"It is meaningless to financially analyse a company without understanding the context and environment in which it operates". Discuss to what extent you agree with this statement.

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“It is meaningless to financially analyse a company without understanding the context and environment in which it operates”. Discuss to what extent you agree with this statement.

Introduction

Financial analysis is the use of financial statements to analyze a company’s financial position and performance, and to assess future financial performance. Therefore, it is a subjective and complex task. To effectively accomplish this task we should adopt interdisciplinary perspective. This includes understanding the context and environment in which a company operates.

So, this essay is tending to discuss the understanding of context and environment in which to interpret the financial statement, and examine it is an important and essential part of financial analysis.  To examine this discussion, this essay is divided into four main parts: the first part illustrates the important role of  the context and environment in which a company operates through a discussion of MicroStrategy case ; the second part examines some interpretation problems arising from ratio analysis, and consequently argues the acontextual financial analysis is inherently limited; the third part specifically considers the foreign environment; finally, the fourth part draws a conclusion about this discussion.

Part 1: MicroStrategy

In March 2000, MicroStrategy (MSTR), a worldwide software company, announced that it was revising its financial results. Sales would be lowered by roughly 25 percent, from $205 million to about $150 million; and profits would be adjusted from 15 cent a share gain to a 43 cent a share loss. The reaction was swift. MSTR’s stock plunged $63. But just two weeks before, its common stock touched $333, up nearly 46-fold in a year. Huge sums of money were lost by investors who based their investment decisions on misleading reported numbers.

While many in the business press blamed the problems on aggressive accounting practice, we should question where those investors who bought MSTR shares at $333 went wrong. In 12 months, the stock had multiplied nearly 46 times. Was it conceivable that this business could be worth 46 times more in one year? Undoubtedly, the answer was “no”. However, the investors were willing to pay airy sums based on tools like price-to-sale, or price-to-earnings, which could not determine values.  

Ultimately, the analyst community should exercise increased care in its assessment of a firm’s prospects. This suggests an analysis fully incorporates all explicit projections and uncovers any implicit assumptions. A better analysis may be accompanied by outside scrutiny and attestation of the processes used by analysts in developing their reports and forecasts, i.e. a successful of financial analysis comes from  the combination of the context and environment in which a company operates and its accounting figures. As what Stickney states:

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 “ effective analysis of a set of financial statement requires an understanding of (1) the economic characteristics and current conditions of a firm’s business; (2 ) the particular strategies the firm selects to compete in each of these businesses; and (3)the accounting principles and procedures underlying the firm’s financial statements.” 

        

Part 2.1: Ratio analysis

There are different principle tools of financial analysis. One of them is ratio analysis, which is based on the externally available financial data from corporations, and used to assess how various line items in a firm’s financial statement related to one ...

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