Analysis of financial statements of thacogroup in vietnam

MASTER IN FINANCIAL MANAGEMENT

Analysis of financial statements of
Thacogroup in Vietnam

Graduate student: Mai, Duc Thao
Supervisor: Dr. Nguyen, Thi Kim Oanh

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HANOI, 2019


ABSTRACT
Thesis Title: Analysis of financial statements of Thacogroup in Vietnam
Pages: 66
University: Vietnam National University, Hanoi
Graduate School: International School
Date: Octorber, 2019

Degree: Master

Graduate Student: Mai, Duc Thao

Supervisor: Dr. Nguyen, Thị Kim Oanh

Keywords: financial analysis, ratio analysis, automobile industry
Thacogroup is the largest automotive corporation in Vietnam and has shown immense
success of the last few years. Understanding the performance of such a powerful automotive
corporation is vital for the overall industry development therefore this topic is considered
highly significant and important within industry financial management This research aims
at analyzing Thacogroup financial performance over the the last 5 years from 2014 to 2018,

in order to assess the corporation’s profitability, liquidity, solvency, asset management,
short term and long term financial position, as well as to make recommendations t o any red
flags identified during the analysis. The quantitative financial analysis flagged up a number
of main areas that required further investigation: cash management, return on equity,
operating efficiency, inventory management, and accounts receivable. These issues were
then further investigated using semi – structured interviews. The red flags raised during the
financial analysis were adequately explained by the interviewed individuals, who were all
senior management at Thaco. The interviewees recommended three way for improving
business performance of Thaco: (1) more comprehensive information systems for a more
decentralized management, (2)

less bureaucratic procedures regarding completion of

paperwork and processing of requests as well as payments, and (3) the need to reduce and
eliminate resistance to change and fear of the unknown.

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ACKNOWLEDGEMENT
By extending my most sincere appreciation to International School, Vietnam
National University, Thacogroup Vietnam, and my supervisor Dr, Nguyen, Thi Kim
Oanh, I would like to express my thanks and gratitude for their input in helping me
complete this master thesis.

Thank you!
Mai, Duc Thao

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TABLE OF CONTENTS
ABSTRACT ............................................................................................................................... 2
ACKNOWLEDGEMENT........................................................................................................ 3
LIST OF TABLES .................................................................................................................... 6
LIST OF FIGURES .................................................................................................................. 7
CHAPTER 1: INTRODUCTION............................................................................................ 8
1.1. General research background on automobile industry and Thacogroup .......................... 8
1.1.1. General research background .....................................................................................8
1.1.2. About Thacogroup ......................................................................................................8
1.2. Research aim and research question .............................................................................. 14
1.2.1. Research aim ............................................................................................................14
1.2.2. Research question .....................................................................................................15
1.3. Scope of research and methodology .............................................................................. 15
1.3.1. Scope of research ......................................................................................................15
1.3.2. Research methodology .............................................................................................15
1.4. Limitations during research............................................................................................ 16
1.5. Structure of the thesis ..................................................................................................... 16
CHAPTER 2: LITERATURE REVIEW ............................................................................. 17
2.1. Definition and objectives of financial statement analysis .............................................. 17
2.1.1. Definition ..................................................................................................................17
2.1.2. Objectives .................................................................................................................18
2.2. Sources of information ................................................................................................... 19
2.2.1. Balance sheet ............................................................................................................19
2.2.2. Income statement ......................................................................................................20
2.2.3. Statement of cash flows ............................................................................................21
2.2.4. Related documents....................................................................................................22
2.3. Financial statement analysis framework ........................................................................ 23
CHAPTER 3: METHODOLOGY ........................................................................................ 30
3.1. Research type ................................................................................................................. 30

3.2. Research methods........................................................................................................... 31

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3.3. Justification of chosen methods ..................................................................................... 31
3.4. Data collection and analysis ........................................................................................... 33
3.5. Methodological limitations ............................................................................................ 34
CHAPTER 4: FINDINGS AND DISCUSSION ................................................................... 36
4.1. Data Sources and Interviewees’ Profiles ........................................................................ 36
4.1.1. Data Sources .............................................................................................................36
4.1.2. Interviewees’ Profiles ...............................................................................................36
4.2. Content Analysis ............................................................................................................ 36
4.2.1. Financial Analysis ....................................................................................................36
4.2.2. Common – Size Analysis .........................................................................................41
4.2.3. Ratio Analysis ..........................................................................................................42
Horizontal Analysis ............................................................................................................49
4.3. Semi – Structured Interviews ......................................................................................... 51
4.3.1. Interview Questions ..................................................................................................51
4.3.2. Interviewee Profiles ..................................................................................................52
4.3.3. Interview Response Analysis ...................................................................................53
4.3.3a. Cash Management issue .........................................................................................54
4.3.3b. Return on Equity issue............................................................................................54
4.3.3c. Operating Efficiency issue ......................................................................................55
4.3.3d. Inventory Management issue ..................................................................................55
4.3.3e. Accounts Receivable issue .....................................................................................56
4.3.3f. Overall financial performance .................................................................................57
4.3.4. Summary...................................................................................................................58
CHAPTER 5: CONCLUSION AND RECOMMENDATIONS ......................................... 59
LIST OF REFERENCES ....................................................................................................... 62

APPENDICES ......................................................................................................................... 65
Appendix 1: Horizontal Analysis............................................................................................. 65

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LIST OF TABLES
Table 1: Thacogroup's Consolidated Statement of Financial Position (Currency:
VND) .............................................................................. Error! Bookmark not defined.
Table 2: Thacogroup's Consolidated Statement of Profit and Loss (Currency: VND) . 39
Table 3: Thacogroup's Consolidated Statement of Cash Flows (Currency: VND) ....... 40
Table 4: Thacogroup's Liquidity Financial Ratios ......................................................... 42
Table 5: Extracts from Thacogroup financial reports .................................................... 43
Table 6: Thacogroup's Operating Asset Management Financial Ratios ........................ 44
Table 7: Thacogroup's Financial Risk Financial Ratios ................................................ 45
Table 8: Thacogroup’s Profitability Financial Ratios .................................................... 48
Table 9: DuPont Analysis .............................................................................................. 48
Table 10: Interviewees' Profiles ..................................................................................... 52
Table 11: Extract from financial statements (profit and loss account) .......................... 56

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LIST OF FIGURES
Figure 1: Thacogroup's Liquidity Financial Ratios graph ............................................. 42
Figure 2: Thacogroup Financial Risk Financial Ratios ................................................. 45
Figure 3: Thacogroup's Profitability Financial Ratios graph ........ Error! Bookmark not
defined.

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CHAPTER 1: INTRODUCTION
1.1. General research background on automobile industry and
Thacogroup
1.1.1. General research background
Financial analysis provides managers with the reality aspect of their business by
way of evaluating fluctuations in financial indicators; advantages and disadvantages of
current financial position, business performance, debt situation, among others. Based on
preliminary evaluations, comprehensive and effective measures as well as strategies are
given to improve profitability, liquidity, or other business goals, thus to create value for
shareholders. The analysis of financial statements not only provides financial
information for managers and shareholders but also brings usefulness to other
stakeholders such as investors, customers, suppliers, lenders, workers, regulatory
agencies. Financial analysis is particularly crucial for organizational decision making
and forecasting.
The automobile industry in Vietnam ranks fourth in the ASEAN region, only after
Indonesia, Thailand, and Malaysia (Vietnamnews, 2019). Experts claim that Vietnam is
a highly potential market for automobile growth whereby production in 2018 constituted
2 per cent of that produced globally and is expected to grow 10 per cent in 2019 (Nguyen
Thanh Dam, 2019). On a monthly basis, in 2018, the average car sales in Vietnam have
risen 17% (Hockey, 2018). Within the Vietnamese automobile industry, Thacogroup is
a key player constituting almost half of market share, therefore it is noteworthy that its
financial performance significantly affects the overall performance of the industry. More
detailed introduction of the company follows later in this thesis.
1.1.2. About Thacogroup
Thacogroup was established in April 1997 with the founder being Mr Tran Ba
Duong, who now (2019) holds the position of Chairman of Board of Management. It is

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the largest automotive corporation in Vietnam and has shown immense success of the
last few years. This enterprise manages the manufacturing and assembly of passenger
cars, trucks, and buses in Vietnam at market share of 40% and localization rate of 1650%. Thaco vehicles are considered quality and affordable cars for the Vietnamese,
whilst having scored top of Vietnam Automobile Manufacturers’ Association sales
charts in 2014-2015. It continues to place in the top two rank as the most profitable
private companies in 2017. Beside the continuous goal to maintain its mountaintop
position domestically, Thaco aims to expand its operations to the ASEAN region, and
even further internationally with the vision to utilize modern technology in their
products, create a global platform, and spread its wings to become a multi-industry
conglomerate on a regional scale. Thaco’s focus of operations currently lays in two main
areas being: manufacturing and maintenance of their vehicles. The enterprise’s owned
passenger car brands currently include South Korean Kia, Japanese Mazda, and French
Peugeot. As of 2019, Thaco employs approximately 22 thousand employees across the
country.
Thaco’s corporate culture takes employees as the core of the sustainable
development. Employees are encouraged to have strong ambitions, positive work
attitude, creativity, and continuous personal development. The highlight feature of
Thaco’s corporate culture is the 8T principles (T being the first letter of the 8 principal
words in Vietnamese): “Dedication - Honesty - Intelligence - Confidence - Respect Prestige - Commitment - Convenience”. Due to the nature of manufacturing and
maintenance industry, Thaco’s employees are trained to perform work with utmost
discipline to ensure high quality and corporate vision, which constitutes one of the
company’s biggest intangible assets. Apart from adequate and systematic training,
Thaco’s corporate culture is also manifested by way of compensation and benefits. In
terms of corporate social responsibility, Thaco supports social community through
various channels such as national defense, social welfare, traffic safety, education,

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culture, musical, sports, charity. Through their active involvement and significant
contributions to the social community, in 2015, Thaco has been acknowledged and
honored by the following awards: Certificates of Merit from the Prime Minister,
Excellent Emulation Flags from the Government; Certificates of Merit from the Ministry
of Transport; Certificates of Merit from Quang Nam provincial People's Committee;
Certificates of Merit from Dong Nai provincial People's Committee; Excellent
Emulation Flags from Dong Nai provincial People's Committee in 5 consecutive years;
Certificates of Merit from Dong Nai Youth Union; Top 10 Gold Star Award; Top 10
Vietnam Brand Award; Vietnam Strong Brand award; "Asia Pacific's Best sales growth
distributor" from Hyundai Motors, among others.
The background information about Thacogroup was obtained from the company’s
website (Thaco, 2019). Truong Hai Automobile Co., Ltd. was established on 29 April
1997, headquartered at 19 Street No. 2A, Bien Hoa II Industrial Zone, Dong Nai
Province. The founder is Mr. Tran Ba Duong, who is now THACO’s Chairman.
Vision: To be a conglomerate and a leading Vietnam enterprise in ASEAN region.
Mission:
- THACO is a Vietnam brand bringing pride to the nation.
- Providing values to the customers, the society, and Vietnamese economy.
- Creating a distinctive and optimal working environment for the employees to
maximize their competence, best meeting the requirements of integration and
contributing to the human resource development of the country.
Thaco LOGO meaning: The logo is designed modern and harmonious with
stylized font, showing Truong Hai uniqueness, strong and industrialized yet elegant.
Blue was chosen as the dominant color. This is the color of the name Truong Hai. Blue
is also one of three primary colors symbolizing the environmental friendliness and
sustainability. Additionally, "Truong Hai Auto" in red is selected as the foundation,

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representing the passion to lead Vietnam's automobile industry and the direction of
enhancing Vietnam’s automobile industry position in the region. The strongest
contrasting colors, red and blue, used in the logo bring a balance of structure and
represent its strong idea. In addition to representing THACO brand - Truong Hai Auto,
the logo also represents the business philosophy of the corporation: Caring for our
products, services, every employee, and the community. Furthermore, Truong Hai
strives to improve the STATUS of the company and its employees in the society to
become a strong corporation representing the automotive industry of the country. In
order to actualize the company philosophy toward the development of a sustainable
corporate culture, Truong Hai proposes eight criteria, including DEDICATTION,
HONESTY,

INTELLIGENCE,

CONFIDENCE,

RESPECT,

PRESTIGE,

ENTHUSIASM, and CONVENIENCE.

In 2007, Truong Hai Automobile Co., Ltd. changed to become Truong Hai Auto
Corporation (THACO). Currently, the company has three administrative offices located
in Ho Chi Minh City, Hanoi, and Chu Lai (Quang Nam). Particularly, Chu Lai - Truong
Hai Auto Manufacture and Assembly Complex (Quang Nam) which was established in
2003 on an area of nearly 600 hectares, consists of 24 subsidiaries and affiliated factories.

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THACO currently operates in auto manufacture, assembly, and distribution;
provides auto spare part and maintenance services, including manufacturing, trading, and
distributing commercial vehicles (trucks and buses), manufacturing and trading
passenger cars from the brands including Kia (South Korea), Mazda (Japan), and
Peugeot (France -Europe). As to April 2016, the distribution system consists of 89
showrooms and 53 dealers nationwide and the company now has 14,900 employees.
At the present time, THACO is the only enterprise in Vietnam that manufactures
and assembles all 3 car lines including passenger cars, trucks, and buses with the
localization rate from 16%-50%, providing Vietnamese people with diversified, quality,
and affordable cars. In 2014 and 2015, THACO has topped the sales chart of Vietnam
Automobile Manufacturers' Association (VAMA).
As the leading auto manufacture, assembly, and distribution company in Vietnam,
THACO aims to maintain its position and expand its market to the ASEAN region,
enhance international cooperation to select appropriate technology, increase the local
content, and join the global value chain creating platform to become a multi-industry
conglomerate in the region.

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Besides manufacture and business activities, THACO also builds a healthy
corporate culture environment, forming THACO's feature culture based on the business
philosophy "Creating the contribution values, improving service values through products
and services" and the principle of "8Ts" "Dedication - Honesty - Intelligence Confidence - Respect - Prestige - Commitment - Convenience". This is the core value of
THACO culture, the intangible asset to create motivations for development. THACO's
culture is also manifested by the fact that compensations and benefits (salary, bonuses,
insurances, allowances, etc.) are always adequately implemented.
With the viewpoint "THACO embraces its social responsibilities", annually,

THACO always supports many social community activities to share its responsibilities
in various fields including: National Defense, Social Welfare, Traffic Safety, Education,
Culture - Music, Medical, Sports, For the underpriviledged, scholarships, etc. From
achivements in business and contributions to the social community, in 2015, THACO
has been acknowledged and honored by the following awards: Certificates of Merit from
the Prime Minister, Excellent Emulation Flags from the Government; Certificates of
Merit from the Ministry of Transport; Certificates of Merit from Quang Nam provincial
People's Committee; Certificates of Merit from Dong Nai provincial People's
Committee; Excellent Emulation Flags from Dong Nai provincial People's Committee
in 5 consecutive years; Certificates of Merit from Dong Nai Youth Union; Top 10 Gold
Star Award; Top 10 Vietnam Brand Award; Vietnam Strong Brand award; "Asia
Pacific's Best sales growth distributor" from Hyundai Motors, etc.
Since its establishment, THACO has received numerous awards and merits from
the Prime Minister, the Ministries, the Ministerial-level Agencies, and the Provincial
Authorities of Dong Nai, Quang Nam, Dong Thap, Lam Dong, Hanoi, and Ho Chi Minh
City on the following aspects:
- “Patriotic Competition” movement, welfare for employees;
- Completion of tax obligations and social insurance;

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- Contribution to the socio-economic development of many provinces, and
creation of Chu Lai Open Economic Zone;
- Outstanding achievements in community activities, sports and athletics
engagement, cultural organization, and “Good People, Good Work” initiatives;
- Outstanding contributions to the nation’s development and security.
Thacogroup is considered a corporate giant in Vietnam and has secured its rank
as the second most profitable private company in 2017 (Thaco, 2017). To achieve such
a financial success corresponds with adequate planning, control, and forecasting.

Moreover, with IFRS adoption soon being implemented for Vietnamese listed
companies by 2025 (Vietnam News, 2016), it is of even higher importance that Thaco’s
financials are thoroughly analyzed to ensure in-depth understanding of the company and
best prepare for the upcoming international accounting standards adoption. This thesis
looks closely at the most recent 5-year period from 2014-2018. This particular period
has been selected for research due to its recent nature whilst 2019 reports are not yet
published.

1.2. Research aim and research question
1.2.1. Research aim
Having recognized the importance of financial analysis as well as the position
that Thaco holds in the Vietnamese market, this thesis aims to analyze Thacogroup
financial performance over the recent years, specifically over the last 5 years from 2014
to 2018, in order to assess the corporation’s profitability, liquidity, solvency, asset
management, short term and long term financial position, as well as to make
recommendations to any red flags identified during the analysis. By way of conducting
the fore-mentioned financial analysis, the research aim is to investigate, synthesize, and
evaluate Thaco’s financial position over a 5-year period from 2014-2018. Basing on the
company’s financial data and using suitable analysis tools to evaluate the company’s
financial position, profitability, liquidity, and solvency, it is possible to provide

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recommendations that would help improve any drawbacks in the financial performance
of the company in the past, present, and future.
1.2.2. Research question
The focal aim of this thesis is to answer the following two questions:
- What was Thacogroup’s financial situation in the period 2014-2018?
- What could the company improve in near future in terms of its financial

performance?

1.3. Scope of research and methodology
1.3.1. Scope of research
Scope refers to how far the research area has explored and parameters in with the
study will be operating in. The scope of this research covers the financial performance
of one case study company, being Thacogroup, during a 5-year period from 2014-2018.
This period has been selected as it is the most recent available period before the IFRS
adoption, a major financial reporting point, and at the time of this thesis write up (2019),
2018 was the latest year with full published annual reports. This thesis will analyze
financial performance of Thacogroup during this period in Vietnam.
1.3.2. Research methodology
Research methodology is the specific procedures or techniques used to identify,
select, process, and analyze information about a topic. In a research paper, the
methodology section allows the reader to critically evaluate a study’s overall validity
and reliability (Wilkinson, 2002). Mixed-method has been deemed most suitable for this
research. Quantitative secondary data will be collected through archival documents of a
case study company being Thacogroup. This financial data will then be analyzed using
various financial analysis tools such as financial ratios, common-size analysis, vertical
and horizontal analysis, among others. Moreover, qualitative primary data will be
collected through interviews with staff at Thacogroup to investigate their perceptions on
the company’s performance and company’s future prospects at the moment and once

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IFRS is adopted. These mixed-methods will together shed light on Thaco’s financial
position and prospect in order to draw recommendations.

1.4. Limitations during research

This research’s major shortcomings lay in data limitations, in terms of time
lengths and sample size. Despite having chosen the most accessible and appropriate
methodology for the research topic, the author acknowledges that for more accurate
results, the studied time period could be extended further back into the past in order to
recognize any trends or impact of historic events, which could be useful for future
decision making. Moreover, the sample size of interviewees could be extended beyond
the company’s staff to other stakeholders, which could give a more representative view
of the results.

1.5. Structure of the thesis
The remainder of this thesis is structured into 4 main parts: (Chapter 2) Literature
Review, (Chapter 3) Methodology, (Chapter 4) Results and Findings, and (Chapter 5)
Conclusion and Recommendations.

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CHAPTER 2: LITERATURE REVIEW
This chapter proceeds to establish a background context for the study by gaining
an insight into existing literature and providing conceptual and theoretical ground for
this research. The chapter is divided into 3 main parts, whereby the first part provides
definition and objective of financial statement analysis, the second part shows the
sources of data and information and the third part looks at the financial statement analysis
framework.

2.1. Definition and objectives of financial statement analysis
2.1.1. Definition
Thanh, T. B., Nguyen, T. D. K. (2011) defined that financial statement analysis
is a set of concepts, methods and tools that allow the analysts to collect and process
accounting information and other management information. The result of this process is

to assess the financial situation and potential risks, evaluate performance, ability and
quality of enterprises, and help users to make appropriate financial decisions and
management decisions.
The primary concern of financial analysts is the assessment of bankruptcy risk
affecting businesses whose expression is solvency, appraise of capital balance,
operational capacity as well as profitability of businesses. On that basis, financial
analysts continue to study and make predictions about the overall performance and
profitability of the business in the future. In other words, financial analysis is the basis
for financial prediction - one of the business prediction directions. Financial analysis can
be applied in various different ways: operational purposes (internal decisions), research
purposes, information collecting purposes (for external users).
Phuc (2013) defined financial statement analysis as the process of reviewing,
examining, and comparing financial data between the current period and past periods of
enterprises. Analysis of financial statements will provide information that can examine

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the potential, performance and future financial risks of the business as well. Analyzing
financial statements not only provide useful information for corporate governance but
also for non-business. Besides, financial statement analysis can be defined as a process
of using appropriate analytical techniques to process data from financial statements and
other related documents, creating a financial indicators system to make assessment and
prediction future financial resources. Thus, financial analysis is primarily about
transferring financial data on financial statements into useful information. This process
can be done in many different ways depending on the analyst's goal.
2.1.2. Objectives
According to James et al (2006), financial statement analysis is viewed as a threelegged stool. The three-legged stool represents analysis objectives based on the
following:
- Determining the economic characteristics of the industry in which a company

participates and the relationship of those economic characteristics to the financial ratios.
- Describing the strategies which a company pursues to distinguish itself from
rivals as a basis assessing the company's competitive advantages, the sustainability of
the company's earnings, and risks.
- Evaluating financial statements including accounting concepts and methods, and
the quality of the information they provide.
In a different light, Ciaran (2006) claimed that the role of financial statement
analysis is taking prepared financial reports, combined with other data and information,
in examining the past, current, and prospective performance and financial statue. This is
done for the goal of making investment, credit, and other economic decisions. The
authors emphasized that there are certain concepts in financial analysis. Generally,
analysts tend to examine the performance of firms, forecast the potential opportunities
and financial position. Analysts are also concerned about factors that may create the risks
in the company’s future performance. Financial analysis will provide systematic and

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scientific evidence for users. Corporate finance activities involve many entities such as
managers, investors, banks, suppliers, state authorities, etc so there are different analysis
objectives for each object (Thanh, 2011). For instance, lenders often provide in two
forms short-term and long-term debt. For short-term debts, sponsors often pay attention
to current financial statue, the liquidity of floating assets and the asset turnover. By
contrast, for the long-term one, analysts often aim to predict cash flows and assess the
profitability of businesses in long term period. However, lenders whether short-term or
long-term are interested in capital structure because capital structure includes both
potential risks and safety for lenders. In addition, the major concern of managers from a
financial analysis is to clarify financial structure, business efficiency and risk issues.
However, there is a different consideration between owners and managers. Normally,
the owner is concerned about profitability of their investment, how to increase owners’

equity, attain higher return from invested capital. Therefore, financial analysis from the
perspective of owners is more synthetic than that from managers. In general, the goal of
analysis ultimately depends on the economic interest of individuals and organizations
related to the business. As the result, applying in practice analysis requires the flexibility
of analysts in each stage.

2.2. Sources of information
Subramanyam (2009) discussed in great detail the four main sources of financial
information as following: balance sheet, income statement, statement of cash flows,
notes to financial statements. Each of the subsections below will in turn discuss these
sources in more details.
2.2.1. Balance sheet
The balance sheet presents the resource of a firm (assets) and the claims on those
resources (liabilities and shareholders’ equity) as of a specific date. The balance sheet
derives its name from the fact that it is reports the following equation:
Asset = Liabilities + Shareholders’ Equity

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Assets are future economic benefits that can be acquired or controlled by a
specific entity as a result of past transactions or events (Harrison, 2006). Assets are
sources that have the potential to bring a company future economic benefits: the ability
to generate cash flows in the future (such as accounts receivable, inventories and
investment securities) or to reduce future cash outflows (as prepaid) or to afford
potential service for operating activities (such as with assets and equipment).
Liabilities are the future sacrifices of economic benefits arising from the current
obligation of a specific entity to transfer assets or provide services to other entities of
transactions or events in the past (Botosan et al, 2005). Hence, liabilities represent a
current obligation of a company to make payments by cash, goods or services in

predictable quantities at a predictable time. Liabilities reflect managers’ expectation of
future sacrifices resources to meet existing obligations.
The shareholders’ equity in a company is a residual interest or claim. That is, the
owner has a claim for property not required to satisfy the requirements of creditors
(Fernandez, 2002). Therefore, the valuation of assets and liabilities in the balance sheet
will determine the value of the total shareholders’ equity.
Typically, analysts often evaluate the relationship between items in the balance
sheet when assessing the financial situation and credit risk of a company (Palepu and
Healy, 2013). For instance, exceeding current assets over current liabilities suggests that
a company has sufficient liquid resources to pay short term lenders (Penman and
Penman, 2007). A relatively low percentage of long term debt to shareholders’ equity
indicates that a company is likely to have long term assets to repay long term debt at
maturity, or at least an ability to borrow new debt financing using use of long term assets
as collateral to repay debt coming due (Dewatripont and Tirole, 1994).
2.2.2. Income statement
The income statement provides information about a company's profitability in a
period of time (Palepu and Healy, 2013). Analysts and investors usually use the terms

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net income, earning, and profit interchangeably when referring to the bottom-line
amount in the income statement (Hillman and Keim, 2001). The income statements
mainly reflect the results of operating decisions (for example, product mix and pricing,
sourcing of production and marketing, and use of plants and equipment). It also reports
the amount of money involved in investing decisions such as interest and dividends
income and financing decisions such as interest expenses. Other comprehensive income
items, which are reported as a part of comprehensive income in the shareholders' equity
statement, reflect profits and losses from changing in value of some assets and liabilities
which are not recorded in net income until you those profits and losses are realized.

2.2.3. Statement of cash flows
Statement of cash flows reports for a period of time net cash flows from three
main business activities: operating, investing and financing (Palepu and Healy, 2013).
The purpose of this statement is simple but important: providing the sources and use of
cash for financial statement users. The statement of cash flows provides information to
complement the income statement, and to demonstrate how cash flows differ from
accrual-based income (Carslaw and Mills, 1991). Because the cash flow statement shows
how companies are generating and using cash, it is also an advantageous tool to assess
how they implement financial strategies (Mills and Yamamura, 1998). Cash flows are
the connecting device between operating, investing and financing activities. They allow
each of these three activities continue smoothly and efficiently. The statement of cash
flows can also be helpful in assessing a company's past ability to generate free cash flow
and predict free cash flow in the future.
The statement of cash flows classifies cash flows as relating to three separate
types of activities: operating, investing or financing activities.
Operating: Selling goods and services is one of the most important ways a
company generates cash. Assessing cash flow from operations for several years shows

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which activities have provided the necessary cash to maintain operating capacity (and
the extent to which companies must rely on other cash resources) (Broome, 2004).
Investing: The acquisition of long-term assets, especially property, plant and
equipment, often represents major ongoing using cash. If companies are to grow, they
must have acquired additional long-lived productive assets (Palepu and Healy, 2013).
Companies get a portion of the cash needed to acquire those types of asset from the sale
of assets. Such cash flows are rarely enough to cover cost of new purchasing, though.
Financing: A company obtains cash from short term and long-term loans and from
issuing preferred and common stock. It uses cash for these loans, paying dividends, and

reacquiring shares of outstanding preferred and common stock (Subramanyam, 2009).
2.2.4. Related documents
Notes to financial statements
Financial statements report the accounts and amounts in balance sheet, income
statement, and cash flow statement, but they do not explain how to determine those
accounts and the amount (Subramanyam, 2009). The notes would provide important
details about the accounting methods and principles that the company has used to
measure assets, liabilities, revenues, costs, profits and losses. They generally provide a
summary of the key accounting principles used by the company. Furthermore, the notes
also indicate important details about important financial statement estimates, such as the
fair values of investment securities, income taxes and intangible assets (Fraser et al,
2010).
Management discussion and analysis
Many companies accompany the financial statements and notes with extensive
narrative and quantitative discussion and analysis from managers (Smith and Taffler,
2000). The management discussion and analysis of the financial statement provides
insight management strategies and assessments of the company's performance. In some

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cases, this paper also provides a glimpse of managers' expectations about the future of
the company.
Managers’ and independent auditor’s attestations
Managers’ attestation and the independent auditor’s attestation provide a
statement of (and take responsibility for) the quality and effectiveness of internal control
system and the fairness of the financial statements and notes in reporting a company’s
financial situation, performance and cash flows. The independent audit adds credibility
and reliability to financial statements and notes prepared by management (Wright and
Davidson, 2000).

2.3. Financial statement analysis framework
Charles (2012) has designed a framework for analyzing financial statements as
per the following table:
Phase
1. Articulate the purpose
and context of the analysis

2. Collect data

Sources of information
The nature of the analyst’s
function, such as
evaluating an equity or
debt investment or issuing
a credit rating.
Communication with
client or supervisor on
needs and concerns.
Institutional guidelines
related to developing
specific work product.
Financial statements, other
financial data,
questionnaires, and
industry/economic data.
Discussions with
management, suppliers,

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Output
Statement of the purpose
or objective of analysis.
A list of specific questions
to be answered by the
analysis.
Nature and content of
report to be provided.
Timetable and budgeted
resources for completion.

Organised financial
statements.
Financial data tables.
Completed questionnaires,
if applicable.


3. Process data

customers, and
competitors.
Company site visits.
Data from the previous
phase.

4. Analyze/interpret the
processed data
5. Develop and

communicate conclusions
and recommendations

Input data as well as
processed data.
Analytical results and
previous reports.
Institutional guidelines for
published reports.

6. Follow up

Information gathered by
periodically repeating
above steps as necessary
to determine whether
changes to holdings or
recommendations are
necessary.

Adjusted financial
statements.
Common-size statements.
Ratios and graphs.
Forecasts.
Analytical results.
Analytical report
answering questions posed
in Phase1.
Recommendation

regarding the purpose of
the analysis, such as
whether to make an
investment or grant credit.
Updated reports and
recommendations.

Step 1: Articulate the purpose and context of analysis
It is essential to clarify the purpose when conducting an analysis. Understanding
of purpose is especially important in analyzing financial statements because there are
many available techniques and significant amounts of data. Some analytical tasks are
well defined, in which case the purpose of the analysis requires little decision from
analysts. For instance, a periodic credit rating of an investment - grade debt portfolio or

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a company's equity analysis report may be guided by institutional rules such that the
intention of analysis given. Moreover, formats, procedures and sources of information
may also be provided. For other analytical tasks, determining the purpose of the analysis
requires the analyst to make a decision. Analysis’s aims orient further decisions on the
approaches, tools, data sources, and formats to report analytical results and the relative
importance of various aspects of the analysis.
Step 2: Collect data
Analysts get the data needed to answer specific questions. An important part of
this step is to gain an understanding of the company's business, financial performance
and financial situation (including trends over time and compared with competitors).
Additionally, information about the economy and industry is essential to understand the
environment that the firm operates. Analysts often adopt a top down approach whereby
they get an understanding of macroeconomic such as the prospects of the economy and

inflation; and identifying the prospects of the company in the expected macroeconomic
environment.
Step 3: Process data
After obtaining the financial statements and other information, the analyst
processes this data with appropriate analytical tools. For example, data processing may
involve calculating ratios; preparing common-size financial statements; creating charts;
performing statistical analyzes, such as Monte Carlo simulations; implementing equity
valuation; or using any of the analytical tools that are suitable for the task. A
comprehensive financial analysis during this stage will include:
- Read and assess financial statements each time period to analysis. This includes
reading footnotes and understanding which accounting standards have been applied,
what accounting choices have been made, and what operating decision have been made
that impact on financial statements.

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