Financial Statement Analysis

Learning Objective,
1. Why study Financial Statements Analysis?
2. Locate and use sources of information about company performance
3. Analyze the performance of a company using trend analysis, common-size
financial statements and segment reporting
4. Use the basic financial ratios to guide your thinking
5. Evaluate corporate performance using various metrics, including ROA, ROE, and
EVA
6. Use financial information to help assess a company’s value
Consider the following questions related to financial statement information for MICROSOFT in
2016:
• Microsoft’s net income in 2017 $21024 in millions. That seems like a lot, but does it represent a large
amount for a company the size of Microsoft?

• Total assets for Microsoft at the end of 2017 were $ 241086 million. Given the volume of business that
Microsoft does, is this amount of assets too much, too little, or just right?

• By the end of 2017, Microsoft’s liabilities totaled $104165 in million.

Is this level of debt too much for Microsoft? The important point to recognize is that just having the
financial statement numbers is not enough to answer the questions that financial statement users want
answered. Without further analysis, the raw numbers themselves don’t tell much of a story.
Financial statement analysis involves the examination of both the relationships among financial
statement numbers and the trends in those numbers over time.

Purpose of financial statement analysis is to use the past performance of a company to predict how it
will do in the future. Another purpose is to evaluate the performance of a company with an eye toward
identifying problem areas. In sum, financial statement analysis is both diagnosis— identifying where a firm
has problems—and prognosis—predicting how a firm will perform in the future.

Investors are interested to know future return from their investment and to which risk they are subject
to.

The objective of Financial Statement Analysis is to shade light on above two issues.

• Creditors  Short term Liquidity and Long term Solvency.

• Equity holders  Profitability and future securities prices.

Source of financial information

• Company annual reports include:

– The financial statements

– Footnotes to the financial statements

– A summary of the accounting principles used

– Management’s discussion and analysis (MD&A)

– The auditor’s report

– Management’s report on its responsibility for the financial statements

– Comparative financial data for a series of years

– Narrative information about the company

• Company website.

• Press release.

• SEC filings. Edgar & XBRL.

• Analyst’s reports.

• Financial websites like:

– Wall Street Journal

Value Line, Dun & Bradstreet

Exhibit 2 illustrates how financial statement analysis fits into the decision
cycle of a company’s management. Notice that the preparation of the financial
statements is just the starting point of the process. After the statements are
prepared, they are analyzed using techniques akin to those to be introduced in
this chapter. Analysis of the summary information in the financial statements
usually doesn’t provide detailed answers to management’s questions, but it does
identify areas in which further data should be gathered. Decisions are then made
and implemented, and the accounting system captures the results of these decisions so that a new
set of financial statements can be prepared. The process then
repeats itself.

For external users of financial statements, such as investors and creditors,

financial statement analysis plays the same role in the decision-making process.
Whereas management uses the analysis to help in making operating, investing,
and financing decisions, investors and creditors analyze financial statements to
decide whether to invest in, or loan money to, a company.