Financial Analysis Overview

Financial analysis helps in understanding a company’s performance, likened to the layers of a matryoshka doll, uncovering deeper insights step-by-step.

1. Starting with Revenue

• Definition of Revenue: Income generated from goods/services delivered to customers.
• Pre-Revenue Phase: When a company has no revenue yet, analysis focuses on business plans and burn rates.
• Revenue Information: Located at the top of the income statement.
• Key Analysis:
  • Absolute revenue amount
  • Revenue growth or shrinkage (Variance % or V%)
• Calculation of Revenue Growth:
  1. Current year number - Prior year number
  2. Result / Prior year number
     Note: For corrections, no need to apply -1.

Example:

• Company A: $1M revenue with 20% growth is more interesting than $2M with no growth.

2. Organic Revenue Growth

• Important to distinguish total revenue growth from organic growth.
• Organic Revenue Growth: Excludes impacts from acquisitions, divestitures, or currency fluctuations.
• Example with ABC Corp:
  • Total Revenue Growth: 10%
  • Currency Impact: 1%
  • Acquisition Impact: 2%
  • Organic Revenue Growth: 7%
• Information typically found in the management discussion section of annual reports.

3. Profitability Analysis

• Profit Calculation: Revenue - Expenses = Profit
• Key Metrics: Gross Profit, Operating Margin, Earnings Before Tax, Net Income
• Focus on Operating Margin:
  • Is it a positive number?
  • How has it developed over time?
• Desired Growth: Operating margin > Revenue growth.

Analyzing Profitability:

• How much Operating Margin is generated?
• Operating Margin as a percentage of revenue.
• Growth or decline in margin.
• Check for unusual items affecting Operating Margin (one-time charges, etc.)

4. Cash Flow Analysis

• Key Concept: Free Cash Flow - Cash available after necessary expenditures.
• Cash Flow Statement Components:
  1. Cash from Operating Activities
  2. Cash from Investing Activities
  3. Cash from Financing Activities
• Calculating Free Cash Flow: Cash from operating activities - capital expenditures.

5. Negative Signs in Analysis

• Opposite indicators: Revenue decline, margin deterioration, free cash flow decline – these suggest unhealthy financial state.
• Important Question: Can the business survive during turbulence?
• Analyze solvency and liquidity to understand vulnerabilities.

6. Balance Sheet Analysis

• Overview of a company’s assets and liabilities.
• Key Metrics:
  • Cash balance and operational months available
  • Current Assets vs. Current Liabilities ratio (Current Ratio)
• Key Solvency Metric: Debt-to-equity ratio. Higher ratios indicate higher financial leverage.

7. Financial Ratio Analysis

• A set of tools for analyzing the relative financial performance of a company.

Conclusion

Financial analysis involves a detailed examination of various metrics from revenue to profitability and ultimately cash flow, along with assessing risk factors from a company's financial statements.