Lesson 1 of 8 · 13 min
The analysis process and ratio basics
Good analysis starts with a clear purpose, compares the company with a benchmark, and treats every ratio as a clue to what happened, not an explanation of why.
In short
- A general framework has six phases: articulate purpose and context, collect data, process data, analyse and interpret, develop and communicate conclusions, and follow up.
- Computation is not analysis. Analysis explains what happened, why it happened and whether it created value.
- Evaluation needs a comparison: cross-sectional analysis (against peers at the same time) or trend (time-series) analysis (against the company's own past).
- Ratios remove size as a factor and help with valuation, investment selection and predicting financial distress, but they have limitations: diversified operations, inconsistent signals, the need for judgment and different accounting methods.
- With an income statement or cash flow item over a balance sheet item, use an average balance in the denominator.
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