The six-step financial statement analysis framework

What are the six steps?

Purpose and context, collect data, process data, analyze and interpret, conclude and communicate, then follow up. Learn the order and what each step produces, because the exam gives you one and asks for the other.

The financial statement analysis framework is the same for an equity analyst valuing a share and a credit analyst rating a bond. Only the purpose changes.

#	Step	Typical inputs	Typical outputs
1	Articulate the purpose and context	The analyst’s function, the client’s needs, institutional guidelines	Statement of purpose, specific questions, nature and content of the report, timetable and resources
2	Collect data	Statements, industry and economic data, management, site visits	Statements and data in a usable form, completed questionnaires
3	Process data	The data from step 2	Adjusted statements, common-size statements, ratios and graphs
4	Analyze and interpret	Input data and processed data	Analytical results, forecasts, valuations
5	Develop and communicate conclusions and recommendations	Analytical results, previous reports, institutional guidelines	Analytical report answering the step-1 questions, a recommendation
6	Follow-up	New information from repeating the earlier steps	Actual versus expected results, revised forecasts, updated reports and recommendations

Financial statement analysis frameworksix steps, in order, repeated when new information arrives

• 1. Articulate purpose and context Memorize what decision, for whom, by when
  • Statement of purpose the objective of the analysis
  • List of specific questions what the analysis must answer
  • Nature and content of the report plus timetable and budgeted resources
• 2. Collect data Memorize statements, industry data, management, site visits
  • Financial statements in a usable form for example a spreadsheet
  • Completed questionnaires if used
• 3. Process data Memorize adjust and scale the numbers
  • Adjusted financial statements
  • Common-size statements
  • Ratios and graphs the output of this step, the input to step 4
• 4. Analyze and interpret Memorize explain what the processed data mean
  • Analytical results
  • Forecasts
  • Valuations
• 5. Develop and communicate conclusions Memorize answer the questions from step 1
  • Analytical report
  • Recommendation invest or not, extend credit or not
• 6. Follow up Memorize repeat earlier steps as needed
  • Actual versus expected results
  • Revised forecasts
  • Updated reports and recommendations

Why does the purpose come first?

Because it decides everything else: which questions matter, which data to collect, how deep to go and what the report looks like. A credit review of a supplier needs different data and depth from an equity valuation.

Opening a spreadsheet and computing forty ratios feels productive, but most of them will answer nothing anyone asked. Write down the decision first, then pick only the numbers that bear on it. Settle the practical frame at the same time: who reads the result, in what form, by which date, and with how much time and budget.

How do you tell processing from analyzing?

Memorize

Processing turns raw data into comparable numbers. Analyzing says what those numbers mean for the question. Sort any activity with one test: is it producing a number, or explaining one?

Activity	Step
Adjusting statements so two companies are comparable	3, process
Preparing common-size statements	3, process
Computing ratios, growth rates and charts	3, process
Saying margins fell because input costs rose	4, analyze and interpret
Building a forecast or a valuation	4, analyze and interpret

Exam tip Ratios are the output of step 3 and the input of step 4. If the stem says “computing”, pick process data.

Sort the outputs and activities into the six steps, then try the process-or-analyze round.

Go deeper The framework is a loop, not a line

In practice, a finding in step 4 often sends you back to step 2 for more data, and follow-up repeats earlier steps whenever new information arrives. The purpose also sets the report format: an internal memo, published research and a credit committee paper are three different deliverables. An equity analyst’s external report typically includes a summary and conclusion, an industry overview and competitive analysis, a financial model with scenarios, a valuation and the investment risks. When communicating, distinguish facts from opinions and disclose the limits of the analysis.

Go deeper A wrinkle: where do forecasts belong?

Forecasting and valuation models are sometimes described as tools you use while processing data, yet the official step-by-step table lists forecasts and valuations as outputs of analyze and interpret. For a “which step” question, follow the table: ratios, common-size and adjusted statements are step 3; analytical results, forecasts and valuations are step 4.