Financial Statement Analysis – Moving from lagging to leading indicators

15 Nov, by

Based on the profound thoughts, original ideas and educated analysis of Michael Matthew Lee:

The Fundamental Issue

Every accountant is expected to know how to perform a Financial Statement Analysis, which is key to understanding the financial health of any company. However, traditional financial statement analysis uses financial ratios which are based on historical (after-the fact) data. They produce an analysis which, at best, are lagging indicators of the financial health of a company.

What is needed are leading indicators and a sound integrative and wholesome approach which not only throw light on the company’s financial health but also predict and protect its business and financial risks.

Two leading indicators are the “Financial Limits to Growth” (FLTG) tests and the 2-level sales analysis, which I have designed based on segmental information.

FLTG predicts whether the company is overstretching its resources and how to fix it, if it does. The 2-level sales analysis focuses on sales trend analysis to predict any impending recession or industry slowdown. It also dwells on segment analysis to assess ROI (return on investment) and the extent of concentration of major product and geographic categories.

For an integrative and wholesome approach, focus on how fixed operating expenses and capital structure affect operating and financial leverage, and business and financial risks is vital. This is in the domain of capital structure optimisation.

In managing the financial health of a company, the CFO or Finance Manager is always concerned about

  1. Volatility of returns (V)
  2. Impairment of assets (I)
  3. Sustainability of operating cashflows (S)
  4. Adequacy of funding resources (A)

I called these concerns V.I.S.A. and when you take care of V.I.S.A., the company’s sustainable growth can be assured. But how do you do it? Moving from lagging to leading indicators in the Financial Statement Analysisis required to mitigate/dispel V.I.S.A. concerns. I called this the “V.I.S.A. Approach”.

This is my “thesis’ for a predictive and sustainable growth of a company thorough a systematic and integrative (wholesome) approach to Financial Statement Analysis.

As this article is purely an introductory, I shall be writing the following articles over the next few months to further explain the lagging and leading indicators, and capital structure optimisation, climaxing in the V.I.S.A. Approach.

  • Traditional financial statement analysis – lagging indicators (Part 1)
  • Financial statement analysis with 2 leading indicators (Part 2)
  • Is there an optimal capital structure? (Part 3)
  • What is V.I.S.A. and its components? (Part 4)
  • Integrating all parts to form the V.I.S.A. Approach to financial statement analysis (Part 5)

There is much to be shared and learnt from the stated articles as I shall be pushing the frontiers of current accounting knowledge, in the process.

——————————-MMLee Oct 2018—————————-


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