are) at fault.
• Take corrective action by attacking the cause of the problem, not the symptom.

Industry and time series analysis

There are two ways to compare ratios. The first is an industry comparison. Different industries behave differently and have different financial characteristics. To compare a ratio ...