Please answer this and explain as much as possible. thank you Chapter 15 covers
ID: 2738848 • Letter: P
Question
Please answer this and explain as much as possible. thank you
Chapter 15 covers Financial Statement Analysis. As you noted in the chapter, there are C 3 common analytical techniques used to analyze a company's financial statements: 1) Horizontal Analysis 20 Vertical Analysis 3) Ratio Analysis Each technique can be used to assess the financial health and future prospects of a Company. The ratios that can be used fall into three categories: 1) Liquidity Ratios measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. In your book on page 693 the liquidity ratios are from Working Capital down to and including Total Asset Turnover. 2) Profitability Ratios measure the income or operating success of an enterprise for a given period of time. In your book on page 693 the profitability ratios are from Gross Margin Percentage down to and including Book Value per Share 3) Solvency Ratios measure the ability of the enterprise to survive over a long period of time. In your book on page 693 the solvency ratios are Times Interest Earned, Debt-to-Equity ratio and Equity Multiplier. In the text the authors state that an analyst should not rely solely on financial statement analysis when evaluating a company? Do you agree or disagree? Why?Explanation / Answer
Yes, I agree that an analyst should not rely solely on financial statement analysis when evaluating a company.
The reasons for the conclusion are the limitations of financial statement analysis, which are:
1) All figures in the financial statements are historical and may not reflect the future course of events. Besides, they do not reflect the current picture ie: do not consider the current cost. Hence, relying solely on them for predictions would be disastrous.
2) Accounting statements are based on accounting policies and different companies follow different policies. The differences can be with respect of inventory valuation (FIFO, LIFO etc), depreciation methods (SLM, accelerated depreciaton methods) and so on. This would make data unfit for comparison with those of other firms.
3) Figures in the financial statement could be subject to distortion by the management. Management may understate or omit liabilities or overstate asset values. Income and expense figures can also be manipulated.
4) Changes in accounting policies can render data from period to period incomparable.
5) Financial statement analysis does not take into account business conditions. Figures under conditions of boom would appear bright and under recession very gloomy. One has to consider this when interpreting ratios or trend analysis. Further, future conditions have to be predicted to make projections.
6) Financial statement analyses consider only the financial data. They do not consider the non financial aspects like company strategy, brand image, core competency skills, relationships, culture etc.