Question

In financial statement analysis, describe three cheap methods of valuation; to include the process involved, and the advantages and disadvantages of each method ,and describe the process of the fundamental approach to valuation and how this differs to the cheap methods

Answer 1

The first method is the use of horizontal and vertical analysis. Horizontal analysis is the comparison of financial information over a series of reporting periods, while vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. Typically, this means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets. Thus, horizontal analysis is the review of the results of multiple time periods, while vertical analysis is the review of the proportion of accounts to each other within a single period.

The second method for analyzing financial statements is the use of many kinds of ratios. Ratios are used to calculate the relative size of one number in relation to another. After a ratio is calculated, you can then compare it to the same ratio calculated for a prior period, or that is based on an industry average, to see if the company is performing in accordance with expectations. In a typical financial statement analysis, most ratios will be within expectations, while a small number will flag potential problems that will attract the attention of the reviewer.

DISCOUNTED CASH FLOW ANALYSIS (DCF)

A DCF valuation attempts to get at the value of a company in the most direct manner possible: a company’s worth is equal to the current value of the cash it will generate in the future, and DCF is a framework for attempting to calculate exactly that. In this respect, DCF is the most theoretically correct of all of the valuation methods because it is the most precise.

However, this level of preciseness can be tricky. What DCFs gain in precision (giving an exact estimate based on theory and computation), they often lose in accuracy (giving a true indicator of the exact value of the company). DCFs are exceedingly difficult to get right in practice, because they involve predicting future cash flows (and the value of them, as determined by the discount rate), and all such predictions require assumptions. The farther into the future we predict, the more difficult these projections become. Any number of assumptions made in a DCF valuation can swing the value of the company—sometimes quite significantly. Therefore, DCF valuations are typically most useful and reliable in a company with highly stable and predictable cash flows, such as an established Utility company.

Because DCFs are so difficult to “get perfect,” they are typically used to supplement Comparable Companies Analysis and Precedent Transaction Analysis (discussed n ext).

advantages of horizontal and vertical analysis:- The main advantage of vertical analysis is the balance sheets, income statements and other financial reports of businesses of all sizes can easily be compared. It also makes it easy to see relative annual changes within one business. ... A snapshot can be taken of a company's financial position by line item.

advantages of use of many kind of ratios:- Financial ratios are designed to help you evaluate a financial statement. Users of financial information such as creditors, investors, management and financial analyst use ratio analysis for different purposes, such as analyzing liquidity and profitability of the company. It is essential for users to understand the different environments that companies operate in when using ratios to analyze the suitability of an investment.

advantages of discounted cash flow analysis:- Discounted Cash Flow Valuation: Advantages & Pitfalls. ... Discounted Cash Flow (DCF) Valuation estimates the intrinsic value of an asset/business based upon its fundamentals. Intrinsic Value of a business is the present value of the cash flows the company is expected to pay its shareholders

When deciding which valuation method to use to value a stock for the first time, it's easy to become overwhelmed by the number of valuation techniques available to investors. There are valuation methods that are fairly straightforward while others are more involved and complicated.

Unfortunately, there's no one method that's best suited for every situation. Each stock is different, and each industry or sector has unique characteristics that may require multiple valuation methods. In this article, we'll explore the most common valuation methods and when to use them.

Valuation methods typically fall into two main categories:  

Absolute valuation models attempt to find the intrinsic or "true" value of an investment based only on fundamentals.

Relative valuation models, in contrast to absolute valuation, operate by comparing the company in question to other similar companies.

The first step is to determine if the company pays a dividend.

The second step is to determine whether the dividend is stable and predictable.