ACCTG 371, Financial Statement Analysis

Assignment 1: John Wang 4365752 Question 1 Four phases of security analysis: a) Business analysis In this phase, the analyst tries to understand the key business drives affecting the firm. To be successful in this phase the analyst will need to have an in-depth understanding of the internal and external environment in which the firm operates in. b) Financial statement analysis In this phase, the analyst uses historical financial statements to learn about the firm s profitability growth, and resource needs. The aim of the phase is to identify the interrelationship between all of the financial variables of the firm and how it may change in the future. An important element of financial analysis is accounting analysis, where considerations must be given to the accounting policies, such as estimates, accounting choices and judgment used by the firm and how those affect the reported numbers. To be successful in this phase, any management distortions in the financial statements must be eliminated. Furthermore, it may be necessary to restructure certain financial statements differently to that required by GAAP to tailor more closely to the information needed for the analysis. c) Forecasting In this phase, the analyst uses the information gathered from the first two phases to predict financial performance of the firm in the future. Depending on the valuation techniques selected, the analyst will forecast different components of finical statements into the future, examples o valuation f techniques include free cash flow method and residual income model. d) Valuation In this final stage, the analyst uses the forecast and a valuation model to determine the value of the firm s equity. The accuracy of the valuation depends on the quality of information gathered in the earlier stages of the analysis. Question 2 The business analysis provides us with an in-depth, forward looking analysis of the business and the environment in which it operates. Without a strong understanding of what will drive the business in the future even a comprehensive financial statement analysis will be useless. Business analysis also helps us determine reasonable estimates of growth, margins and capital requirements anditis used to assess how performance ratios may change in the future. This phase of the analysis provides the basis for analysts to determine whether the firm can maintain profitability,

ACCTG 371, Financial Statement Analysis

Assignment 1: John Wang 4365752 become more profitable or become less profitable. Thus business analysis is perhaps the most important step in the valuation process.

Question 3 Business analysis and financial statement analysis are closely linked. The analyst may use the business analysis to identify certain areas that requires more attention in the financial statement analysis. Similarly, financial statement analysis can be used to help understand the key business drivers included in the business analysis and identify concerns that require more detailed business analysis. Often these two phases are done concurrently or back and forth, as each phase highlights issues to be further studied by the other phase. These two phases provide the information the analyst need to understand the business and make accurate forecasts.