Question

Identify and describe the six major building blocks of financial statement analysis. What is the initial step in applying the building blocks to analysis of financial statements? (300 words minimum)

Answer 1

The Six major building blocks of financial statement analysis include:-

1. Activity ratios: These ratios are calculated to tell us the operating efficiency of the company and how efficiently the company is utilizing it. These include: Inventory turnover ratio, Receivables turnover etc.
2. Liquidity ratios: These are the ratios which tell us whether the firm is able to meet its short term obligations or not. eg: Current ratio, Quick ratio etc.
3. Solvency ratios: These ratios tell us about the firms capability to meet the longer term obligations . eg: Debt to capital , Debt to equity etc.
4. Profitability ratios: These ratios gives the analyst an idea about the firm's profit margins as well as the return percentages. eg: Gross profit margin, EBIT Margin, PBT Margin etc.
5. Valuation Ratios: They give an analyst a brief about the company as well as the equity value eg : P/E ratio, EV/EBITDA.
6. DuPoint Analysis: This is used to analyze company's Return on Equity, which is calculated by breaking it down it to different ratios.

The very first step involved in the analysis of financial statement includes establishing the objectives of financial analysis by defining the purpose of the analysis.