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FRAMEWORK FOR BUSINESS

ANALYSIS AND VALUATION

Key Concepts
Financial statements are an important source of

information to the capital markets and business

analysts.

Analyzing financial statements addresses a

number of issues of interest to external

stakeholders and company insiders.

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The Role of Financial Reporting in

Capital Markets
Financial reporting provide much-needed

information to capital market participants

Financial intermediaries depend upon the information in

financial statements to evaluate investment

opportunities.
Information intermediaries assure the quality of financial
statement representations.
Relevant and reliable financial information is essential
for the functioning of capital markets.

How Capital Markets Function

Copyright (c) 2008 Thomson South-Western, a part

of the Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used
herein under license.

Chapter 1: Framework for

Business Analysis and Valuation
Using Financial Statements
Palepu & Healy

11/7/2016

From Business Activities to

Financial Statements
Financial statements measure and summarize

the economic consequences of business

activities.
Accounting systems facilitate information quality.
The role of accrual accounting.
The need for generally accepted accounting principles
(GAAP).
Auditing and the quality of financial information.

From
Business
Activities to
Financial
Statements

Copyright (c) 2008 Thomson South-Western, a part

of the Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used
herein under license.

Chapter 1: Framework for

Business Analysis and Valuation
Using Financial Statements
Palepu & Healy

11/7/2016

Financial Statements and Business Analysis

Business intermediaries use financial statements

to accomplish four key objectives:

Business strategy analysis
Accounting analysis
Financial analysis
Prospective analysis

Business
Strategy
Analysis

Copyright (c) 2008 Thomson South-Western, a part

of the Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used
herein under license.

Chapter 1: Framework for

Business Analysis and Valuation
Using Financial Statements
Palepu & Healy

11/7/2016

Concluding Comments
Financial statements are source of widely available data

on publicly traded corporations.

Accrual accounting attempts to accurately reflect

expectations of economic performance, but requires

careful analysis.
This chapter has outlined a useful framework for business

analysis using financial statements.

DISCUSSION

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Can financial analysis add value if capital

market are efficient?
The efficient market hypothesis implies:
Security prices reflect all available information
There is no further need for analysis involving a search for
mispriced securities.

Capital markets may not be efficient, because of:

Information asymmetry
Potentially conflicting interests
Imperfect accounting rules and auditing
Capital in market efficiency is not relevant in some areas:
assess how much value created through acquisition of target
company,
Estimate the stock price of a company considering IPO,
and predict the likelihood of a firms future financial distress.

Discuss some types of errors that can arise in

financial reporting.
Accounting rules
Forecast errors
Managers accounting choices

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Learning BVA using financial statements is not very

useful, unless you are a financial analysis. Comment.
BVA skills are useful not only for financial analysts but

also for corporate managers and loan officers.

For corporate managers:
Can assess whether the firm is properly valued by investors.
Can identify a potential takeover target and assess how much

value can be created through acquisition.

For loan officers:

Assess borrowing firms liquidity, solvency, and business risk.
Examine whether or not extend a loan, how the loan should be
structured, and how it should be priced.

Explain each of the four steps for business

analysis, and how they relate to one another.
Business strategy analysis
Key success factors
Key business risk
Competitive advantages
Profitability
Accounting analysis
undo any accounting distortion
Improve the reliability of conclusions
Financial analysis
Evaluate the performance of firms
Prospective analysis synthesizes the insights from

business strategy, accounting, and financial analysis in

order to make predictions about a firms future.