Framework for Analysis
What you'll learn
- LOS 12.aDemonstrate the use of a framework for the analysis of financial statements, given a particular problem, question, or purpose (e.g., valuing equity based on comparables, critiquing a credit rating, obtaining a comprehensive picture of financial leverage, evaluating the perspectives given in management’s discussion of financial results).
The primary purpose of financial statement analysis is to identify potential outcomes, good or bad, that could affect an investment decision.
A basic framework, presented in Figure 12.1, has been developed to assist the user based on the objectives of the analysis. The framework can be used in making decisions about an equity ownership interest in a firm, a lending decision, evaluating a credit rating, or anticipating the impact on a firm of a change in accounting standards.
Figure 12.1: Framework for Analysis
Of course, which data are processed and analyzed will depend on the specific objectives of the analysis. In the example we present here, the objective is an analysis of a purchase decision for a long term equity investment. The analysis focuses on the following:
Sources of earnings and return on equity. Asset base.
Capital structure. Capital allocation decisions. Earnings quality and cash flow analysis.
Market value decomposition. Anticipating changes in accounting standards.