RSM1320 – Financial Accounting

FINANCIAL ANALYSIS TECHNIQUES (RATIO ANALYSIS)

KEY POINTS TO KNOW
1) Financial analysis is ultimately contextual and purpose-driven. In other words, there is always a reason why you are performing the analysis. You need to be clear about the objective of the analysis.
2) The tools and techniques that you use will depend on your purpose. As we discussed earlier, analyzing the company as an investment opportunity (which generally focuses on indicators of profitability of growth) is often different from analyzing the company from the perspective of a credit (lend or not) decision (which generally focuses on indicators of risk, liquidity, and solvency).
3) Financial analysis will seldom provide an “answer” to your objective or starting question (e.g. invest or not, lend or not).
The usefulness of financial analysis is to provide valuable insights and additional questions to ask in arriving at a particular decision. Each individual ratio is a basic “indicator”, but it does not by itself provide an explanation of “why” something happened. To get the most value out of financial analysis, you need to understand how these ratios relate to one another and to the business model (and industry) of the company you are analyzing. This requires experience.
4) There is no single authoritative source providing rules about how particular ratios are calculated. While there are standards of practice (that we will follow), there is also significant variation between how practitioners calculate and interpret particular ratios. This primarily relates the points 1 and 2 above. The ratios we will discuss are a “starting point”.
Any advanced application of them could include adjustments and modification.
5) Whenever have ratio that includes both income statement (i.e. period of time) and balance sheet (i.e. point in time), try to
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