Friday, February 17, 2012

How to Write a Financial Statement Analysis

A financial statement analysis is a comprehensive examination of the financial statements of a business. Financial statement analyses are often used for investment research in the context of scrutinizing the health of a target company. There are five discrete steps required to write the most common form of financial statement analysis. Accurate numeric calculation is the key to a successful analysis.


o    1
Get the financial statements for your target business. The financial statements of publicly traded companies are available for free through the Securities and Exchange Commission's EDGAR database (see Resources). For privately held companies, financial statements are very difficult to obtain. These companies are under no obligation to report or even prepare financial statements. Publicly traded companies must file financial statements at set intervals. For this reason, financial statement analyses are usually conducted on publicly traded companies.
o    2
Obtain the financial statements for businesses that operate in the same industry as your target business. For publicly traded companies, use the SIC codes from the SEC's EDGAR database to identify companies in the same industry. The most common form of financial statement analysis involves comparing a target company against a benchmark developed from the financial statements of competitors. The more company financial statements you have available, the better your benchmark.
o    3
Compare each line item on the financial statement of your chosen company against the identical item on a competitor's financial statement. For example, look at the current assets section of the balance sheets to compare the accounts receivable of the two companies. If your target company has a much larger accounts receivable balance than its competitor in the same industry, this suggests you should investigate this particular financial statement item further.
You should be able to identify items of significant difference or items of surprising similarity for use in additional analysis. It is crucial to compare similar companies on a line-by-line basis in writing a financial statement analysis, to identify small differences in terminology or item placement.
o    4
Conduct detailed ratio analysis for accounts of interest. Continuing the previous example, if your target company has an extraordinarily high accounts receivable balance, you should construct an accounts receivable turnover ratio by dividing the accounts receivable balance into sales. Compare the accounts receivable turnover ratio of your target company with its competitor. Any significant difference is grounds for written investigation and interpretation.
Ratios are used to normalize line-item differences for companies of different sizes. It is generally useful to normalize these differences by dividing by sales or total assets.
o    5
Use items that have significantly different ratios and balances in a text description of your target company. For the example, write a paragraph detailing the dollar value and ratio difference in the accounts receivable balances between the companies.
Next, explain why you believe this difference exists. Note that your explanation is generally a matter of subjective interpretation, but the dollar and ratio differences are matters of objective fact. However, if the numeric calculations are accurate, your interpretation will be grounded by factual observation and thus form the key component of your financial statement analysis.

No comments:

Post a Comment