Fundamental Principles of Financial Analysis

Good Analysis = Due Diligence?

Until the headlines at the turn of this century surrounding Enron, WorldCom, Health South, Tyco, and Waste Management, followed by Adelphia Communications, AOL Time Warner, Parmalat, and many others, it is unclear what the general public knew about analysis of financial information. Specifically, what did the non-expert know about analysis and deduction when it came to financial results and information, and how to interpret it?

Now that we have a basic understanding of financial fraud, how it occurs, who commits it, and some of the underlying principles of accounting and entities involved, we need to consider how a nonexpert can undertake financial analysis and understand what it all means.

Financial analysis can be conducted as part of due diligence before a transaction occurs, and as part of an investigation after a fraud has occurred or is believed to have occurred. Typically, the sheer volume of transactions within a business will prohibit the ability to examine each and every piece of paper and underlying transaction. Financial analysis therefore may be needed to first identify and then focus on the problem areas, to perform due diligence before a transaction is consummated, or to determine specifically what areas to investigate in a fraud situation. It is the latter that is the focus of this book and therefore the focus of this chapter.

If a party suffers a loss, largely due to the lack ...

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