Abstract
Financial statement analysis has traditionally been seen as part of the fundamental analysis required for equity valuation. But the analysis has typically been ad hoc. Drawing on recent research on accounting-based valuation, this paper outlines a financial statement analysis for use in equity valuation. Standard profitability analysis is incorporated, and extended, and is complemented with an analysis of growth. An analysis of operating activities is distinguished from the analysis of financing activities. The perspective is one of forecasting payoffs to equities. So financial statement analysis is presented as a matter of pro forma analysis of the future, with forecasted ratios viewed as building blocks of forecasts of payoffs. The analysis of current financial statements is then seen as a matter of identifying current ratios as predictors of the future ratios that determine equity payoffs. The financial statement analysis is hierarchical, with ratios lower in the ordering identified as finer information about those higher up. To provide historical benchmarks for forecasting, typical values for ratios are documented for the period 1963-1999, along with their cross-sectional variation and correlation. And, again with a view to forecasting, the time series behavior of many of the ratios is also described and their typical "long-run, steady-state" levels are documented.
Download PDF
Citation
Nissim, Doron, and Stephen Penman. "Ratio Analysis and Equity Valuation: From Research to Practice." Review of Accounting Studies 6, no. 1 (March 2001): 109-54.
Each author name for a Columbia Business School faculty member is linked to a faculty research page, which lists additional publications by that faculty member.
Each topic is linked to an index of publications on that topic.
Topic 2 – Building Blocks in Financial Accounting
I-Basic building blocs
1.Definitions
Asset: economic resource of the firm. It
must be acquired at measurable cost,
obtained or controlled by the entity,
expected to produce future economic
benefits and arises from a past transaction
or event
Non-current asset: in the entity for more
than 1 year or longer than operating cycle
Current asset: in the entity for less than a
year
Tangible asset: physical substance
Intangible asset: without physical
substance
Financial asset: derives value because of a
contractual claim
Inventories: held for sale in normal course of business or input to produce goods or services for sale
Accounts receivable: created by a credit sale on open account
Cash: in cash money or equivalent
Lliabilities: it must involve a probable
future sacrifice of economic resources
by the entity, the economic resource
transfer to another entity, the future
sacrifice is a present obligation arising
from a past transaction or event
Shareholders’ equity: economic
obligation towards owners of firm
Share capital: economic obligation
towards owners of firm from
shareholders
Retained earnings: economic
obligation towards owners of firm
from the firm itself, net income
retained in a corporation. It is
increased by net income and is
decreased by dividends and a net loss
Liabilities economic obligation towards third parties to firm
Asset and liabilities = balance sheetExpenses and revenue = income statement
1/13