9.9 Summary: The Fundamentals of Accounting and Financial Analysis
This might be a good place to review what we have learned thus far. First, we highlighted some difficulties in reading financial statements for financial analysts. We did this by focusing on examples of current (inventory) and long-term asset accounting (depreciation) respectively. These highlights assisted us in listing and understanding the four primary issues related to accounting data interpretation namely, historical bias, the arbitrary use of cost method, and problems having to do with estimates and reserves. For us, the statements may not be what they seem, with consequent reduced usefulness. If we are going to use accounting data as inputs for ratio analysis, we must first and foremost be cognizant of this, and (later) learn how to adjust the numbers, a skill, which you would acquire in a Financial Statements Analysis course.
Between highlighting accounting problems and presenting ratio analysis, we discussed the creation of pro forma financial statements and created a projected income statement. We also looked at a model for projecting free cash flow, a very important predictor of a company’s ongoing performance, and a metric by which possible investment projects are evaluated. Finally, we discussed the External Funds Needed model, an important tool in capital planning in order to accommodate growth.