Part 1: Framework

Chapter 1
A framework for business analysis and valuation
using financial statements

Revision Questions

1. Qian, who has just completed his first finance course, is unsure whether he should
take a course in business analysis and valuation using financial statements
because he believes that financial analysis adds little value, given the efficiency of
capital markets. Explain to Qian when financial analysis can add value, even if
capital markets are efficient.

2. Four steps for business analysis are discussed in this chapter (strategy analysis,
accounting analysis, financial analysis and prospective analysis). For each of the
following professional roles, explain which step is the most important and how
accounting information is used in that step:
a. Auditor
b. Loan officer
c. Management consultant.

3. Explain voluntary disclosure of information in financial reports as a solution to the

‘lemons problem’ described in the chapter. Is it a full solution or a partial
solution? Why?

4. Research demonstrates that managers usually report truthfully, rather than

seeking to distort the firm’s performance and financial position. Explain why
accounting analysis is still an important step in financial statement analysis.

5. Summarise the arguments for and against accounting reports providing useful
information to outside investors.

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6. Financial, information, transaction and regulatory intermediaries were described

in this chapter as ‘adding value’ to a well-functioning capital market. Identify two
intermediaries that operate in your country, and discuss how they add value.

7. Considering the arguments in the previous question, do you think that investors
would be better off if ‘raw’ (unadjusted) accounting numbers were provided, in a
system of reporting such as XBRL (eXtensible Business Reporting Language)? Why
or why not?

8. Some scholars consider financial statement analysis to be a capstone subject for

all business students. Below is a list of other business disciplines that use financial
statement analysis. Indicate which of the four steps each one contributes to:
– accounting
– econometrics
– economics
– finance
– law
– management
– marketing
– statistics.

9. Would you invest in this company?

b. What else would you like to know about this company?

i Would you find this information in the annual financial report?
ii If not, where might you find it?

10. Find the latest annual report for the company Kathmandu Holdings Ltd. Describe
its contents and your initial impressions of the company’s performance (without
making any calculations). What other information would you like to know be-
fore you analyse this company’s financial statements and calculate its value?
Where might you find that information?

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