We get information about corporations in which we want to invest in several ways. Businesses may prepare a prospectus for the SEC when making an initial public offering, the financial press may make statements about a business, industry or market as a whole, businesses provide news releases, important figures make public statements about the business, and, most importantly, we can look at the financial statements the business prepares.
As a result, analyzing financial statements is of critical importance to security analysts and financial managers. But because the development of financial statements is an accounting concept, we must understand that sound financial statement analysis integrates financial concepts with accounting concepts, exploiting the latter to allow us to find bits of information about a firm’s ability to generate earnings growth. We use this information to forecast future earnings in order to value the firm.
The everyday financial manager, analyst, accountant and banker have a toolkit of basic financial ratios they use to shed light on the financial performance of the firm. Financial ratios help provide information about five key areas of financial performance:
- Solvency: Can the firm meet its obligations over the next year or operating cycle as they become due?
- Activity: How effectively are the firm’s assets being managed?
- Financial Leverage: Is the firm financed with debt or equity? By how much?
- Profitability: Is the firm profitable?
- Value: What is the value of the firm?
At BrainMass.com, our finance Experts can help students examine the financial statements of a business from a financial perspective. Our solution bank for this topic also offers a number of examples for calculating these ratios, analyzing what these ratios mean, and preparing memos to communicate your understanding.
For information on the use of individual ratios, please see Financial Ratios under Accounting
Accounting-Based Approach to Valuation
When valuing securities, analysts look at complex accounting-based valuation models that help to get a better understanding of both the earnings and fundamental value of a business. That is, earnings forecasts are what drive share price, and analysts have developed a number of valuation models that convert forecasted earnings into a valuation of the fundamental value of the business. At BrainMass.com, we also look at the use of accounting-based valuations under Financial Statement Analysis.
See also: Stock Valuation, Dividend Discount Model, and Payout, Retention and Growth Ratios