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Financial Valuation: Applications and Models, + Website, 3rd Edition by James R. Hitchner

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Chapter 4

Financial Statement and Company Risk Analysis

The power of the Internet dramatically enhanced our ability to obtain, harness, and disseminate information. Information that was once privately owned or perhaps available only to experts is now widely accessible, almost instantaneously. The availability and accessibility of all this data provides the analyst with an expanded tool set by which to gain a deeper insight into the strengths, weaknesses, opportunities, and threats of a given company or industry.

Due to the enormously expanded amount of data available, analysts must go beyond simply measuring the economic income of a given enterprise. Analysts also must attempt to determine what factors give rise to the ability (or inability) of the enterprise to generate required returns for the foreseeable future; that is, they must make in-depth enterprise risk assessments. Consequently, a well-reasoned valuation analysis includes certain critical elements:

  • An estimation of the amount of future economic benefits (normalization and projection of future cash flows)
  • An assessment of the probability or risk that the projected future economic benefits will be realized and will be sustainable over the long run

This chapter (also see Chapter 5) discusses the methods generally used to evaluate a business in this way. It also focuses on the mechanics of the process of financial statement analysis, generally considered to be five steps:

1. Spreading historical financial statements ...

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