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Evaluation of Financial Performance. Sources of Comparative Financial Analysis A Word of Caution About Financial Ratio Earnings and Balance Sheet Quality and Financial Analysis Market Value Added: An Alternative Measure of Performance Inflation and Financial Statement Analysis.

What is the usefulness of comparative financial statement analysis?.

For comparative purposes; a nalysts, investors, and business managers use a company's:.

Trade Journal. Annual Reports. . Commercial Banks.

IL MANAC OF BUSINESS+ INDUSTRIAL FINANCIAL RATIOS 2012 EDITION 1 FO TROY, Ph.D. o.

First: Ratios are only as reliable as the accounting data on which they are based..

Third: Valid comparative analysis depends on the availability of data for appropriately defined industries..

In summary, ratios should not be viewed as substitutes for sound business judgement. Instead they are simply tools that can help management make better decisions..

When performing a financial analysis of a firm, an analyst must be mindful of the quality of the earnings reported by a firm as well as the quality of the firm’s balance sheet..

When considering the quality of a firm’s earnings, t wo key factors should be kept in mind..

. Distortions in earnings can arise from such issues as the time of revenue recognition, the establishment of reserves for such items as loan loss provisions in b anking , the amortization of intangible assets, and the like..

Another area of earnings reporting abuse is so-called “pro forma” profitability measures. They are computed by companies “as if” certain ordinary expenses did not exist. In one particularly abusive example, Waste Management treated the cost of painting its trucks as an extraordinary one-time expense and thus excluded this expense from pro forma earnings calculations..

The quality of a firm’s balance sheet should also be of concern to a financial analyst. If the assets on a firm’s balance sheet have a market value equal to or greater than the book value at which they are being carried, this enhances the quality of the firm’s balance sheet..

For example, Philip Morris (now Altria Group) was willing to pay over 10 times the fair value of Kraft’s physical assets in order to obtain the brands (e.g., Velveeta cheese and Miracle Whip salad dressing) and consumer loyalty that Kraft had spent decades building up..

The Market Value Added Concept. MVA is defined as the market value of debt, preferred equity, and common equity capitalization, less capital. Capital is a measure of all the cash raised from investors or retained from earnings to fund new investments in the business, since the company’s inception..

T±Ie3.6 Ste-n St—u-t MVA 2 3 4 6 7 8 9 10 11 12 2706 2707 2708 2709 2710 2711 2712 2713 2714 271S 2716 2717 N gne Eke•trk Ca- Carp VW-t•Ert Procter & Ca- Busöes Ca-p- Motors Corp- Ve-is..•t. AOL'Tüne AT&T Corp- MVA ($ $222.767 212.3e 207.346 124.237 107076 92.231 90.422 82.413 77.3% 69.425 6.8.on (9.231) (12.093) (14081) ( 14.809 (25.49) (27.140 (34.657) (35.21' (38.372) (72.674) EVA ($ $5.983 2.201 2.928 2.839 3872 2.315 (8.032) (2.175) 2.496 (3.736) 360 2.964 (833) ( .762) (713) (1.393) (5849) (3,646) (27.539) (19.959) (7635) (8.434) (27.1 16).

Economic Value Added (EVA®) is a measure of operating performance that indicates how successful a firm has been at increasing the MVA of the enterprise in any given year. EVA is defined as: EVA = [Return on total capital (r) – Cost of capital (k)] X Capital where r = net operating profits after tax divided by beginning of year capital, and k = weighted after-tax cost of capital..

(1) increasing operating efficiency and thereby increasing r (return on total capital;.

( 3) redirecting resources from projects that do not earn adequate returns (relative to the cost of capital) and show little promise of doing so in the future, to more productive uses, including the payment of dividends and reduction of debt levels if no adequate-return projects are present ..

Inflation and Financial Statement Analysis. Inflation can cause a number of problems for a financial analyst who is trying to assess the performance of a firm over time and in comparison with other firms in the industry..

. C onsider a supply company that buys equipment parts wholesale from the manufacturer for $4.00 each and sells them at a retail price of $5.00 each, realizing a profit of $1.00 per unit. Suppose the manufacturer announces a price increase of $0.50 per unit to $4.50, effective on the first of next month. If the supply company passes the increase on to customers and announces a price increase of its own to $5.50, also effective on the first of next month, it will realize a gross profit of $1.50 on every unit sold that originally cost $4.00..

The last-in, first-out (LIFO) inventory valuation method assumes that the items a firm uses from inventory are those that were acquired most recently. Thus, they can be priced out of the inventory based on the most recent inventory acquisition costs..

In contrast, the first- in,first -out (FIFO) method of inventory valuation, which assumes that the items a firm uses from inventory are the oldest items in inventory, results in the firm’s having to show a higher profit and therefore pay higher income taxes..

Inventory profits and inflation are only two factors that can affect a firm’s reported earnings. Differences in the reporting of earnings, the recognition of sales, and other factors can also make comparisons between firms somewhat misleading. Again, a good financial anlyst will always “go behind” the figures stated on a firm’s income statement or balance sheet to find out what is actually occurring within a company.