A firm records depreciation of its fixed, long-term assets every year. It is not an actual expense of cash paid, but is only a reduction in the book value of the asset. The book value is calculated by subtracting the accumulated depreciation of prior years from the price of the assets. Current liabilities of the firm are obligations that are due in less than one year. These include accounts payable, deferred expenses and also notes payable.
Long-term liabilities of the firm are financial payments or obligations due after one year. These include loans that the firm has to repay in more than a year, and also capital leases which the firm has to pay for in exchange for using a fixed asset. It is the difference between total assets owned by a firm and total liabilities outstanding.
It is different from the market value of equity stock market capitalization which is calculated as follows: number of shares outstanding multiplied by the current share price. The balance sheet is analyzed to obtain some key ratios that help explain the health of the firm at a given point in time.
These metrics are as follows:. The debt-equity ratio is also called a leverage ratio. It is calculated to assess the leverage, or gearing, of a firm to show how much it relies on debt to finance its activities. This ratio has pertinent implications for the financial health of the firm and the risk and return of its shares. The variations in this ratio also show any value added by the management and its growth prospects.
The enterprise value of a firm shows the underlying value of the business. The purpose of an income statement is to report the revenues and expenditures of a firm over a specific period of time. It was previously also called a profit and loss account. The general structure of the income statement with major components is as follows:. The net income on the income statement, if positive, shows that the company has made a profit.
If the net income is negative, it means the company incurred a loss. Earnings per share can be derived from knowing the total number of shares outstanding of the company:. Some useful metrics based on the information provided in the income statement and the balance sheet are as follows:. Net profit margin: This ratio calculates the amount of profit that the company has earned after taxes and all expenses have been deducted from net sales. Return on Equity: This ratio is used to calculate company profit as a percentage of total equity.
It assesses whether the stock is overvalued or undervalued. It is essentially a statement whereby the net income is adjusted for non-cash expenses and any changes to the net working capital.
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It also reflects changes in cash coming from, or being used by, investing and financing activities of the firm. The structure and main components of the cash flow statement are as follows:. In order to measure how much cash is available to the company for investments without outside financing or money diverting from operations, it is useful to conduct a simple cash flow statement analysis. The free cash flow, as the name suggests, allows a company to be able to pay dividends, repay its debts, buy back its stock and also make new investments to facilitate future growth.
The excess cash produced by the company, free cash flow, is calculated as follows:.
In order for the company to be doing extremely well, the cash from operating activities must be consistently greater than the net income earned by the company. Apart from the key financial statements, complete financial reporting statements also include the following:. It serves as a preface to all the complete reporting statements in which the management talks about recent events, discloses essential information regarding expansion and future plans, and discusses significant developments in the business industry.
The business and operating review is a good place for the company to share any good news with the general public. It reconciles the opening balances of the equity accounts with the closing balances. These notes provide details and information that are left out of the main reporting documents.
They are important for the sake of clarity on many points as they outline the accounting methodology used for recording certain transactions. The notes to the financial statements are essentially footnotes because if included in the main statements, they would obscure the important information, as they are generally quite elaborate and detailed. The following notes are usually used to impart important disclosures for explaining the numbers on the financial statements:. Financial statement analysis is a brilliant tool to gauge the past performance of a company and predict future performance, but there are several issues that one should be aware of before using the financial statement analysis results blindly, as these issues can interfere with how the results are interpreted.
Some of the issues are:.
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This is a big issue for analysts because they can seemingly compare financial statement analyses between different companies on the basis of ratios used, but in reality it may not paint an accurate picture. The financial ratios of two different companies may be compared to see how they match up against each other, but each company may aggregate all their information different from each other in order to draw up their accounting statements.
This may lead to incorrect conclusions drawn about a company in relation to other companies in the industry. The change in accounts where financial information is stored may skew the results of the financial statement analysis, from one period to the next. For example, if a company records an expense in one period as cost of goods sold , while in another period, it is recorded as a selling and distribution expense, the analysis between those two periods would not be comparable.
Analysts do not take into account operational information of a company, as only financial information is analyzed and reviewed.
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There may be several indicators in operational information of the company which may be predictors of future performance, for example, the number of backlogged orders, any changes in licenses or warranty claims submitted to the company or even changes in the culture and work environment. Organizations can use this indicator to determine long and short-term trends in line with strategic funding goals for example, move towards self-sufficiency and decreasing reliance on external funding. For the purpose of this calculation, business revenue should exclude any non-operating revenues or contributions.
Total expenses should include all expenses operating and non-operating including social costs. A ratio of 1 means you do not depend on grant revenue or other funding. Is your gross profit margin improving? Small changes in gross margin can significantly affect profitability. Is there enough gross profit to cover your indirect costs.
Is there a positive gross margin on all products? This is a very useful measure of comparison within an industry. A low ratio compared to industry may mean that your competitors have found a way to operate more efficiently. This is one of the most important ratios to investors. Are you making enough profit to compensate for the risk of being in business? How does this return compare to less risky investments like bonds? A decreasing ratio is considered desirable since it generally indicates increased efficiency. The higher the turnover, the shorter the time between sales and collecting cash.
What are your customer payment habits compared to your payment terms. You may need to step up your collection practices or tighten your credit policies. These ratios are only useful if majority of sales are credit not cash sales. This is a good indication of production and purchasing efficiency. A high ratio indicates inventory is selling quickly and that little unused inventory is being stored or could also mean inventory shortage. If the ratio is low, it suggests overstocking, obsolete inventory or selling issues. The higher the turnover, the shorter the period between purchases and payment.
A high turnover may indicate unfavourable supplier repayment terms. A low turnover may be a sign of cash flow problems. Compare your days in accounts payable to supplier terms of repayment. An increasing ratio indicates you are using your assets more productively. A social enterprise needs to ensure that it can pay its salaries, bills and expenses on time.
Failure to pay loans on time may limit your future access to credit and therefore your ability to leverage operations and growth. This is done through the synthesis of financial numbers and data. One of the most common ways to analyze financial data is to calculate ratios from the data to compare against those of other companies or against the company's own historical performance.
For example, return on assets ROA is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several similar companies and compared as part of a larger analysis. Financial analysis can be conducted in both corporate finance and investment finance settings. In corporate finance, the analysis is conducted internally, using such ratios as net present value NPV and internal rate of return IRR to find projects worth executing.
A key area of corporate financial analysis involves extrapolating a company's past performance, such as gross revenue or profit margin, into an estimate of the company's future performance. This allows the business to forecast budgets and make decisions based on past trends, such as inventory levels. In investment finance, an outside financial analyst conducts a financial analysis for investment purposes. Analysts can either conduct a top-down or bottom-up investment approach.
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A top-down approach first looks for macroeconomic opportunities, such as high-performing sectors, and then drills down to find the best companies within that sector. A bottom-up approach, on the other hand, looks at a specific company and conducts similar ratio analysis to corporate financial analysis, looking at past performance and expected future performance as investment indicators.
There are two types of financial analysis: technical analysis and fundamental analysis. Technical analysis looks at quantitative charts, such as moving averages MA , while fundamental analysis uses ratios, such as a company's earnings per share EPS.