Financial Statement Analysis: Applications

Analyst can apply  financial analysis tools and techniques to evaluate the past and future financial performance, assess credit risk, and screen potential equity investments.Important concepts such as assessing credit quality, and analyst adjustments to financial statements  in order to make them comparable with other companies’ reports form part of the applications of Financial Statement Analysis.

Analyst Adjustments

While performing financial analysis, an analyst will make several adjustments to the financial statements of a company in order to make them comparable with other companies. The adjustments are required due to the different accounting choices made by the firms and also due to the differences in accounting standards. Some of these adjustments are listed […]

Screening Equity Investments

Analysts also use financial statement analysis to screen equity investments. For example, in a mutual fund, the portfolio manager is required to pick stocks for its portfolio from thousands of stocks. Depending on the objective of the fund, such as growth fund, value fund, or balanced fund, the portfolio manager will screen stocks using various […]

Credit Ratings

Rating agencies such as Standards and Poor’s, and Moody’s study the companies and issue credit ratings to companies as well as specific debt issues. To arrive at these ratings, the rating agencies employ formulas that are based on financial numbers, ratios, and business characteristics. The items used in these formulas can be broadly classified into […]

Assessing the Credit Quality

An investor will generally analyse a company for an equity investment or a potential debt investment. With respect to debt investment, the investor is interested in assessing the credit quality, i.e., the ability of the company to meet its interest and principal repayments on schedule. The investor would be interested in positive future cash flows. […]

Projecting a Firm’s Financial Performance

Along with analyzing past performance, an analyst will also project a firm’s future income and cash flows. A simple model to project a firm’s future performance starts with the forecast of GDP growth and forecasts the firm’s net income as follows: Forecast expected GDP growth rate. The analyst can use the GDP growth forecast supplied […]

Evaluating a Company’s Past Financial Performance

One of the key reasons an analyst looks at the financial statements of a business is to evaluate the past financial performance of a company. In the previous readings we learned a number of financial ratios including profitability, liquidity, solvency, and leverage ratios. An analyst will be interested in understanding how these ratios have changed […]

Defined Benefit Plans & the Company Balance Sheet

A Net Asset or a Net Liability Exists (unless DBO value = value of Plan Assets) DBO End of Period Recall that the defined benefit obligation represents the present value of company retirement compensation promises for vested and un-vested employees, with assumptions for future salary increases (GAAP term is projected benefit obligation).   For accounting purposes, […]

Pension Expense (both GAAP & IFRS) for the Income Statement

Pension Expense = Increase in the DBO/PBO during the accounting period. Five Components of Company Pension Expense Current Service Cost = Amount by which a company’s defined benefit obligation increases as a result of employee service during the accounting period.  The current service cost is fully and immediately recognized for the accounting period. Interest Cost (same as the […]

Defined Benefits Plans vs. Defined Contribution Plans

Company provision of employee retirement (or post-employment) benefits often takes one of two forms: Defined contribution (DC) plans Defined benefits (DB) plans Defined Contribution (DC) Plans DC plans outline the periodic amounts than a retirement plan sponsor (the employing company) contributes to the retirement plan and how those contributions are provided to employees. DC Plan […]