Financial Analysis and the Predictability of Important Economic Events

Financial Analysis and the Predictability of Important Economic Events

Financial Analysis and the Predictability of Important Economic Events

Financial Analysis and the Predictability of Important Economic Events

Synopsis

Financial analysis, based on ratio analysis, has been used as a tool for analyzing the financial strength of corporations. Although ratio analysis is generally used as a univariate strategy, the accounting and finance literature has evolved to include multivariate-based models in finacial analysis, and these models can be used to explain important economic events and often predict them. Thus, in an "exhaustive coverage" of the economic events to which they can be applied, Riahi-Belkaoui discusses these models in a way that will have special value to corporate management, financial planners, and to their colleagues in the academic community who specialize in business and economic analysis.

Excerpt

Financial analysis is an information processing system used to provide relevant information for decision making. The main source of information is published financial statements. Basically, various accounts from published financial statements are evaluated in relation to each other to form performance indicators, which are then compared to ‘‘established’’ standards. These performance indicators are better known as ratios, and constitute the main tools of conventional financial analysis. Some of the ratios are particularly relevant to the prediction of economic events. It is therefore the purpose of this chapter to elaborate on financial analysis and the predictive approach.

FINANCIAL STATEMENTS AND ACCOUNTING DATA

The financial statements included in annual reports generally include a balance sheet, an income statement, a statement of changes in the financial position, notes to the financial statements, a reconciliation of retained earnings, an auditor’s opinion, and supplementary information on the effects of changing prices. These reports are discussed next.

The Balance Sheet

The balance sheet, or statement of financial position, expresses the financial position of a firm at the end of the accounting period, a moment in time. More precisely, it presents both the assets of a firm and claims on those assets (liabilities and owner’s equity) at a point in time. Two major questions of interest

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