Regression Analysis in Financial Statement

What is Regression Analysis?

Regression Analysis is defined as a statistical method used by managers, stakeholders, business owners, potential investors and shareholders in finance. To determine strength, weakness, and character of a firm. Helps analyze and see true state of a business. It uses variables denoted as X and Y. Y being a dependent variable on X. As a result, dependent variables standing alone makes incomplete sense without independent variables. There are types of regression but we will focus on linear regression. This is further termed as simple linear and multiple linear regression. Simple linear regression uses independent variable to explain the outcome of the dependent variable Y. Multiple linear regression uses two or more independent variables to further explain the outcome. I am loving regression, it brings out the absolute financial truth.

Why Regression Analysis?

Regression in financial statement focuses on it’s uses, effect and interpretation. It also incorporates data analytics for financial interpretation purpose. Regression is one of the ways to interpret and analyze financial statement. Managers use regression to understand the variables in business. It helps understand present status of businesses at a point in time. Also, it helps in asset or stock value for investment purpose and for managers. It gives clarity and shows a true picture of financial statement. It also helps interpret difficult data or datum.   

Measuring Regression Analysis

There are no fixed data in determining the true picture of an organization. You need to understand your objective to inform your choice of data. Ask questions, what is the purpose for regression? Is it to determine profit? To measure growth? To see likelihood of fraud? Just to note that there will be variables(y) depending on another variable (x) for regression to be measured.  The main metrics for evaluating regression are Square/Adjusted R Square, Mean Square Error and Mean Absolute Error (MAE). Interpreting regression table is also a skill required because the feedback table gives report of the company in view.

Liquidity Ratio in Regression Analysis

Depending on the objective, liquidity ratio is one of the best ratios used in regression. Identify the dependent and independent variable and compare. This ratio determines the ability of a company or firm to cover short term obligations and cashflow. When a company (for example banking industry), isn’t liquid enough (have less cash), it becomes impossible to attend to customers satisfaction. Bank’s daily transaction requires lots of cashflow, the absence of it shows low or no liquidity. In a liquid company, the main operations must be the source of funds. It shows liquidity problem when financing and investing becomes source of fund. Regression analysis shows the true picture of this.

The Analysis so far

Regression helps you predict and forecast. Beyond seeing the true picture of a company, depending on your objective. It helps see a firm’s performance to enable you invest appropriately. As a manager, it helps forecast the future. Measures are put in place to avoid becoming a zombie firm afterwards. I have learnt in Corporate Financial Accounting that a financial statement showing whooping profit does not necessarily mean they have money. Especially if the source of fund is by borrowing. This means, profit in paper does not mean the company is liquid. Profitability doesn’t mean fraud free or that CEO is leading well. Regression helps with the interpretation using figures provided by the organization also known as financial statement.

In Other News…

In my next post, I will analyze the impact of liquidity on firm performance. How does a firm not liquid affect the performance of organizations? Firm performance becomes dependent on liquidity in this topic. This means, to analyze and measure having enough cash in a business. Understanding how it affects performance; I will also compare with listed companies in Nigeria stock exchange. This thereby shows the true picture of all organizations using ten years data across board. I’m just saying that the financial statement can have profit in millions of naira but with no real money in reality. Everyone want to be profitable, we want to invest in organizations profitable, liquid enough to run daily operations. When there are no enough funds to run daily activities, firm performance drop drastically. This is not good for business, hence the reason for the analysis ahead. See you then!