TKM_Chapter_04

TKM_Chapter_04 - CHAPTER 4 FINANCIAL ANALYSIS SIZING UP...

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CHAPTER 4 FINANCIAL ANALYSIS: SIZING UP FIRM PERFORMANCE Financial statements analysis involves the process of extracting information from a firm’s financial statements in order to evaluate the firm’s financial performance. Analyzing past performance of a firm is a valuable tool in predicting future performance and cash flows. Financial analysis is important to a variety of constituencies, including managers, lenders, suppliers, credit-rating agencies, and investors. This chapter will develop a number of key types of statements and measures that are valuable in performing a financial analysis. Common-size statements standardize financial statements to allow for comparison. Financial ratios are developed to assess a firm’s liquidity, leverage, asset management efficiency, profitability, and market performance. The DuPont Method provides a way of analyzing the relationship among a number of key ratios and identifying key factors that affect firm performance. Two main types of benchmarks are used in analyzing a firm’s financial performance: trend analysis and peer group comparisons. Students sometimes get the impression that accounting data is useless because care must be used when interpreting some of the results. They sometimes ask why we bother with financial statement analysis at all. Robert Higgins provides a good answer to this question: “objectively determinable current values of many assets do not exist. Faced with a trade- off between relevant, but subjective current values, and irrelevant, but objective historical costs, accountants have opted for irrelevant, but objective historical costs. This means that it is the user’s responsibility to make adjustments.” Financial statement information is often our ONLY source of information. Consequently, we use the information we have and make adjustments where appropriate. Learning Objectives 4-1. Explain what we can learn by analyzing a firm’s financial statements. 4-2. Use common size financial statements as a tool of financial analysis. 4-3. Calculate and use a comprehensive set of financial ratios to evaluate a company’s performance. 4-4. Select an appropriate benchmark for use in performing a financial ratio analysis. 4-5. Describe the limitations of financial ratio analysis. Guidelines for Financial Statement Analysis Identify whose perspective you are using to analyze a firm—management, shareholder, or creditor. Use only audited financial statements if possible. 1
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Perform analysis over a three- to five-year period—trend analysis. Compare the firm’s performance to its direct competitors—that is, firms that are similar in size and offer similar products. Perform a benchmark analysis. This involves comparing it to one or more of the most relevant competitors—American Air with Delta or United Airlines. CHAPTER ORGANIZATION
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This note was uploaded on 09/17/2011 for the course FIN 3403 taught by Professor Keys during the Spring '08 term at FIU.

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TKM_Chapter_04 - CHAPTER 4 FINANCIAL ANALYSIS SIZING UP...

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