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Subject 1. Analytical Tools and Techniques PDF Download
Financial analysis techniques are useful in summarizing financial reporting data and evaluating the performance and financial position of companies. The results of financial techniques provide important inputs into security valuation.
Ratios express one quantity in relation to another. As analytical tools, ratios are attractive because they are simple and convenient. They can provide a profile of a company, its economic characteristics and competitive strategies, and its unique operating, financial, and investment characteristics.
Ratio analysis is essential to comprehensive financial analysis. However, analysts should understand the following aspects when dealing with ratios:
Limitations of Ratio Analysis
There are a significant number of estimates and subjective information that go into financial statements and therefore it is imperative that the analyst understands the numbers before calculating and relying on ratio analyses based on these numbers. An analyst needs to ask questions like:
Raw numbers hide relevant information that percentages frequently unveil. Common-size statements normalize balance sheet, income statement, and cash flow statement items to allow easier comparison of different-sized companies. They reduce all the dollar amounts to a percentage of a common amount.
These ratios can be used to compare financial statements of different-size companies or of the same company over different periods.
- Ratios may be affected by changes in a company's internal factors, such as production, marketing, and financial policies.
- Ratios are based on accounting data provided on a historical cost basis; thus, inflation may cause spurious trends in ratios or render them non-comparable.
- Comparability may also be impaired due to changes in depreciation or inventory valuation methods across time.
- The benchmark comparison ratios may suffer from the same problems, leaving the company's problems or strengths unnoticed.
Common-size statement ratios are useful to:
- Compare companies of different sizes.
- Identify trends over time within an individual company.
- Examine the relative size of items or the relative change in items in a company's financial statement.
Graphs and Regression Analysis
Graphs facilitate comparison of performance and financial structure over time, highlighting changes in significant aspects of business operations. In addition, graphs provide analysts with a visual overview of risk trends in a business. Graphs may also be used effectively to communicate analysts' conclusions regarding aspects of financial conditions and risk management.
Regression analysis can help identify relationships or correlation between variables.
User Contributed Comments 6
|Tommy||Ratios are used everywhere in these days.|
|tybe0012||in these days and days to come|
|holtz||for all eternity|
|choas69||especially when dealing with non-U.S. company. Indeed.|
|Gavala92||Great Contributions guys!|
I am happy to say that I passed! Your study notes certainly helped prepare me for what was the most difficult exam I had ever taken.
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