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Chapter One
Contemporary Financial
Statement Analysis and the
Need for Data Analytics
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Learning Objectives
LO 1.1: Define financial statement analysis (FSA) and data
analytics.
LO 1.2: Describe the FSA framework, the data analytics
process, and the FSA-AMPS model.
LO 1.3: Analyze a company’s competitive environment and
strategic positioning.
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Chapter 1 Contemporary Financial Statement
Analysis and the Need for Data Analytics
Topical Overview:
1. What Is a Modern Approach to Financial Statement Analysis?
2. The FSA Framework, the Data Analytics Process, and the Amps Model.
•
The FSA Framework.
•
The Data Analytics Process.
3. Ask the Question.
4. Master the Data.
5. Perform the Analysis.
6. Share the Findings.
7. Competitive Advantage, Strategic Positioning, and Financial Statements.
•
Company’s Competitive Environment (Porter’s Five Forces).
•
Company’s Strategic Positioning.
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What Is a Modern Approach to Financial
Statement Analysis?
1
Financial statement analysis (FSA) is the process of using
analytical techniques to examine different data sources
relating to a firm’s past financial performance and current
financial condition to make predictions about the future.
Two key points:
1. Focus is on using financial statements to understand the
past. In FSA, accounting is a means-to-an-end.
2. Predicting the future is more important than measuring the
past.
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What Is a Modern Approach to Financial
Statement Analysis?
2
Data analytics (DA) is the process of taking raw data,
employing data analytics techniques, and using results from
the analysis to answer questions.
Three key points:
1. DA (often) requires the use of data from different sources.
2. Many different techniques exist.
3. Results from data analytics support your answer.
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What Is a Modern Approach to Financial
Statement Analysis?
3
A modern approach to financial statement analysis (FSA) combines:
1. Careful analysis of information contained in the financial statements.
•
10K.
•
10Q.
•
Annual report.
2. Careful analysis of relevant information available in data sources outside of
the financial statements.
•
Equity analyst reports.
•
Non-GAAP earnings.
•
Management earnings forecasts.
•
Conference call transcripts.
•
Message boards and Twitter (X) feeds.
•
Industry reports.
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The FSA Framework
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The FSA Framework: Step 1
Determine the stakeholder of interest.
Different stakeholders will have different questions:
• Vendors ≠ Lenders ≠ Owners (Equity).
• Defining the stakeholder helps focus the analytic work.
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The FSA Framework: Step 2
Master the past.
Employ data analytic (DA) processes to understand:
• What happened?
• Why did it happen?
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The FSA Framework: Step 3
Predict the future.
Employ data analytic (DA) processes to:
• Make forecasts and predictions.
• Assess which action is best given the forecasts and
forecast sensitivity.
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The FSA Framework: Step 4
Predict the future.
Answer the stakeholders’ question.
What should the stakeholder do given the results of the
analysis?
• What is the recommended action?
• Support the recommendation with results from analysis.
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The AMPS Model
1. Ask the Question: What are
you trying to understand?
2. Master the Data: Identify
relevant data to answer
question.
3. Perform the Analysis:
Perform data analytics to
answer question.
4. Share the Findings:
Communicate findings using
data visualization.
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Ask the Question
Different stakeholders will have different
questions:
• Vendors: Can the firm pay for its
inventory?
• Secured lenders: Can the firm’s
collateral cover its loan?
• Unsecured creditors: Can the firm make
its interest payments?
• Employees: Can the firm pay its pension
obligations?
• Equity investors: Is firm value sensitive
to growth assumptions?
Clearly defining the question minimizes the
time spend on unnecessary analysis.
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Master the Data
Identify, understand, and incorporate
available data sources into the
analysis.
Data identification:
• Identification and collection of
information that is relevant to the firm’s
economic performance and financial
condition.
Data incorporation:
• Process of linking relevant information
identified in prior step into a cogent
economic story of the firm.
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Perform the Analysis
1
Employ data analytic techniques and processes to
answer the question.
Descriptive analytics:
•
Data analytic techniques used to characterize,
summarize, and organize high level data.
•
Answers such questions as:
•
What happened?
•
What is happening?
Diagnostic analytics:
•
Data analytic techniques used to investigate why
something happened.
•
Answers such questions as:
•
Why did the firm realize low earnings growth?
•
Why is the firm’s inventory turning slowly?
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Perform the Analysis
2
Employ data analytic techniques and processes to
answer the question:
Predictive analytics:
•
Data analytic techniques used to predict future
outcomes.
•
Answers such questions as:
•
What will earnings growth be next year?
•
What is the likelihood that the firm will realize high
sales growth next year?
Prescriptive analytics:
•
Data analytic techniques used to assess best future
action given constraints.
•
Answers such questions as:
•
Should the firm liquidate its inventory given our
demand predictions?
•
Should the firm issue additional short-term debt to
fund additional inventory purchases?
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Share the Findings
Once analysis is complete, the
results need to be communicated
to others:
Data visualization:
•
•
•
•
Graphs.
Plots.
Bubble charts.
Sparklines.
Sensitivity analysis:
• What-if analysis.
• Pivot tables.
• Open- and closed-form analysis.
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Company’s Competitive Environment:
Porter’s Five Forces
Porter’s Five Forces is a framework
for analyzing the competitiveness of
an industry.
Attributed to Michael Porter (1979).
Industry competitiveness is directly
related to profitability.
• More competitive industry →
more difficult to remain profitable.
Understanding dynamics that affect
profitability will guide your FSA.
• Profitability is the most important
metric of firm success.
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Porter’s Five Forces: Rivalry within
the Industry
Rivalry within the industry captures the extent to
which firms directly compete against each other.
Product uniqueness/importance to customers
best characterizes this force:
•
Unique/important product → weak force.
•
Common/unimportant product → strong force.
Financial statement items/ratios that capture
force:
•
Lower profitability.
•
Higher advertising expenditures.
•
Faster reversals of abnormal profitability.
Industry examples where force is weak:
•
Restaurants.
•
Commercial air travel.
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Porter’s Five Force: Threat of New
Entrants
The threat of new entrants captures the ease
which new firms can enter the industry when
profitable opportunities exist.
Existence of barriers to entry is the dynamic that
best characterizes force:
•
High barriers → weak force.
•
Low barriers → strong force.
Financial statement items/ratios that capture force:
•
Significant fixed assets due to production
scale.
•
Legal protection via intangible assets (patents).
•
Sale of products requiring regulatory approval.
Industry examples where force is weak:
•
Airlines.
•
Petrochemical.
•
Pharmaceutical drugs.
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Porter’s Five Forces: Bargaining
Power of Suppliers
The bargaining power of suppliers captures the
importance of individual vendors’ products to the
business model of the firm.
The use of vendors for which viable substitutes do
not exist best characterizes force.
•
Lots of substitutes → weak force.
•
No substitutes → strong force.
Financial statement items/ratios that capture
force:
•
High A/P turnover ratios.
•
Low gross margins (due to higher COGS).
Industry examples where force is strong:
•
Industries requiring rare-earth minerals.
•
Smart phone manufacturers.
•
Lithium battery manufacturers.
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Porter’s Five Forces: Threat of
Substitute Products
Threat of substitute products captures the ease which
customers can, and are willing, to switch to similar
products offered by other firms.
The uniqueness and importance of the firm’s products
best characterizes this force:
•
Unique/important product → strong force.
•
Commodity-like product → weak force.
Financial statement items/ratios that capture this force
if strong:
•
Lower gross margin (due to low sales price).
•
Low A/R turnover ratio.
Industry examples where force is weak:
•
Fast food restaurants.
•
Gas stations.
•
Coffee shops.
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Porter’s Five Forces: Bargaining
Power of Buyers
The bargaining power of buyers captures the
importance of individual customers to the firm.
Existence of customers that constitute significant
purchase volumes best characterize this force.
•
Lots of small customers → weak force.
•
Very few customers → strong force.
Financial statement items/ratios that capture force:
•
Low A/R turnover ratios.
•
Low gross margins (due to price discounts).
Industry examples where force is strong:
Defense industry.
•
Sell to US government.
Commodity electrical supplies.
•
Sell to The Home Deport; Lowes.
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Strategic Positioning: Porter’s
Competitive Strategies Matrix
Given the:
•
Competitive dynamics of industry.
•
Competitive advantages of firm.
Firm choose corporate strategies that maximize the benefits
of their competitive advantages given the competitive
dynamics of the industry.
Cost Focus:
Choose to be a low-cost producer:
•
Produce wide product assortment at low cost (For example, Walmart).
•
Produce narrow product range at low cost (For example, Little Caesars Pizza).
Differentiation Focus:
Choose to sell unique products at high price:
•
Broad differentiation (For example, Macy’s, Harrods).
•
Narrow differentiation (For example, Apple i-products).
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