Applications of financial statement analysis Flashcards
What are the main components of analyzing a company’s past financial performance?
- Identify important changes that have occurred,
- Comparisons of the company’s financial ratios with others from the same industry and the reasons behind any differences.
- Examination of critical performance aspects for a company to successfully compete in the industry.
- The company’s business model and strategy and how they influence its operating performance.
What is the top-down approach, and what is its step?
It is typically used to forecast sales. The steps are:
- Attain forecasts for the economy’s expected GDP growth rate.
- Use regression models to determine the historical relationship between the economy’s growth rate and the industry’s growth rate.
- Undertake market share analysis to evaluate whether the firm being analyzed is expected to gain, lose, or retain market share over the forecasting horizon.
What are the 2 method to estimate income and CF? Describe them.
- Estimate gross or operating profit margins: apply these estimates over the forecasting horizon and apply them to revenue forecasts.
- Make separate forecasts for individual expense items: aggregate these forecast and subtract the total from sales to calculate NI.
What are the most important things to take into account when forecasting CF?
- Required increases in working capital.
- Capex on new fixed assets.
- Repayment and issuance of debt.
- Repurchase and issuance of stock (equity).
What is the credit risk?
It is the risk of loss from a counterparty of the debtor’s failure to make a promised payment.
What are the 4 C’s of credit analysis?
- Character: quality of management.
- Capacity: ability of the issuer to fulfill its obligations.
- Collateral: assets pledged to secure a loan.
- Covenants: limitations and restrictions on the activities of issuers.
What are the 4 general categories of items considered to evaluate the credit risk of a company? Describe them.
- Scale and diversification of the business: larger companies enjoy significant leverage in negotiations with suppliers and lenders.
- Operational efficiency: firms that earn a higher return on their assets and have better operating and EBITDA margins have lower credit risk.
- Stability and sustainability of profit margins: consistently high-profit margins indicate a higher probability of repayment and reflect low credit risk.
- Degree of financial leverage: comfortable levels of CF compared to interest payment requirements indicate that a firm is adequately cushioned and should be able to meet debt-servicing requirements comfortably.
What is screening?
It is the process of filtering a set of potential investments into a smaller set by applying a set of criteria.
What are the 2 types of security selection analysis? Describe them.
- Top-dow analysis: involves identifying attractive geographical and industry segments and then choosing the most attractive investments from them.
- Bottom-up analysis: involves selecting specific investments within a specific investment universe.
What are growth investors?
They invest in companies that are expected to see higher earnings growth in the future.
What are value investors?
- They try to pay a low price relative to a company’s net asset value or earning prowess.
- The use of screens involving financial ratios is most common among value investors.
What are market-oriented investors?
They are an intermediate group of investors who cannot be categorized as growth or value investors.
What are the factors that an analyst should bear in mind while screening a company?
- Inputs to ratios are derived from financial statements. The ratios can differ with respect to the set of standards they subscribe to, the specific accounting methods permitted within a particular set of standards, or the estimates used in applying a particular accounting method.
- Back-testing may not provide accurate predictions of future performance.
- Implementation decisions can dramatically influence returns.
What are the adjustments that the analyst should make to facilitate comparison?
- Adjustments related to investments
- Adjustments related to inventory
- Adjustments related to PP&E
- Adjustments related to goodwill
- Adjustments related to off-balance-sheet financing
