Financial Analysis and Accounting Basic: Financial Analysis Is The Process of Evaluating Businesses, Projects, Budgets

FINANCIAL ANALYSIS AND ACCOUNTING BASIC
Financial Analysis is the process of evaluating businesses, projects, budgets,

and other finance-related transactions to determine their performance and
suitability. Typically, financial analysis is used to analyze whether an entity is
stable, solvent, liquid, or profitable enough to warrant a monetary investment.
6 Steps to Developing an Effective Analysis of Financial Statements
1. Identify the industry economic characteristics
First, determine a value chain analysis for the industry—the chain of activities
involved in the creation, manufacture and distribution of the firm’s products
and/or services. Techniques such as Porter’s Five Forces or analysis of
economic attributes are typically used in this step.
2. Identify company strategies
Next, look at the nature of the product/service being offered by the firm,
including the uniqueness of product, level of profit margins, creation of brand
loyalty and control of costs. Additionally, factors such as supply chain
integration, geographic diversification and industry diversification should be
considered.
3. Assess the quality of the firm’s financial statements
Review the key financial statements within the context of the relevant
accounting standards. In examining balance sheet accounts, issues such as
recognition, valuation and classification are keys to proper evaluation. The
main question should be whether this balance sheet is a complete
representation of the firm’s economic position. When evaluating the income
statement, the main point is to properly assess the quality of earnings as a
complete representation of the firm’s economic performance. Evaluation of the
statement of cash flows helps in understanding the impact of the firm’s
liquidity position from its operations, investments and financial activities over
the period—in essence, where funds came from, where they went, and how
the overall liquidity of the firm was affected.
4. Analyze current profitability and risk
This is the step where financial professionals can really add value in the
evaluation of the firm and its financial statements. The most common analysis
tools are key financial statement ratios relating to liquidity, asset management,
profitability, debt management/coverage and risk/market valuation. With
respect to profitability, there are two broad questions to be asked: how
profitable are the operations of the firm relative to its assets—independent of
how the firm finances those assets—and how profitable is the firm from the
perspective of the equity shareholders. It is also important to learn how to
disaggregate return measures into primary impact factors. Lastly, it is critical
to analyze any financial statement ratios in a comparative manner, looking at
the current ratios in relation to those from earlier periods or relative to other
firms or industry averages.
5. Prepare forecasted financial statements
Although often challenging, financial professionals must make reasonable

assumptions about the future of the firm (and its industry) and determine how
these assumptions will impact both the cash flows and the funding. This often
takes the form of pro-forma financial statements, based on techniques such
as the percent of sales approach.
6. Value the firm
While there are many valuation approaches, the most common is a type of
discounted cash flow methodology. These cash flows could be in the form of
projected dividends, or more detailed techniques such as free cash flows to
either the equity holders or on enterprise basis. Other approaches may
include using relative valuation or accounting-based measures such as
economic value added.
Types of Financial Analysis
1. Horizontal Analysis
This involves the side-by-side comparison of the financial results of an

organization for a number of consecutive reporting periods. The intent is to
discern any spikes or declines in the data that could be used as the basis for a
more detailed examination of financial results.
2. Vertical Analysis
This is a proportional analysis of the various expenses on the income

statement, measured as a percentage of net sales. The same analysis can be used
for the balance sheet. These proportions should be consistent over time; if
not, one can investigate further into the reasons for a percentage change.
3. Short Term Analysis
This is a detailed review of working capital, involving the calculation of

turnover rates for accounts receivable, inventory, and accounts payable. Any
differences from the long-term average turnover rate are worth investigating
further, since working capital is a key user of cash.
4. Multi-Company Comparison
This involves the calculation and comparison of the key financial ratios of two
organizations, usually within the same industry. The intent is to determine the
comparative financial strengths and weaknesses of the two firms, based on their
financial statements.
5. Industry Comparison
This is similar to the multi-company comparison, except that the comparison is
between the results of a specific business and the average results of an entire
industry. The intent is to see if there are any unusual results in comparison to the
average method of doing business.
6. Valuation Analysis
This involves the use of several methods to derive a range of possible

valuations for a business. Examples of these methods are discounted cash flows
valuation, a comparison to the prices at which comparable companies have sold, a
compilation of the valuations of the subsidiaries of a business, and a compilation
of its individual asset values.
BASIC ACCOUNTING
Some of the basic accounting terms that you will learn include revenues,

expenses, assets, liabilities, income statement, balance sheet, and statement
of cash flows. You will become familiar with accounting debits and credits as
we show you how to record transactions.
5 Important Principles of Modern Accounting
1. The Revenue Principle
This principle defines a point in time when bookkeepers may record a

transaction as revenue on the books. The revenue principle states that revenue
for the business is earned and recorded at the point of sale. This means that
revenue occurs at the time at which the buyer takes legal possession of the
item sold or the service is performed, not at the moment at which cash for the
transaction is accepted by the seller. This concept is sometimes called the
“revenue recognition principle.”
2. The Expense Principle
This principle defines a point in time at which the bookkeeper may log a
transaction as an expense in the books. The expense principle, or expense
recognition principle, states that an expense occurs at the time at which the
business accepts goods or services from another entity. Essentially, it means
that expenses occur when the goods are received or the service is performed,
regardless of when the business is billed or pays for the transaction.
3. The Matching Principle
The matching principle states that you should match each item of

revenue with an item of expense. For example, if you are selling tacos, you
could count the expense of the shells, meat, and toppings at the time at which
a customer buys the taco. In other words, you match the expense of the taco
ingredients with the revenue earned from the sale of the taco. When a
business applies the revenue, expense, and matching principles in practice,
they are operating under the accrual accounting method.
4. The Cost Principle
The cost principle states that you should use the historical cost of an

item in the books, not the resell cost. For example, if your business owns
property, such as real estate or vehicles, those should be listed as the historical
costs of the property, not the current fair market value of the property.
5. The Objectivity Principle
The objectivity principle states that you should use only factual,

verifiable data in the books, never a subjective measurement of values. Even if
the subjective data seems better than the verifiable data, the verifiable data
should always be used.

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FINANCIAL ANALYSIS AND ACCOUNTING BASIC

Financial Analysis is the process of evaluating businesses, projects, budgets,

6 Steps to Developing an Effective Analysis of Financial Statements

1. Identify the industry economic characteristics

2. Identify company strategies

3. Assess the quality of the firm’s financial statements

4. Analyze current profitability and risk

5. Prepare forecasted financial statements

Although often challenging, financial professionals must make reasonable

6. Value the firm

This involves the side-by-side comparison of the financial results of an

This is a proportional analysis of the various expenses on the income

3. Short Term Analysis

This is a detailed review of working capital, involving the calculation of

This involves the use of several methods to derive a range of possible

Some of the basic accounting terms that you will learn include revenues,

5 Important Principles of Modern Accounting

1. The Revenue Principle

This principle defines a point in time when bookkeepers may record a

3. The Matching Principle

The matching principle states that you should match each item of

4. The Cost Principle

The cost principle states that you should use the historical cost of an

5. The Objectivity Principle

The objectivity principle states that you should use only factual,

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