Financial Statement Analysis and Valuation
Reading the statements
The income statement, balance sheet and cash-flow statement interlock: net income flows into retained earnings, while non-cash charges and working-capital movements reconcile profit to operating cash flow. Watch revenue-recognition timing, capitalised versus expensed costs, provisions and off-balance-sheet obligations - the usual levers of earnings management.
Ratios and quality
Liquidity (current, quick), leverage (debt/EBITDA, interest cover), profitability (gross, operating and net margin, DuPont ROE) and efficiency (inventory and receivable days). Low cash conversion and high accruals flag aggressive accounting.
Valuation
DCF discounts free cash flow at WACC; terminal value often dominates, so test the growth and discount-rate assumptions. Multiples such as P/E, EV/EBITDA and P/B need genuinely comparable peers and consistent numerator and denominator - enterprise value pairs with pre-interest metrics.
Worked example
EBIT $120m, tax 25%, D&A $30m, capex $40m, working-capital increase $10m, WACC 10%, terminal growth 2%. FCFF = 120 x 0.75 + 30 - 40 - 10 = $70m. Terminal value = 70 x 1.02 / (0.10 - 0.02) = $892.5m, which is then discounted and added to the explicit-period present value.
Traps
Discounting net income instead of cash flow; pairing EV with EPS; and letting terminal growth exceed long-run nominal GDP growth.