Methods For Determining Financial Performance Essay

1040 words - 4 pages

Chapter three covers various methods of evaluating financial performance. Discuss three of these methods giving the strengths and weakness of each.The three methods of evaluating financial performance that I have chosen to discuss are:1. The Financial Statement Analysis2. The DuPont System of Ratio Analysis3. Pro Forma Financial StatementsFinancial Statement AnalysisThere are three main financial statements investors analyze. They are the balance sheet, income statement and the cash flow statement. The balance sheet is a snapshot in time. It shows all the assets owned and liabilities owed for a company. It also shows the amount of equity or ownership that is paid for by investors. The income statement looks at the entire year. It starts with revenues and then deducts expenses for net income. The cash flow statement shows where the cash is really coming by breaking down cash flow into cash from operations, investing and financing. There are advantages and disadvantages to analyzing financial statements for investment decisions (Bamber, Harrison, & Horngren, 2005).Strengths:Full disclosure is one of the main advantages of, and one of the main purposes for, financial statements. The Securities and Exchange Commission made the 10K report a requirement for all public companies. This 10K includes full disclosure of all financial statements as well as notes explaining all assumptions contained with the notes.Regulatory authorities like International Accounting Standards Board can ensure whether the company is following accounting standards or not.Helps the government agencies to analyze the taxation due to the company.Weaknesses:While financial statements are good for the data needed to conduct a thorough ratio analysis, they are based on the accrual system of accounting, which is not market based. This is both an advantage and a disadvantage. It's good to have a basis for comparing book value to market value. Above all it helps to pinpoint bargains in the market. However, value discrepancies can also work to the disadvantage of financial statement analysis. It can make it difficult to know the real value of assets, which translates into unreliable ratios.Errors in data entry can corrupt the reportsAlthough financial statement analysis is highly useful tool, it has two limitations. These two limitations involve the comparability of financial data between companies and the need to look beyond ratios.The DuPont SystemThe DuPont System of Ratio Analysis is an integrative approach used to dissect a firm's financial statements and assess its financial condition. This tool is particularly powerful because it allows a company's overall business strategy to be divided into just three ratios that directly affect a manager's area of responsibility: profit margin, asset utilization, and financial leverage. The system helps evaluate changes in the firm's performance and determine whether they reflect improvement or deterioration in underlying business...

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