Financial Analysis, from Scratch to Professional!

Let's burst three myths about accounting:

• Accounting is boring. This is untrue, or at least true for people, which do not understand how accounting works. If comprehended accounting can be very intuitive and fun.
• Accounting is not about math. Accounting is not about math, but logic. If you are endowed with a logical mind you can expect to excel in accounting.
• Accounting is worthless. Untrue! Accounting is the foundation of business and its language. A good accounting department can make a difference between a successful and unsuccessful business.

In this lecture I want to show you how Accounting can be poetical as well. You will find here the Balance Sheet and Income Statement in verses.

The Double-Entry System was used for the first time (at least officially and in its raw version) by the Venetian Merchant, Luca Pacioli.

Ever since, the system which is the backbone of the accounting discipline has almost remained unchanged.

Double-entry means that to record a transaction this must hit two sides of two accounts. In other words, if you received cash from a customer, you will record that cash by hitting the debit side of the cash account. On the other hand, to complete the recording, you myst hit the credit side of the income account.

In this lecture we are going to see from a practical standpoint how this all works and how to perform double-entries.

Although those two statements seem to apparently conflict, they are intimately related. Indeed, BS and IS are brothers, with very different personalities, but each of them crucial to the understanding of the health of the organization.

In this lecture we are going to see how those statements are connected. In fact, there is no way to have the "BS balancing" if we don't make the IS' bottom line flow into the balance sheet.

In fact, while the balance sheet is comprised of two sections:

• Assets, comprised of two subsections: Current and Non-Current or Fixed Asset
• Liability & Equity. Liabilities are comprised of two subsections: Current and Non-Current Liabilities.

The income statement is comprised of two main categories:

• Revenues
• Expenses

Once we subtract from the revenues, the expenses we get the Net Profit or Loss. This is called also bottom line and must flow within the equity section of the balance sheet. Once completed this step we will be able to balance the books.

Why the bottom line flows into the equity section of the balance sheet? Remember that equity is capital invested into the business by shareholders. Shareholders by risking their capital expect to share profits, once the company produces them but also to share losses. Therefore, each time there will be a Net Profit or Loss this will affect positively or negatively the capital invested into the business.

In this lecture we are gong to see how those statements work from the practical standpoint through some real life examples.

The General Ledger (GL) is the centerpiece of the accounting building. Indeed, in this report are described all the transactions which happened in a certain time period.

However, while the BS and IS show the summary of those transactions the GL, instead, is a very detailed report.

In fact, if BS and IS can be defined as brothers, the GL is of course the father of those reports. In other words, the GL is a register where all single transactions are recorded.

The GL is crucial for three reasons:

• Detail account of the transactions happened in a certain period of time
• Document from which main financial statements are built
• Can be very useful for auditing

In this lecture you will understand how the GL works, so that you will be able to build BS and IS starting from the GL.

In this lecture we are assuming that you have access to information contained in the GL, which are usually internal information.

Through the Accounting Game you will practically understand how to manipulate financial statemetns. What can you expect after completion of this lecture?

• Understanding of how the double-entry system works
• Comprehending how the Balance Sheet and Income Statement are intertwined
• Maturing the ability to build your own financial statements from scratch

I came up with this system when I had to explain accounting to some of my students, which were new to the discipline. They appreciated this method so much, that I included it in this course as well.

Follow the instructions below:

Step 1. Open The Accounting Game spreadsheet

Step 2. Watch the video and follow the instructions

Step 3. Build BS and IS on your own before confronting it to the result at the end of the video

This lecture has been placed at the end of the section "From Scratch to Professional Accountant," since if you will be able to complete it successfully you are ready to be an accountant.

A Ratio is a comparison, that's it!

It is a comparison about anything. Imagine, you just bought apples and oranges. You want to understand what is the comparison between those two items. In other words, you have 10 apples and 5 oranges.

You take the number of apples (10) divide it by the number of oranges (5) and you get a ratio of 2. What does this number mean? It means, that we have twice as much apples than oranges. On the other hand, we could also reverse the equation and still have the same result. We could divide the number of oranges (5) by the number of apples (10) and get a Ratio of 0.5. It means that we have half the number of oranges compared to apples.

Financial Ratios follow the same concept. We have ratios for anything. Although, in finance we have five specific categories of ratios:

• Profitability
• Liquidity
• Leverage
• Efficiency
• Valuation

Those ratios are a goldmine for the analyst which can really analyze any company by just looking at the Balance Sheet and Income Statement.

The Profitability Ratios measure the level of profitability, therefore the ability to produce earnings of any company. What does "producing earnings" mean?

A company produces earnings when its Revenues are greater than its overall Expenses. In other words, each time you look at the Income Statement's bottom line, you will see either a Net Profit, or a Net Loss.

When this statement shows a Net Profit, that is when a company can be said to produce earnings. But why do we use Profitability Ratios?

The Income Statement itself gives you a good amount of information about a company's ability to produce earnings. Although, the human brain is hardwired to think in percentage. Therefore, when we plug the hard numbers that we see on the Income Statement to compute our Profitability Ratios, automatically recreate a relationships between metrics on the Income Statement which tells us a clearer story.

For example, if I tell you, "your Revenues are $100, while your Net Income is $10." Automatically, your brain thinks "Hum, my net income is 1/10 of the sales." In short. your brain relates the items, and it does it automatically. Indeed this ratio is called Profit Margin. Now if we translate this number into a percentage, we know that 10/100 = 0.10 or 10%, that's it! We have our Profitability Ratio.

In this lecture we are going to use the main Profitability ratios:

• Gross Profit Margin
• Net Profit Margin (Profit Margin)
• Return on Assets
• Return on Equity

Liquidity marks the difference between a successful and a failing business. Indeed, liquidity is the ability of a company to meet its short-term obligations. But how can we assess liquidity?

Simply by looking at the comparison between current assets and current liabilities of an organization. Indeed, the current assets are the resources at the company disposal, which will be converted into cash within one year or so. While, current liabilities, are short-term obligations, to be paid within one year or so.

However, not all current assets are really liquid. In other words, there are certain current assets which are more liquid (cash of course!) compared to others (inventories or prepaid expenses).

For such reason we are going to see three liquidity ratios based on the level of liquidity of the current assets, which can be subdivided in:

• Current Ratio
• Quick Ratio
• Absolute Ratio

Anywhere in finance you hear the term "Leverage." As obscure and arcane this world can seem, it is actually very intuitive. Ancient men already understood the power of levers, and they actually used them to move objects that otherwise would have been too heavy for humans.

The same principle applies in finance. Sometimes leverage is referred to the fact that certain financial instruments allow their holders to handle a position that otherwise would require way more capital. For instance, when in finance you hear "1 to 100 leverage" it just means that a certain instrument (called future) gives you the chance to manage a position worth $100 with just $1. As you can imagine, you know that the $1 you hold can be lost very easily. On the other hand you also know that, your potential earnings can be huge.

The same principle applies to financial statements, and Balance Sheet in particular. In fact, since the Balance Sheet shows the financial position of a firm, it is there that we will find precious information about leverage. In fact, by looking at the relationship between total liabilities and equity, that is how we understand how the company is handling leverage.

Often, shareholders are incentivized to make the company as much indebted as possible, since their ROE would increase. For instance, if you invested $100 into the business as shareholder and the company made $10 of profits, your ROE would be 10% (10/100). Imagine instead the case in which you invested $50 into the business and borrowed $50 from creditors. The company now makes $9 of profits (you pay $1 in interests), but your ROE is now 18% (9/50)! Therefore, you increased your ROE by 80% thanks to leverage!

There is no downside to leverage if used cautiously. in short, firms often use leverage to improve their capital structure (how to make debt work for the firm). However, when debt becomes the main driver of growth for the firm that is when leverage becomes a double-edged sword.

Through Leverage Ratios we can understand whether leverage is a weapon that the firm is using at its advantage or rather a double-edge sword that will soon make the company fragile to speculation.

The main Leverage Ratios we are going to see are:

• Debt Ratio
• Debt to Equity Ratio
• Interest Coverage Ratio

The concept of Efficiency recalls that of Effectiveness. An effective person is someone who is able to have maximum results with minimum effort. For instance, Joe and Alan, started with a portfolio of $10,000 each. After ten years Joe had $12,000, while Alan had $100,000. Who was the most effective of the two? Alan, since he made his assets (in this case cash) give him a 10x return.

The same principle applies to companies. Firm that are able to generate more returns in comparison with the assets owned are the ones which are more efficient.

In this lectures we are going to see the main efficiency ratios:

• Inventory Turnover
• Account Receivable in days
• Account Payable in days

Value, value, value! This is another word, which can mean all and nothing in finance. The concept of value is not an absolute one. One thing is valued more when there is more demand compared to offer, and it is worth less when there is less demand in relation to offer.

A bottle of water into the desert will be worth way more than a bottle of water in a supermarket. This is how demand and offer trivially work. This is true for goods in general, but who set the price for firms? The market.

If a firm is not listed (not a public company) the value of the company will depend upon the offers a company receives by private investors. When, instead a company is listed the value of the company will be given by its stock price. The stock price in turn is created by the stock market, which is a place where investors meet to exchange stocks.

Keep in mind, Mr. Market is not always right in pricing stocks. In this lecture we are going to see how the main valuation ratios work:

• EPS (Earnings per share)
• P/E (Price over earnings)
• Dividend yield
• Payout
• P/Book (Price over book value)

The ROE can often be misleading. In fact, the ROE has two variables: net profit and shareholders equity. When the ROE increases it can be for two reasons;

• due to improved net profit
• due to decreased equity

The first scenario is positive. Indeed, the firm was able to either make more money or to reduce its expenditures.

The second scenario is not necessarily positive. If the company reduced its equity it means an increased debt level. if this strategy isn't necessarily bad, it can also be risk in the long-run.

The DuPont analysis is a good way to remove the drawbacks coming from the ROE alone.

In this lecture you will be taught how to determine what made the ROE change overtime.

Thanks to the Internet financial information can be found anywhere. Although, this may seem an advantage, it is actually harder for the average person to understand which information is worth listening and which not.

The Analyst cannot afford to listen to formation produced by other financial sources but rather to create its own opinion based on financial reports issued by the organization.

In this lecture we are going to see what are the main reports that will help us throughout the financial analysis we are going to perform throughout the course.

Among the reports produced by listed companies, the 10K (or Annual Report) is the main source of the financial information to be used as starting point of our analysis.

In this lecture we are going to see how a real 10K looks like and what we want to look at when we actually open this report up. You will learn how to handle this report.

The context is very important in every domain. In fact, if you have to participate in a competition, it is important to get ready without caring too much about the competitors.

On the other hand, being bling about the context can be also harmful, since you may loose the chance to understand how is you performance from an objective standpoint.

In this lecture, we are going to see what aspects to take into account when selecting comparable companies. In short, companies which share the same features of the target firm we are going to analyze.

Based on that, in this lecture we are going to see tow main profiles:

• Business Profile
• Financial Profile

In this lecture we are going to use a tool, the Stock Screener, which we can use to find the comparable we are looking for, based on the business and financial profile features we were able to acquire in the previous lecture.

Thanks to this tool we can select the criteria that we want to use to find the peers of our target company.

It is crucial to understand the concept of risk as defined in corporate finance. The objective of this lecture is to give you an introduction to risk.

In fact, risk has a bivalent meaning. On one hand, risk means danger. On the other hand, it also means opportunity.

What are going to tackle three main points:

• What is risk
• According to whom we can assess risk
• Until which extent can risk be diversified

In addition, we are going to see how risk can be classified based on the concept of diversification. In other words, we are going to see what risk can be diversified away and which part of risk instead cannot.

Excel if the most powerful tool at disposal of the Analyst. Although, having technical background is the prerequisite, knowing excel can really boost your career.

In this section we are going to see five main features in Excel, which can be used by the analyst to build nice and automated reports.

Although may seem a trivial task, formatting is very important to give consistency to your reports. The professional analyst knows that a report has to look 100% professional before it gets submitted to clients or upper management.

In this lecture, we are going to see how to make raw data appear very professional. Many times reports are prepared for an audience, which is not from the finance world. Your objective is to guide your audience, and highlight some metrics on the financial reports, that are more relevant compared to others.

The Hyperlink is a very simple tool, that allows you to link external sources to our excel document. Although the financial info related to the analysis has to be into the spreadsheet, some information get updated periodically. For instance, the stock price is actually updated daily.

In this lecture we are going to see how to insert a link into the spreadsheet to recall the stock price of the target company.

The IF Statement is a practical tool, that can be used to automate reports. The cool thing about this too is its versatility. In short, this function allows us to program excel to give us a certain result, when a certain condition (that we are going to set up) will happen.

In this lecture we are going to see hot to use the IFERROR function to have our reports look professional and also how to use the general IF statement to make our report automated.

The Vlookup is really one of the most used function in the financial industry. Due to its versatility this function can be used for many purposes.

For instance, in this lecture we are going to see how to generate a box where you can tell excel how to give you back what you are looking for.

Any firm, which is looking for accountants, analysts or finance professionals will ask as requirement the use of Vlookup function.

Our brains work visually. In short, through images we grasp things quickly. Also a concept which initially looked difficult can be simplified and understood through images.

No surprise Tables and Charts are among the most used excel tools. In this lecture we are going to learn how to create a table and also how to use that table to create nice charts, which will make our report look super professional.

In this lecture are summarized the three steps we are going to take to complete the first part of the financial analysis. The purpose of this analysis is to understand how the company performed in the current year in comparison to the previous year and also how the firm compares to its peers.

Eventually we will be able to assess the health of the organization from internal and external standpoint. In this lecture you will see how to set up the analysis.

Before we start it is very important to have organized all the information you will need throughout the analysts. Indeed, in this lecture we are going to set up a folder where all the main reports will be gathered. Eventually this folder will be the central source of our analysis.

The main objective for this lecture is to compare the financial results from the current year to the financial results related to the previous year (you can also use the same format for three or five years comparison). A set of ratios were selected to assess four main aspects:

• Profitability
• Liquidity
• Leverage
• Efficiency

Eventually we will know how the firm performed in comparison to the previous year.

The main purpose of the DuPont Analysis is to understand why the ROE increased. In Lecture 13 (DuPont Analysis Explained) we already saw how this equation works. We are going to repeat the exercise here, but in this case it will be done in the context of our ratio analysis.

As you will see Apple Inc. ROE increased substantially and through this lecture we will understand why. The analyst objective is to understand what goes on behind the scenes of any firm by looking at its financials. If an inexpert eye would look at an increased ROE naively, the analyst has to always be skeptical. In fact, from a further investigation wi will understand throughout this course how the firm was able to ultimately improve its profitability.

Once selected the two peers (you can select as much peers as you want for your analysis) we are going to compare the financial metrics of our target company with that of its comparable. In this lecture we selected two comparable based on few determinant aspects: Business and Financial Profile. Although, at a first look those companies may seem very different, you will see how the core business is the same.

Indeed, the peers were selected based on the software side, rather than just hardware. The hardware, which played an important role in the past has become less and less significant. Today, the success of the computer, smartphone and technological equipment industry largely depends on the software features that a product may offer.

The purpose of this lecture is not to make any inference yet but rather just learn how to compute the main ratios for the comparable companies.

In the first three steps taken so far, we performed the main financial ratios. The information acquired will be analyzed more in detail in this lecture. Indeed, while the purpose of the previous steps was to mainly run those ratios, now we want to understand what is happening.

The ratio analysis is just a starting point for the analyst. In fact, like a general, which commands a sheep and by using its radar can understand where the enemy may be; the analyst uses the ratio analysis to spot the main issues, that will need further investigation.

In this lecture we are going to spot those issues, which will be further investigated in the next lectures.

Although the profitability substantially increased from 2014, we want to see what is the main source of income for the company. For such reason, we are going to perform a sales breakdown analysis from 2013 up to 2015. The purpose of this analysis is to understand on what basis the profitability of the firm (which today is very strong) is based on.

For instance, we are going to see whether the profitability of the firm depends on a certain product or market. Although, dependence from one product or one particular market is not necessarily bad, it also makes the profitability of the firm more fragile and open to future speculation.

Therefore, we want to ask: Is the company decreasing its dependence from a single product (therefore diversifying its project/product specific risk)? Is the company working on inscribing or decreasing its dependence on a single market (to assess the level of international risk)?

In this lecture we are going to gain an insight on how the company sales evolved from 2013 up to 2015.

Two other concerns, which came out from our analysis were Liquidity and Leverage. Those two issues, which don't have to be necessarily related, are instead linked in this specific case.

In this lecture we are going to see what determined a substantial increase in liquidity and leverage of Apple Inc.

In this lecture we are going to draw some conclusions based on all the information acquired so far. It is also time to make some inferences. The purpose of this lecture is to understand how to interpret the financial data acquired up to this point.

In this lecture I am going to show you how to write a professional report.

For this purpose, attached to this lecture you will find:

• Word template to compile
• Apple's sample already compiled
• Apple's PDF sample

Take advantage of those resources to write a nice and professional report.