Question

One of your clients is trying to diversify your investment portfolio and asks you to perform an analysis of the financial statements and various financial reasons of some foreign companies.

Before advising your client to invest high amounts of money:

(1) What are some of the potential problems you may encounter when analyzing financial statements of a foreign company?

(2) Why should you be careful when comparing financial ratios of companies operating in different countries?

Note:Could you please don't use your handwriting to answer this question to be easy for me to solve... Thanks

Answer 1

1. Some of the issues encountered while analyzing financial statements of a foreign country

a. Availability of data: Except for some developed and developing countries, data availability would be a major issue while analyzing  financials.

b. Foreign language: The target financials of the foreign country may be in their domestic language, requiring the analyst to hire a translator

c. Domestic Currency: The most probable issue while analyzing foreign financials would be that they are in their domestic currencies. The analyst would be required to convert them at appropriate rates to have meaningful comparison and analyses.

d. Different Terminologies: The terms used in accounting and while reporting the financial statements could differ country-wise requiring the analyst to dwell deep in to terminologies used by target countries.

e. Different accounting principles - Generally Accepted Accounting Principles: The requirements while reporting financial statements may differ country-wise in that various countries adopt different accounting principles. Though majority of the countries have adopted IFRS, many countries have their own GAAP or are in a phase of transition towards IFRS.  

2. Issues when carrying comparative analysis of financial ratios of companies operating in different countries

a. Different accounting principles: As discussed above, the adoption of different accounting principles by different countries calls for caution while exercising ratio analysis between companies operating in different countries.

b. Economic Scenario: The operational performance of any company is affected a lot by the economic conditions subsisting in that country. Therefore, the ratios that are sought to be compared should factor in degree of impact of economic shifts in that country. Example, a steady performance in a economic distress may be required to be valued more than a lucrative performance in a booming economy.

c. Cooking of Financial statements: Many a countries may not be relied upon for their financial reporting for many reasons such as lack of securities regulator's oversight, involvement of government, etc. The financial statements in such areas or countries are cooked up typically to attract foreign investors. Analyzing a genuine company's financial ratios with such a company may produce absurd results.