Analyzing financial statements provides us with a correct valuation of the company".

1- Introduction
Financial statement analysis is a process that examines past and current financial data for the purpose of evaluating performance and estimating future risk and potentials. Financial statement analysis is used by investors, creditor, security analysts, bank lending officers, managers, governmental agencies, suppliers, and many other parties who rely on financial data for making economic decisions about a company

2- Financial Analysis Statement Specifications and Users

Financial analysis is designed to determine the relative strengths and weaknesses of a company. Investors need this information to estimate both future cash flows from the firm and the riskiness of those cash flows. Financial managers need the information provided by analysis both to evaluate the firms past performance and to map future plans. Financial analysis concentrates on financial statement analysis, which highlights the key aspects of a firms operations. Financial statement analysis involves a study of the relationships between income statement and balance sheet accounts, how these relationships change over time (trend analysis), and how a particular firm compares with other firms in its industry (bench-marking). Analysis of financial statements focuses primarily on data provided in external reports plus supplementary information provided by management. The analysis should identify major changes or turning points in trends, amounts, and
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relationships financial statements are merely summaries of detailed financial information. Many different groups are interested in getting inside financial statements, especially investors and creditors. Their objectives are sometimes different but often related. However, the basic tools and techniques of financial statement analysis can be applied effectively by all of the interested groups. Financial statement analysis can assist investors in finding the type of information they require for making decisions to their interests in a particular company. Financial reports are the primary means by which managers communicate company results to investors, creditors and analysts. These parties use the reports to judge company performance, to assess creditworthiness, to predict future financial performance, and to analyze possible acquisitions and take-over. Users of financial statements must be able to meaningfully interpret financial reports, construct measures of financial performance and analyze the reporting choices made by companies. Also, since company managers choose accounting techniques when making their reports, users must learn to undo the effects of these accounting choices.

3- Financial Analysis Techniques

Financial statement analysis is an evaluative method of determining the past, current and projected performance of a company. Several techniques are commonly used as part of financial statement analysis including horizontal analysis, which compares two or more years of financial data in both dollar and percentage form; vertical analysis, where each category of accounts on the balance sheet is shown as a percentage of the total account; and ratio analysis, which calculates statistical relationships between data. It is the process of identifying financial strengths and weaknesses of the firm by properly establishing relationship between the items of the balance sheet and the profit and loss account.

3.1-Financial Analysis Primary Tools: 3.1.1Financial Statements. Balance sheet, Income Statement, Cash Flow Statements. are the most important financial statements and if properly analyzed and interpreted can provide valuable insights into a companys business. Income Statement A financial statement that shows the revenues, expenses and net income of a firm over a period of time A financial report that tells how well a company is performing (its profitability or net profit) during a specific period of time. Net Income is a primary determinant of the firms cash flows and, thus, the value of the firms shares Balance Sheet A financial statement that shows the value of the firms assets and liabilities at a particular time A summary of a firms financial position on a given date that shows total assets = total liabilities + owners equity. Statement of Cash Flows A summary of a firms revenues and expenses over a specified period, ending with net income or loss for the period. A financial statement that tracks cash coming into and flowing out of a firm over a period of time. 3.1.2 - Comparison of financial ratios to past, industry, sector and all firms Financial ratios are designed to help one evaluate a firms financial statements. The burden of debt, and the companys ability to repay, can be best evaluated: (1) By comparing the companys debt to its assets. (2) By comparing the interest it must pay to the income it has available for payment of interest.
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Such comparisons are made by ratio analysis.

4- Financial Ratio Analysis

Financial statement analysis is a study of accounting ratios between various items in financial statements. Ratios are classified as profitability ratios, liquidity ratios, asset utilization ratios, leverage ratios and valuation ratios based on the indications they provide. 4.1- Types of Comparison (Ratio) 4.1.1-Liquidity Ratios :
Current: Shows a firms ability to cover its current liabilities with

its current assets. Acid-Test (Quick): Shows a firms ability to meet current liabilities with its most liquid assets. 4.1.2-Financial Leverage Ratios: Debt-to-Equity: shows the extent to which the firm is financed by debt.
Debt-to-Total- Assets: Shows the percentage of the firms assets that are supported by debt financing.

4.1.3-Coverage Ratios: Interest Coverage, Indicates a firms ability to cover interest charges.

4.1.4-Profitability Ratios: Gross Profit Margin, Indicates the efficiency of operations and firm pricing policies. Net Profit Margin, Indicates the firms profitability after taking account of all expenses and income taxes Return on Investment, Indicates the profitability on the assets of the firm (after all expenses and taxes)

Return on Equity, Indicates the profitability to the shareholders of the firm (after all expenses and taxes)

4.2-Objectives of Ratio Analysis

o o o o o o

Standardize financial information for comparisons Evaluate current operations Compare performance with past performance Compare performance against other firms or industry standards Study the efficiency of operations Study the risk of operations

4.3-Summary of Financial Ratios: Ratios help to: o Evaluate performance o Structure analysis o Show the connection between activities and performance Benchmark with o Past for the company o Industry Ratios adjust for size differences 4.4-Ratios and Forecasting: Common stock valuation based on o Expected cash flows to stockholders Ratios influence expectations by: o Showing where firm is now o Providing context for current performance Current information influences expectations by: o Showing developments that will alter future performance

5-Sources of Data for Financial Analysis:

1- Companys financial reports (Quarterly, Semiannual or Annual reports). Via mail, SEC or company websites 2-Published collections of data e.g., Dun and Bradstreet or Robert Morris 3-Investments sites on the web Examples http://moneycentral.msn.com/investor http://www.marketguide.com 4 -Local official financial markets. Like Abu Dhabi financial market, Dubai financial market.

6-Financial Statement Analysis performance

A comprehensive financial statement analysis can highlight some of the more important issues and questions a savvy investor will usually ask such as:

Does the company have enough liquidity to overcome any short-term market fluctuations? How was the performance relative to the industry it belongs to? How risky is it to invest in this company? How does the company handle its working capital? How did the company perform over the last couple of years and what were the returns it generated for the previous stakeholders?

7- Rationale behind the statement Analysis

1- A firm has resources 2- It converts resources into profits through: Production of goods and services. Sales of goods and services 3- Ratios: measure relationships between resources and financial flows show ways in which firms situation deviates from:Its own past Other firms The industry All firms

8-Financial Statements Advantages

There are various advantages of financial statements analysis: 1- The major benefit is that the investors get enough idea to decide about the investments of their funds in the specific company. 2- Regulatory authorities like International Accounting Standards Board can ensure whether the company is following accounting standards or not. 3- Financial statements analysis can help the government agencies to analyze the taxation due to the company. 4- Moreover, company can analyze its own performance over the period of time through financial statements analysis. 5- Helps to identify sources of strength and weakness in current performance 6- Helps to focus attention on value drivers
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9-Financial Statement analysis Limitations

Although financial statement analysis its very useful, it has many advantages, and it's a highly useful tool, however, it has limitations also, but when its used with care and judgment, it can provide some very useful insights into a companys operations

Limitations:1-The first limitation involves the comparability of financial data between companies; Comparison of one company with another can provide valuable clues about the financial health of an organization. Unfortunately, differences in accounting methods between companies sometimes make it difficult to compare the companys financial Sometimes enough data are presented in the foot notes to the financial statements to restate data to a comparable basis. Otherwise, the analyst should keep in mind the lack of comparability of the data before drawing any definite conclusion. Nevertheless, even with this limitation in mind, comparisons of key ratios with other companies and with industry averages often suggest avenues for further investigation.

2-The second limitation, that an inexperienced analyst may assume that ratios are sufficient in themselves as a basis for judgment about the future. Nothing could be further from the truth. Conclusions based on ratios analysis must be regarded as tentative. Ratios should not be viewed as an end, but rather they should be viewed as starting point, as indicators of what to pursue in greater depth. They raise many questions, but they dont answer all questions by themselves. 3-A firms industry category is often difficult to identify. 4-Published industry averages are only guidelines. 5-Accounting practices differ across firms. 6-Sometimes difficult to interpret deviations in ratios. 7-Industry ratios may not be desirable targets. 8-Seasonality affects ratios.
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10-Beyond the Provided Financial Statement Information

In addition to ratios, other sources of data should be analyzed in order to make judgment about the future of an organization. The analyst should look, for example, at industry trends, technological changes, changes in consumer tastes, changes in broad economic factors, and changes within the firm itself. A recent change in a key management position, for example, might provide a basis for optimization about the future, even though the past performance of the firm (as shown by its ratios) may have been mediocre. 10.1-Pension found: A special long-term liability, the pension fund. For many companies, this is a very large liability and, for the most part, its not captured on the balance sheet. We could say that pensions are a type of off-balance-sheet financing. Companies are now required to disclose how the pension plan is invested. For example, PepsiCo's footnote explains the target asset allocation of its pension (60% stock and 40% bonds) and then breaks down its actual allocation. Furthermore, investors should check to see how much of the pension fund is invested in the company stock

11-Impervious Factors
While it is important to understand and interpret financial statements, sound financial analysis involves more than just calculating and interpreting numbers. Good analysts recognize that certain qualitative factors must be considered when evaluating a company. Some of these factors are: The extent to which the companys revenues are tied to one key customer. The extent to which the companys revenues are tied to one key product. The extent to which the company relies on a single supplier. The percentage of the companys business generated overseas. Competition.
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 Future prospects. Legal and regulatory environment.

12-Summary and Recommendations:

In summary, financial statement analysis is concerned with balance sheet analysis and income statement analysis of a business to interpret the business ratios & financial ratios for financial modeling, financial forecasting and business valuation. Financial analysis is part of the decision making process. Financial decision making involves analyzing the financial condition that the company or investors faces and deciding which course of action should be taken. Its impossible to say which of the various techniques of financial analysis is the best. They are all tools to be used in decision making and, as such, should be applied according to the situation. An important consideration in financial analysis is timing .The timing of various financial policies is important in terms of interest rates, inflation, taxes, and the capital market.

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