Financial Statement Analysis of an Established Business

The stock selection process involves a large component of expectations.

The investor is usually a student of the intrinsic value and relative value, and he incorporates projections routinely into stock evaluations.

In order to form a reasonable basis for predicting corporate performance, however, the investor must understand historical financial results.

The business review enables the practitioner to attach product innovations, competitive struggles, and other qualitative items to changes in sales and earnings.

As the numerical complement to the business review, the financial analysis provides a statistical summary of the company's past by boiling it down to the common denominator of all profit-seeking enterprises - dollars and cents.

Model Research Report

1. Introduction
2. Macroeconomic Review
3. Relevant Stock Market Prospects
4. Review of the Company and Its Business
5. Financial Analysis
6. Financial Projections
7. Application of Valuation Methodologies
8. Recommendation.

Notes:

To a large extent, financial statement analysis is a lost art.  Few business schools stress the topic, and MBA students who major in finance, graduate with only a rudimentary knowledge of accounting, the nuts and bolts of financial statement analysis.

Wall Street and the institutional community deemphasize a careful study of prior financial results.  Research departments are so preoccupied with predicting future earnings that they don't take time to scrutinize past accounting data.  Furthermore extensive analysis is an expensive proposition.

With most institutions owning hundred of stocks and turning over their portfolios two to three times annually, placing a lot of effort in studying the financial statements of a single holding is not worthwhile.

Step-by-step approach to financial statement analysis

1. Begins with organizing the raw information
2. Calculating ratios and interpreting them.
3. Integrate this with the industry-specific performance ratios to make conclusions about a firm's earnings power moving forward.
4. The historical analysis sets the stage for projections, an important component of business valuation.