Financial Statement Analysis Framework
| Phase | Sources of Information | Output |
|---|---|---|
| Articulate the purpose and context of the analysis. | The nature of the analyst’s function, such as evaluating an equity or debt investment or issuing a credit rating.Communication with client or supervisor on specific needs and concerns.Institutional guidelines related to developing specific work product. | Statement of the purpose or objective of analysis.A list (written or unwritten) of specific questions to be answered by the analysis.Nature and content of report to be provided.Timetable and budgeted resources for completion. |
| Collect data. | Financial statements, other financial data, questionnaires, and industry/economic data.Discussions with issuer investor relations, management, suppliers, customers, competitors, and company or industry experts.Company site visits (e.g., to production facilities or retail stores). | Financial statements and other quantitative data in a usable form, such as a spreadsheet.Completed questionnaires, if applicable. |
| Process data. | Data from the previous phase. | Adjusted financial statements.Common-size statements.Ratios and graphs. |
| Analyse/interpret the data. | Input data as well as processed data. | Analytical results.Forecasts.Valuations. |
| Develop and communicate conclusions and recommendations (e.g., with an analysis report). | Analytical results and previous reports.Institutional guidelines for published reports. | Analytical report answering questions posed in Phase 1. Recommendation regarding the purpose of the analysis, such as whether to make an investment or extend credit. |
| Follow-up. | Information gathered by periodically repeating the previous steps as necessary to determine whether changes to holdings or recommendations are necessary. | Comparison of actual to expected results Revised forecasts Updated reports and recommendations. |
Articulate the Purpose and Context of the Analysis
Some analytical tasks are well defined, in which case articulating the purpose of the analysis requires little decision making by the analyst.
For other analytical tasks, articulating the purpose of the analysis requires the analyst to make decisions about the approach, the tools, the data sources, the format in which to report the results of the analysis, and the relative importance of different aspects of the analysis.
The analyst should also define the context at this stage.
Collect Data
A key part of this step is obtaining an understanding of the target company’s business model, financial performance, and financial position (including trends over time and relative to peer companies).
Furthermore, information on the economy and industry is necessary to understand the environment in which the company operates. Analysts often take a top-down approach whereby they
(1) gain an understanding of an issuer’s macroeconomic environment, such as prospects for growth in the economy and inflation;
(2) analyse the prospects of the industry in which the company operates, based on the expected macroeconomic environment; and
(3) determine the prospects for the company given the expected industry and macroeconomic environments.
Process Data
A comprehensive financial analysis at this stage may include the following:
- Reading and evaluating financial results for each company being analysed. This includes understanding any factors that may affect comparability between companies, such as differences in business models, operating decisions (e.g., leasing versus purchasing fixed assets), accounting policies (e.g., when to report revenue on the income statement), and tax jurisdictions.
- Making any needed adjustments to the financial statements or using alternative measures to facilitate comparison. Note that commonly used databases do not always make such analyst adjustments.
- Preparing or collecting common-size financial statement data (which scale data to directly reflect percentages [e.g., of sales] or changes [e.g., from the prior year]) and financial ratios (which are measures of various aspects of corporate performance based on financial statement elements. Analysts can use these to evaluate a company’s relative profitability, liquidity, leverage, efficiency, and valuation in relation to past results or peers.
Analyse/Interpret the Data
The answer to a specific question is seldom the numerical answer alone. Rather, the answer relies on the analyst’s interpretation of the output, and the use of this interpreted output to support a conclusion or recommendation. The answers to the specific analytical questions may themselves achieve the underlying purpose of the analysis, but usually, a conclusion or recommendation is required.
Develop and Communicate Conclusions and Recommendations
Communicating the conclusion or recommendation in an appropriate format is the next step. The appropriate format will vary by analytical task, by institution, or by audience.
Follow-Up
The process does not end with the report. If an equity investment is made or a credit rating is assigned, periodic review is required to revise forecasts and recommendations based on the receipt of new information.
