- Now when it comes to corporate
financial statement analysis,
there are several common methods of analysis.
One method relates to what is called
common-size financial statements.
We prepare common-size financial statements
by dividing financial statement numbers
by either total sales or total assets.
A common-size income statement, for example,
is prepared by dividing all the numbers
on the income statement by sales.
A lot of information can be gleaned
from this simple set of calculations.
With common-size statements,
you can compare financial statements of different sizes
across time for the same company
and across companies at the same point in time.
For example, I'm sure you've heard the term profit margin.
What does that term mean and where does it come from?
Well, profit margin means the amount of profit
generated in cents for every dollar of sales.
It's easily computed by dividing the bottom number
from the income statement, net income or net profit,
by the top number on the income statement, sales or revenue.
When someone is talking about a firm's profitability,
this is usually the ratio they are referring to.
The point is this.
We can get a lot of powerful information
with a few simple computations.
Now, another common method for analyzing
financial statements is called financial ratio analysis,
which involves examining the relationships
between specific financial statement numbers.
We will introduce you to one of my favorite things
in all of accounting, the Dupont framework,
which tells us all about the profitability,
the efficiency, and the leverage of a company.
With this analysis we will be able to tell
how a company's doing on these three dimensions.
When it comes to financial statement analysis,
there's a four-step process.
First, we'll use the Dupont framework to break down
return on equity into its component parts.
Return on equity is a general overall measure
of how well a firm is doing.
Once we've done the Dupont framework,
we'll then prepare common-size financial statements.
Step three will involve using additional ratios
to asses a firm's profitability, efficiency, and leverage.
Based on these first three steps,
we should be able to identify individuals
that we need to speak to about the financial results.
This is the fourth and most important step.
We'll see these four steps throughout this course
as we do our financial statement analysis.
Now it's important to point out
over and over and over again,
the numbers are the start of the analysis process.
The numbers are not the end of the process.
An analysis of the numbers will eventually lead us
to individuals who are responsible for those numbers.
If we want the numbers to be different,
we need to find the individuals who influence those numbers
and then motivate them to change.
Remember, people make the numbers.
Numbers don't make the people.