Financial Analysis Flashcards
(45 cards)
What is the primary aim of financial analysis (Ch 11)?
To examine financial statements to form an opinion about the value a business has created and its prospects for creating value in the future.
What two key aspects must always be considered when analysing a business?
Expected return (future value creation) and risk (likelihood of achieving that return).
What is a business’s risk-return profile?
A combination of expected return and the risk associated with achieving that return.
What are the three stages of financial analysis in Ch 11?
-Learn about the business’s operating context
-Understand the main story from financial statements
-Conduct ratio analysis for depth
What is the purpose of Stage 1: Learning about the business’s operating context?
To build foundational knowledge by carefully reading and understanding the financial statements.
What key questions are asked in Stage 2: Understanding the main story?
-What assets has the business invested in?
-How much revenue did the assets produce?
-How much profit was earned?
-How much profit was converted into operating cash flows?
-How did operating cash flow combine with other cash activities?
-How are the assets funded?
Why is operating cash flow considered the ultimate measure of value creation?
Because cash is real and shows the actual financial strength, unlike profit which can be influenced by accounting methods.
What is AMBER analysis used for in ratio evaluation?
It frames ratio interpretation by asking: Aspect, Message, Benchmark(s), Explanation, and Risk.
What is the purpose of Stage 3: Ratio Analysis?
To provide deeper insight by calculating ratios that assess efficiency, profitability, leverage, liquidity, and market performance.
Name five performance aspects assessed through ratio analysis.
-Asset efficiency
-Profitability
-Leverage
-Liquidity
-Market performance
What are some examples of ratios for overall performance?
ROE (Return on Equity) and Du Pont analysis.
What challenges in financial analysis are acknowledged in Ch 11?
Selecting appropriate ratios, effects of expansion, data tweaking, inconsistent formulas, aggregation, and contradictory results.
What is suggested as a countermeasure to financial analysis challenges?
Conducting thorough analysis: assessing earnings quality, scrutinising tax rates, checking for unrecognised liabilities, and reviewing related party transactions.
What are the two key concepts in financial analysis as discussed?
1) The business’s risk-return profile
2) Benchmarks.
Why is it imperative to always consider both return and risk in financial analysis?
Because they together define the business’s financial prospects and the uncertainty surrounding them.
What is a benchmark in financial analysis?
Financial information used for comparison purposes.
List the three typical benchmarks used in financial analysis.
-Prior year information (own historical data)
-Competitor data (direct competitors)
-Industry or sector averages
Why are benchmarks essential in financial analysis?
They provide context and make performance assessments meaningful by offering comparison points.
What is The Main Story in financial analysis?
It’s the narrative the financial statements tell about how the business uses funding, invests in assets, earns revenue, generates profit, and manages cash flows.
Why is understanding The Main Story crucial before ratio analysis?
It provides context and helps identify key areas to explore deeper during ratio analysis.
List the six key questions analysts ask when understanding The Main Story.
-What assets has the business invested in?
-How much revenue did those assets produce?
-How much profit was earned from the revenue?
-How much profit was converted into operating cash flows?
-How did operating cash flows combine with other cash activities?
-How are the assets funded?
How can profit earned from revenue be analyzed?
By using common-sizing techniques and alternative performance measures like EBITDA.
When analyzing assets, what should an analyst look for?
identify largest assets, check for surprising items, missing assets, and note major acquisitions or disposals.
Why is operating cash flow seen as the ultimate measure of value creation?
Because cash is real and shows actual financial strength, unlike profit which can be manipulated by accounting rules.
