Monday, November 21, 2011

Financial Statement Analysis: The Power to Compare

In a business school curriculum, whether at the undergraduate or graduate level, the analysis of financial statements crops up in many different courses.  These include courses dedicated to financial statement analysis but also others, such as corporate finance and investments as well as accounting courses.  In these courses, it is important for students to understand what information is available about a company and how to draw conclusions about a companies performance from its financial reports.   But ultimately, understanding performance cannot be done for a company in isolation.  Students need to be able to compare a company to others, including its competitors, those in its industry, and even to the market as a whole. 
Without making comparisons, it is hard to get a feel for what the raw numbers mean.  For some types of performance variables, like returns, benchmarking is almost automatic: it is usual to compare returns to a market benchmark like the S&P500, or to historical performance.  
One complexity with comparing companies on the basis of financial statement many different numbers that can be calculated.  For example, you could do a common size analysis or a cost-volume-profit analysis or you could drill down into the drivers of ROE and ROA.   For a student to perform these comparisons, they would need to extract a large amount of data from the statements.  For example, if you want to compare the DuPont decomposition of a company to stocks in the S&P 500, you would have to collect data for a large number of companies, import it into Excel, make the calculations, and so on. 
Valuation Tutor simplifies this task.  The software and textbook show you how to extract data from the statements and analyze a company.  But it also comes with a dataset, currently of 1500 companies but to be extended by the end of this year to the companies in the Russell 3000 index (representing over 98% of the US equity market).   The dataset give you the power to compare.  You can compare a company to those in the same sector, same industry, the same SIC code, to broad market indexes, and in fact to any subset of securities you choose.    The software also performs decile analysis so you can see how the company ranks relative to those in your comparison set.
Together with the dataset, we have developed a series of projects that show students how to use the comparisons  to make informed judgments about performance.  The project are in the online text at (click on the textbook contents on the left and you will see the link to the case studies and projects).  The screen below shows you the capability.  You choose a stock to analyze, select what you want to compare in the tree at the left (we have selected Break-Even Analysis in the example), select whom you want to compare it to, and click the Compare button:
The results will be shown in a new window, and if you click the “Calculate Deciles” button you will see the cutoff for each decile for each column and the decile the company falls into:


Darcy Grubaugh said...

Financial statements are basically the backbone of any business. Reading it can help you learn about the effectiveness of present processes, as well as pinpoint the strengths and weakness of the company.

- Darcy Grubaugh

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