Links between interpretation and financial strategy
As was pointed out in the Introduction, finance is above all a 'revealer' or illuminator of strategies. If you know that your strategy is working, good; if it is not, you can take remedial action or change your strategy. Interpretation of financial statements is above all about monitoring and thus managing strategies. Interpretation can also help you understand strategies either in your own business, in a competitor (benchmarking) or in a model to identify how a strategy may deliver.
External interpretation of financial statements can be focused on the bigger picture of delivery of objectives, as we should not forget that it is not a strategy per se that should be successful but the fact that it leads to achieving an objective. External interpretation is often focused on why a share price is what it is. The often fickle markets may focus too much on the short-term results rather than on progress to long-term and sustainable objectives.
No strategy will succeed if figures are not understood.
Content, order and logic of this chapter
Within this chapter we will cover the following topics:
- Techniques for interpreting financial statements
- Ratio analysis
- Working capital and gearing
- Analytical review
- External ratios
- Why we have to disclose ratios
Order and logic
There are many techniques used to analyse and understand figures and we have used several already. The first part of this chapter looks at the principal types and where they can be useful in understanding and tracking how strategies are progressing. Ratio analysis is a well-established tool in accounting circles as the principal method of explaining the numbers in financial statements and how they relate. Analytical review is a higher-level method but potentially more thoughtful in that it requires a complete and linked understanding of the numbers with what is going on in the business. Benchmarking and scorecards use typical ratios and techniques with the aim of improving performance through comparison with the best and by taking a more balanced view of a business with a balance scorecard. It is claimed that balanced scorecards don't simply focus on financial ratios. Finally, all of the interpretation techniques may be used by external analysts but there are also specific stock market ratios and measures.