Business Analysis & Valuation Using Financial Statements

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A F r am e w o rk fo r Bu sin e ss An alysis an d

Valu at i on U sin g Fin an c ial S t at e me n t s

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Framework

he purpose of this chapter is to outline a comprehensive framework

for financial statement analysis. Because financial statements provide the most widely

available data on public corporations’ economic activities, investors and other stakeholders rely on financial reports to assess the plans and performance of firms and corporate managers.

A variety of questions can be addressed by business analysis using financial statements, as shown in the following examples:

• A security analyst may be interested in asking: “How well is the firm I am following performing? Did the firm meet my performance expectations? If not, why not?

What is the value of the firm’s stock given my assessment of the firm’s current and

future performance?”

• A loan officer may need to ask: “What is the credit risk involved in lending a certain

amount of money to this firm? How well is the firm managing its liquidity and solvency? What is the firm’s business risk? What is the additional risk created by the

firm’s financing and dividend policies?”

• A management consultant might ask: “What is the structure of the industry in which

the firm is operating? What are the strategies pursued by various players in the industry? What is the relative performance of different firms in the industry?”

• A corporate manager may ask: “Is my firm properly valued by investors? Is our investor communication program adequate to facilitate this process?”

• A corporate manager could ask: “Is this firm a potential takeover target? How much

value can be added if we acquire this firm? How can we finance the acquisition?”

• An independent auditor would want to ask: “Are the accounting policies and accrual estimates in this company’s financial statements consistent with my understanding of this business and its recent performance? Do these financial reports

communicate...