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ACCOUNTING FOR DECISION MAKERS – LECTURES 15 & 16 FINANCIAL STATEMENT ANALYSIS Overview of Week 8 lectures Approaches to, and purpose of, business and financial statement analysis (FSA) Discuss the need for benchmarks and comparative analysis – Suitable benchmarks may be suitable for one company, but not suitable for another different type of industry. Discuss the need to adjust earnings to reflect: o The future and o Quarantine operations from other activities (EBIT) Identify the tools of financial statement analysis – Eg: Common size statements and ratio analysis Review the interrelationships between different ratios and pieces of accounting data (Du Pont analysis – Helps to consider the factors of increase and decrease of ratios in a business and how the owner’s return is impacted) Reminder of the various ratios and describe their purpose and use in analysing the profitability, efficiency, liquidity, and solvency of an entity Overview of shareholder/market based measures Discuss the limitations of financial statement analysis Users and decision making The users of financial reports can broadly be categorised as: o Resource providers to the firm – Eg: Creditors, lenders, shareholders, employees (assessing risk and return?). These are based on the equity and liabilities. Resource providers also consider what return they will receive when providing resources. o Recipients of goods and services – Eg: Customers, debtors (future pricing?). Usually considers this based on the cost of providing certain services, plus the profit margin, so will the profit margin actually cancel out? o Parties performing an overview or regulatory function – Eg: Tax office, corporate regulator, statistical bureaus (future taxes; provision of subsidies?) o Internal management to assist in their decision making duties to measure internal performance for decision-making and evaluate and manage the firm itself.
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Financial analysis of entities Varied objectives Assessing o Future cash flows – What will be the future cash flows generated in the business? o Risk – What is the risk of the cash flows? Can be based on several factors, such as the risk of not being able to pay back, or operating risks. o Growth potential – What opportunities exist for the entity to grow in the future, or in different type of markets? o Ability to pay debts – How has management spent their money? o Accountability – Investors trust in manager with their money, as they give money to try and gain a return for shareholders. Shareholders need to know how their money is used. Most important lesson There are no free lunches – Thus everything has a cost for benefit. Two broad forms of analysis Charting (movements in security prices of listed entities). Drawing a graph of recent share prices movements or other things, such as volume of trade: o Looking for trends in past share prices to predict future prices.
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