By scope of financial statement analysis, we simply mean those vital issues that must be dealt with while carrying out financial statement analysis exercise. Financial statement analysis is a subset of the whole body of business analysis. Financial statements analysis is not all about ratio analysis as many would think. It goes beyond that and that is where this article fits in. This article is in response to a question from one of my hub readers.
ASPECTS OF FINANCIAL STATEMENT ANALYSIS
There are basically two aspects of financial statement analysis, namely; quantitative and non-quantitative financial statement analysis.
QUANTITATIVE FINANCIAL STATEMENT ANALYSIS
The quantitative aspect of financial statement analysis has to do with the use of mathematical models and ratios to predict the pattern of future event. This is the traditional imagery that one conjures any time financial analysis is mentioned. There are software that can be used to run these iterative and simulations. The focus steroids has long moved from this aspect to the non quantitative area as that is where most expert systems cannot perfectively fit in yet. Nonetheless, accountants and financial analysts still need these financial models and tools so as to be better placed to interpret them.
NON-QUANTITATIVE FINANCIAL STATEMENTS ANALYSIS
My interaction with successful businessmen and businesswomen has revealed to me that it takes more than figures and number crunching to understand the direction that a business is heading. More of our sixth sense is needed when faced with the challenge of tearing down the annual report of a business while searching for the grail message that will aid our investment decision. Investment is an art and should be treated as one else, good investment opportunities will always delude us.
THREE (3) QUALITIES OF A GOOD QUALITATIVE FINANCIAL STATEMENT ANALYST
ABILITY TO UNDERSTAND THE UNWRITTEN LANGUAGE OF ECONOMIC INDICATORS
Economic indicators carry both written and unwritten messages. Your ability to hear the unwritten part of the communication between a company and the economy both at the micro and macro level is what distinguishes success investors and those that failed while trying to delve into the world of investment. Remove bias and sentiment, then ask yourself questions that will reveal the true implication of government policies or potential government policies on major information contained in the financial statement you are analysing. If for example you read a statement made by the chairman or one of the directors about importation of certain components used in the manufacturing of a company’s product, ask yourself; what effect will lax monetary policy of the source country have on the product being imported for use by our target company? There are so many ways of reading to understand the unspoken language of government policies and economic indicators, just make use of a fraction of the over 14 billion cells in your brain.
ABILITY TO SEE THE INTENT OF MANAGERS BEFORE THEY BECOME OBVIOUS
There is a load of information in the accounts of corporate bodies that serves as green light to better or worse tomorrow. Carefully read the different documents that are contained in the financial statement and then establish a form of correlation to see where the vehicle is going to. It is not enough to only read the chairman’s report and take every single word you find there on their face meaning- probe a little. This is easily done by pulling words from different documents to see if they added up.
ABILITY TO SENSE THE TREE ELEMENTS NEEDED FOR A FRAUD TRIANGLE TO BE COMPLETE:
What is the point of staking your money in a venture if you are not certain that your capital will be safe? Although there are government agencies bestowed with the sole responsibly of fighting fraud and economic crime, we still need to look out for warning signs. After all, major frauds in our time and in the past have all escaped the watch of the so-called antifraud bodies. You need to do what I called “track record forensics” on the members of the board of directors as part of the qualitative financial statement analysis- very essential, yet neglected by many.
In as much as you need to be friendly with numbers for you to have the appetite to analyse and interpret financial statement of a company, the scope of financial statement analysis go far beyond the use of complex and often confusing mathematical models for analysis.