Financial Analysis Procedures
Overview
This skill provides systematic approaches to analyzing financial statements, calculating key performance metrics, and generating comprehensive investment reports.
Key Metrics to Calculate
Profitability Ratios
| Metric | Formula | Interpretation |
|---|---|---|
| Gross Margin | (Revenue - COGS) / Revenue | Higher = better pricing power |
| Operating Margin | Operating Income / Revenue | Operational efficiency |
| Net Margin | Net Income / Revenue | Bottom-line profitability |
| ROE | Net Income / Shareholders' Equity | Return on shareholder investment |
| ROA | Net Income / Total Assets | Asset utilization efficiency |
| ROIC | NOPAT / Invested Capital | Return on all invested capital |
Formulas:
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Gross Margin = (Revenue - COGS) / Revenue * 100 Operating Margin = Operating Income / Revenue * 100 Net Margin = Net Income / Revenue * 100 ROE = Net Income / Average Shareholders' Equity * 100 ROA = Net Income / Average Total Assets * 100 ROIC = NOPAT / (Total Debt + Shareholders' Equity - Cash) * 100
Valuation Metrics
| Metric | Formula | Use Case |
|---|---|---|
| P/E Ratio | Price / EPS | Relative valuation |
| EV/EBITDA | Enterprise Value / EBITDA | Acquisition valuation |
| P/B Ratio | Price / Book Value per Share | Asset-heavy industries |
| P/S Ratio | Price / Revenue per Share | Early-stage/growth companies |
| PEG Ratio | P/E / EPS Growth Rate | Growth-adjusted valuation |
Enterprise Value Calculation:
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EV = Market Cap + Total Debt - Cash and Equivalents EV = Market Cap + Preferred Stock + Minority Interest + Total Debt - Cash
Liquidity Ratios
| Metric | Formula | Healthy Range |
|---|---|---|
| Current Ratio | Current Assets / Current Liabilities | 1.5 - 3.0 |
| Quick Ratio | (Cash + Receivables + Marketable Securities) / Current Liabilities | 1.0 - 1.5 |
| Cash Ratio | Cash / Current Liabilities | 0.5 - 1.0 |
Leverage Ratios
| Metric | Formula | Interpretation |
|---|---|---|
| Debt/Equity | Total Debt / Shareholders' Equity | Lower = less risk |
| Debt/EBITDA | Total Debt / EBITDA | Industry-dependent |
| Interest Coverage | EBIT / Interest Expense | Higher = safer |
DCF Model Structure
Step 1: Project Free Cash Flow
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Free Cash Flow = EBIT(1-Tax Rate) + Depreciation - CapEx - Change in Working Capital Projection periods: 5-10 years Terminal value: Gordon Growth Model or Exit Multiple
Step 2: Calculate WACC
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WACC = (E/V * Re) + (D/V * Rd * (1 - Tc)) Where: E = Market value of equity D = Market value of debt V = E + D Re = Cost of equity (CAPM) Rd = Cost of debt Tc = Corporate tax rate
Step 3: Discount Cash Flows
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DCF Value = Sum of [FCF_t / (1 + WACC)^t] + [Terminal Value / (1 + WACC)^n]
Report Structure
1. Executive Summary (1 page)
- •Investment thesis (bull/bear case)
- •Target price and current price
- •Key catalysts and risks
- •Recommendation (Buy/Hold/Sell)
2. Business Overview
- •Company description
- •Revenue segments
- •Competitive landscape
- •Management assessment
3. Financial Performance Analysis
- •Revenue growth trends (3-5 years)
- •Margin analysis
- •Cash flow generation
- •Capital allocation
4. Peer Comparison
| Metric | Company | Peer 1 | Peer 2 | Industry Avg |
|---|---|---|---|---|
| P/E | ||||
| EV/EBITDA | ||||
| Gross Margin | ||||
| Revenue Growth |
5. Valuation Assessment
- •DCF analysis with sensitivity table
- •Comparable company analysis
- •Precedent transactions (if M&A relevant)
6. Risk Factors
- •Industry risks
- •Company-specific risks
- •Macroeconomic factors
- •Regulatory considerations
7. Investment Recommendation
- •Price target methodology
- •Upside/downside scenarios
- •Timeline for thesis to play out
Output Format Requirements
Always include:
- •Data tables with key metrics
- •YoY (Year-over-Year) comparisons
- •QoQ (Quarter-over-Quarter) trends
- •Industry benchmark comparisons
- •Clear source citations for all data
- •Date of analysis
Red Flags to Watch
- •Declining margins despite revenue growth
- •Increasing receivables faster than revenue
- •Negative operating cash flow with positive net income
- •Frequent accounting policy changes
- •High executive turnover
- •Unusual related-party transactions
- •Goodwill larger than equity
Industry-Specific Considerations
| Industry | Key Metrics | Unique Factors |
|---|---|---|
| Tech | ARR, CAC, LTV, Net Retention | Scalability, TAM |
| Banking | NIM, NPL Ratio, CET1 | Interest rate sensitivity |
| Retail | Same-store sales, Inventory turns | Seasonality |
| Healthcare | Pipeline value, Patent cliff | Regulatory approval |
| Real Estate | FFO, NAV, Cap Rate | Interest rate impact |