The financial statements of an enterprise present the summarized data of its assets, liabilities, and equities in the balance sheet and its revenue and expenses in the income statement. If not analyzed, such data may lead one to draw erroneous conclusions about the firm’s financial condition.
Various measuring instruments may be used to evaluate the financial health of a business, including horizontal, vertical, and ratio analyses. A financial analyst uses the ratios to make two types of comparisons:
1. Industry comparison. The ratios of a firm are compared with those of similar firms or with industry averages or norms to determine how the company is faring relative to its competitors.
Industry average ratios are available from a number of sources, including:
a. Risk Management Association (RMA). RMA (formerly known as Robert Morris Associate) has been compiling statistical data on financial statements for more than 75 years. The RMA Annual Statement Studies provide statistical data from more than 150,000 actual companies on many key financial ratios, such as gross margin, operating margins, and return on equity and assets.
If you are looking to put real authority into the ‘‘industry average’’ numbers that your company is beating, the Statement Studies are the way to go. They are organized by SIC codes, and you can buy the financial statement studies for your industry in report form or over the Internet (www.rmahq.org).
b. Dun and Bradstreet. Dun and Bradstreet publishes Industry Norms and Key Business Ratios, which covers over 1 million firms in over 800 lines of business.
c. Value Line. Value Line Investment Service provides financial data and rates stocks of over 1,700 firms.
d. The Department of Commerce. The Department of Commerce Financial Report provides financial statement data and includes a variety of ratios and industrywide common-size vertical financial statements.
e. Others. Standard and Poor’s, Moody’s Investment Service, and various brokerate compile industry studies. Further, numerous online services such as Yahoo! and MSN Money Central, to name a few, also provide these data.
2. Trend analysis. A firm’s present ratio is compared with its past and expected future ratios to determine whether the company’s financial condition is improving or deteriorating over time.
After completing the financial statement analysis, the firm’s financial analyst will consult with management to discuss their plans and prospects, any problem areas identified in the analysis, and possible solutions.
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