2 Learn Corporate Finance Principles in 1 Hour: Financial Analysis

I'm glad that you decided to take the plunge in our first short lesson we're going to look at financial analysis financial analysis is used for all sorts of purposes managers financial and non-financial alike use financial analysis to interpret financial information that is what is the information telling us is it something good is it something bad are we on target behind target or ahead of target what is working and what isn't investors use financial analysis to identify and evaluate investment opportunities accountants use financial analysis to identify areas of potential errors or to describe variances from plans and bankers use financial analysis to evaluate the financial health of their borrowers financial analysis involves studying trends making comparisons and calculating different types of ratios trends are important for getting an understanding of the future direction of cash flow our sales increasing or decreasing and how about expenses what is the growth rate of the industry comparisons can be made between periods between companies in the same industry or totally unrelated companies these comparisons can identify areas of either under or over performance ratio analysis is particularly helpful for supplementing trend or comparative analysis a ratio takes two or more financial accounts and relates them to one another consider these common examples of financial ratios gross profit margin which is the amount of profit you generate on the sale of each unit of inventory divided by sales and expressed as a percentage operating margin which is the amount of profit you generate after paying all of your overhead divided by your sales and expressed as a percentage return on equity which is the net income divided by the balance of shareholders equity expressed as a percentage current ratio which is a mess Solvency that is the ability to pay bills as they come due it's calculated by taking your current assets assets that can be easily converted to cash and dividing it by your current liabilities which are any obligations that are payable within one year and finally your debt to equity ratio which is a measure of financial leverage that is the degree of debt used by the company to finance its operations we're going to come back to this in a later lesson I've developed a course covering all of the different types of financial analysis and ratios that are used in practice so for more information or a deeper understanding I'd suggest you go there or refer to the teaching supplement that I'm providing with this course that summarizes all of the various ratios and their purposes to become proficient at financial analysis you need to appreciate the difference in perspective between accountants and financial analysts the main reason is because much of this ratio analysis and trend analysis that we just talked about is based on an accountants view of the world now accountants keep the records and report the results the financial analyst on the other hand analyzes and interprets them recognize that both perspectives are useful and valuable it's like looking at the same coin only from opposite directions let's sensitize you by working through an example let's substitute a balance sheet of Microsoft Corporation for the coin for a moment a balance sheet shows the value of assets liabilities and equity of a business at a specific point in time often December 31st at midnight it adds up all the various categories of assets does the same for liabilities and the difference represents the residual interest I talked about during the introduction let's look at the shareholders equity section of the balance sheet specifically the shareholders equity is made up of a number of line in what accountants call accounts capital stock or common stock typically represent the value of the money received when the shares were issued initially which by the way is it all likelihood different than the amount you paid for your shares retained earnings represents the amount of net income generated by the business but not yet distributed in the form of dividends accountants calculate the amount of net income a company makes which is quite simply revenue minus expenses positive net income flows into retained earnings and dividends paid to shareholders gets posted against this account when you take the value of shareholders equity and divide it by the number of shares a company has it issued and outstanding you are calculating the book value of equity per share this is an accountants view of value but it's rarely the true market value because it's based on historical performance the finance view of the world is different finance people are forward-looking the market of buyers and sellers set the return expectation for this company and this is signaled by the trading price the stock price is significantly influenced by the expectation of future earnings the stock markets tend to favor earnings and not cash flow as cash flow tends to be a little more erratic between years note the variation from finance theory which dictates that cash flow not earnings to determine value practical insight number one duly noted notice that we can take that 8.1 billion shares and multiply it by the forty seven dollars and forty seven cent trading price to calculate what is called market capitalization of three hundred and eighty four billion dollars when compared to the accountants view of shareholders equity that we saw in the previous slide this number is four point one nine times higher this gap in value is a result of the very profitable business model of Microsoft that relies on intellectual capital and so-called internally generated goodwill instead of hard capital like real estate and equipment that would typically show up on a balance sheet to generate the returns but it still annoys me that investors largely ignore cash flows fortunately the financial statements contain a statement that helps us better understand cash flow better in this course we won't spend a lot of time talking about the difference between accounting income and cash income but just realize that in practice the two vary accounting income is full of non-cash charges such as depreciation amortization accruals of various sorts and dozens of other adjustments that exist to report transactions in the most appropriate period cash income on the other hand is a little harder to give because it is what it is both perspectives are important but they are almost never the same over any given period however over the life cycle of a company cash income and accounting income will balance out to exactly the same thing sometimes it takes a long long time to see the convergence in this lesson we talked about financial analysis financial analysis is a core skill that requires strong financial literacy the accountants financial statements form the backbone of financial analysis however it doesn't tell a complete story and must be supplemented with other sources of information for instance stock market information or operational information as we talked about during this lesson financial analysis is used to assess financial state to forecast the future which is the topic of our next lesson

test attribution text

Add Comment