Financial%20Analysis - Introduction to Financial Analysis...

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Introduction to Financial Analysis Understanding financial performance involves 2 distinct but related activities: 1. Finding the information and calculating appropriate financial ratios. 2. Interpreting the various ratios to determining what they reveal about the company. The first activity is a straightforward exercise – all it requires is some leg work and a little math. The second activity, however, requires both an understanding of what the individual ratios mean and an ability to integrate the information from different ratios to reach reasonable conclusions. Note the use of the term reasonable in the last sentence above. Why reasonable rather than accurate or correct or some other more concrete and definitive term? Because understanding financial performance involves a combination of science, art, judgment, and preference. While it would be nice if financial statements and the various ratios we calculate from them were definitive, the reality is that they never will be. For one thing, there are a variety of judgments made by the accountants who initially create the financial statements - for many of these judgments, there are 3, 4, 5 or even more ways consistent with generally accepted accounting principles that could determine how the numbers could be stated. Depending on the judgments made, the conclusions that the numbers point to could vary substantially. Next, while there general rules of thumb regarding how to interpret the value of any given ratio, there are exceptions for everyone. Further, when you begin to look across ratios and integrate interpretations across several different financial areas, the possibility of multiple reasonable conclusions increases. Finally, personal preferences and experiences of the person interpreting the numbers come into play. What one person considers a risky venture another may interpret as a reasonable chance for a significant return. What one person considers too much debt, another may consider a wise financial choice given the available financing options. In neither of these cases is there an absolute “right” or “wrong” answer. The best that we can hope for is a reasonable answer given all of the information available. Some of you may wonder where this leaves us and why we even bother to calculate the numbers if there is no “right” answer. This is a reasonable concern. You must always remember, though, that the numbers do not exist in or come from a vacuum, nor are they really the final end we are seeking. The numbers are a result of various past actions and decisions made by those who operate the company. What we are really seeking to understand when we do financial analysis is a general understanding of how the firm has performed in the past, how they are likely to perform in the future, and where we should focus our attention in doing further analysis of the company. In the information that follows, we will try to gain a clear understanding of where the appropriate
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This note was uploaded on 10/12/2011 for the course ECON 101 taught by Professor Mikson during the Spring '08 term at Aarhus Universitet.

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Financial%20Analysis - Introduction to Financial Analysis...

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