Financial Terms Factor analysis

Definition of Factor analysis

Factor analysis

A statistical procedure that seeks to explain a certain phenomenon, such as the return on a
common stock, in terms of the behavior of a set of predictive factors.

Related Terms:

the present value of a finite stream of cash flows for every beginning \$1 of cash flow.

PPF (periodic perpetuity factor)

a generalization formula invented by Abrams that is the present value of regular but noncontiguous cash flows that have constant growth to perpetuity.

Amortization factor

The pool factor implied by the scheduled amortization assuming no prepayemts.

Annuity factor

Present value of \$1 paid for each of t periods.

BARRA's performance analysis (PERFAN)

A method developed by BARRA, a consulting firm in
Berkeley, Calif. It is commonly used by institutional investors applying performance attribution analysis to
evaluate their money managers' performances.

Break-even analysis

An analysis of the level of sales at which a project would make zero profit.

Cluster analysis

A statistical technique that identifies clusters of stocks whose returns are highly correlated
within each cluster and relatively uncorrelated between clusters. Cluster analysis has identified groupings
such as growth, cyclical, stable and energy stocks.

Common-base-year analysis

The representing of accounting information over multiple years as percentages
of amounts in an initial year.
Common-size analysis The representing of balance sheet items as percentages of assets and of income
statement items as percentages of sales.

Comparative credit analysis

A method of analysis in which a firm is compared to others that have a desired
target debt rating in order to infer an appropriate financial ratio target.

Conversion factors

Rules set by the Chicago Board of Trade for determining the invoice price of each
acceptable deliverable Treasury issue against the Treasury Bond futures contract.

Credit analysis

The process of analyzing information on companies and bond issues in order to estimate the
ability of the issuer to live up to its future contractual obligations. Related: default risk

Discount factor

Present value of \$1 received at a stated future date.

Discriminant analysis

A statistical process that links the probability of default to a specified set of financial ratios.

Factor

A financial institution that buys a firm's accounts receivables and collects the debt.

Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

Factor portfolio

A well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of
zero on any other factors.

Factoring

Sale of a firm's accounts receivable to a financial institution known as a factor.

Fundamental analysis

Security analysis that seeks to detect misvalued securities by an analysis of the firm's
business prospects. Research analysis often focuses on earnings, dividend prospects, expectations for future
interest rates, and risk evaluation of the firm.

Horizon analysis

An analysis of returns using total return to assess performance over some investment horizon.

Horizontal analysis

The process of dividing each expense item of a given year by the same expense item in
the base year. This allows for the exploration of changes in the relative importance of expense items over time
and the behavior of expense items as sales change.

Maturity factoring

factoring arrangement that provides collection and insurance of accounts receivable.

Mean-variance analysis

Evaluation of risky prospects based on the expected value and variance of possible outcomes.

Multifactor CAPM

A version of the capital asset pricing model derived by Merton that includes extramarket
sources of risk referred to as factor.

Multiple-discriminant analysis (MDA)

Statistical technique for distinguishing between two groups on the
basis of their observed characteristics.

Net benefit to leverage factor

A linear approximation of a factor, T*, that enables one to operationalize the
total impact of leverage on firm value in the capital market imperfections view of capital structure.

Old-line factoring

factoring arrangement that provides collection, insurance, and finance for accounts receivable.

One-factor APT

A special case of the arbitrage pricing theory that is derived from the one-factor model by
using diversification and arbitrage. It shows the expected return on any risky asset is a linear function of a
single factor.

The decomposition of a money manager's performance results to explain
the reasons why those results were achieved. This analysis seeks to answer the following questions: (1) What
were the major sources of added value? (2) Was short-term factor timing statistically significant? (3) Was
market timing statistically significant? And (4), Was security selection statistically significant?

Pool factor

The outstanding principal balance divided by the original principal balance with the result
expressed as a decimal. Pool factors are published monthly by the Bond Buyer newspaper for Ginnie Mae,
Fannie Mae, and Freddie Mac(Federal Home Loan Mortgage Corporation) MBSs.

Present value factor

factor used to calculate an estimate of the present value of an amount to be received in
a future period.

Pro forma capital structure analysis

A method of analyzing the impact of alternative capital structure
choices on a firm's credit statistics and reported financial results, especially to determine whether the firm will
be able to use projected tax shield benefits fully.

Regression analysis

A statistical technique that can be used to estimate relationships between variables.

Reported factor

The pool factor as reported by the bond buyer for a given amortization period.

Scenario analysis

The use of horizon analysis to project bond total returns under different reinvestment rates
and future market yields.

Sensitivity analysis

analysis of the effect on a project's profitability due to changes in sales, cost, and so on.

Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

Technical analysis

Security analysis that seeks to detect and interpret patterns in past security prices.

Two-factor model

Black's zero-beta version of the capital asset pricing model.

Vertical analysis

The process of dividing each expense item in the income statement of a given year by net
sales to identify expense items that rise faster or slower than a change in sales.

VERTICAL ANALYSIS

A financial analysis technique that relates key amounts on the income statement and balance sheet to a 100 percent or base figure for the present and previous year.
It shows the percentage change from last year to this year, making it easier to spot problems that require analysis.

Costâ€“volumeâ€“profit analysis (CVP)

A method for understanding the relationship between revenue, cost and sales volume.

Limiting factor

The production resource that, as a result of scarce resources, limits the production of goods
or services, i.e. a bottleneck.

Ratio analysis

A method of analysing financial reports to interpret trends and make comparisons by using ratios â€“ two numbers, with one generally expressed as a percentage of the other.

Sensitivity analysis

An approach to understanding how changes in one variable of costâ€“volumeâ€“profit analysis are affected by changes in the other variables.

Variance analysis

A method of budgetary control that compares actual performance against plan, investigates the causes of the variance and takes corrective action to ensure that targets are achieved.

Ratio analysis

A method of relating numbers from the various financial statements to one another in order to get meaningful information for comparison.

capital investment analysis

Refers to various techniques and procedures
used to determine or to analyze future returns from an investment
of capital in order to evaluate the capital recovery pattern and the
periodic earnings from the investment. The two basic tools for capital
investment analysis are (1) spreadsheet models (which I strongly prefer)
and (2) mathematical equations for calculating the present value or
internal rate of return of an investment. Mathematical methods suffer
from a lack of information that the decision maker ought to consider. A
spreadsheet model supplies all the needed information and has other

Ratio Analysis

The process of using financial ratios, calculated from key accounts
found in a company's financial statements, to make judgements
concerning the finances and operations of the firm

activity analysis

the process of detailing the various repetitive actions that are performed in making a product or
providing a service, classifying them as value-added and
non-value-added, and devising ways of minimizing or eliminating

correlation analysis

an analytical technique that uses statistical
measures of dispersion to reveal the strength of the
relationship between variables

cost-benefit analysis the analytical process of comparing the

relative costs and benefits that result from a specific course
of action (such as providing information or investing in a
project)

cost driver analysis

the process of investigating, quantifying,
and explaining the relationships of cost drivers and
their related costs

critical success factors (CSF)

any item (such as quality, customer
service, efficiency, cost control, or responsiveness
to change) so important that, without it, the organization
would cease to exist

incremental analysis

a process of evaluating changes that
focuses only on the factors that differ from one course of
action or decision to another

least squares regression analysis

a statistical technique that investigates the association between dependent and independent variables; it determines the line of "best fit" for a set of observations by minimizing the sum of the squares
of the vertical deviations between actual points and the
regression line; it can be used to determine the fixed and
variable portions of a mixed cost

Pareto analysis

a method of ranking the causes of variation
in a process according to the impact on an objective
Pareto inventory analysis an analysis that separates inventory
into three groups based on annual cost-to-volume usage

sensitivity analysis

a process of determining the amount of change that must occur in a variable before a different decision would be made

variance analysis

the process of categorizing the nature (favorable or unfavorable) of the differences between standard and actual costs and determining the reasons for those differences

Regression analysis

Statistical analysis techniques that quantify the
relationship between two or more variables. The intent is quantitative
prediction or forecasting, particularly using a small population to forecast the
behavior of a large population.

Factoring

The sale of accounts receivable to a third party, with the third party bearing
the risk of loss if the accounts receivable cannot be collected.

All the costs incurred during the manufacturing process, minus the
costs of direct labor and materials.

Pareto analysis

The 80:20 ratio that states that 20% of the variables included in an
analysis are responsible for 80% of the results. For example, 20% of all customers
are responsible for 80% of all customer service activity, or 20% of all inventory
items comprise 80% of the inventory value.

annuity factor

Present value of an annuity of \$1 per period.

break-even analysis

analysis of the level of sales at which the company breaks even.

credit analysis

Procedure to determine the likelihood a customer will pay its bills.

discount factor

Present value of a \$1 future payment.

scenario analysis

Project analysis given a particular combination of assumptions.

sensitivity analysis

analysis of the effects of changes in sales, costs, and so on, on project profitability.

simulation analysis

Estimation of the probabilities of different possible outcomes, e.g., from an investment project.

Cost-Benefit Analysis

The calculation and comparison of the costs and benefits of a policy or project.

Factor of Production

A resource used to produce a good or service. The main macroeconomic factors of production are capital and labor.

Factoring

The discounting, or sale at a discount, of receivables on a nonrecourse, notification
basis. The purchaser of the accounts receivable, the factor, assumes full risk of collection and
credit losses, without recourse to the firms discounting the receivables. Customers are notified to
remit directly to the factor.

Failure analysis

The examination of failure incidents to identify components
with poor performance profiles.

Scrap factor

An anticipated loss percentage included in the bill of material and
used to order extra materials for a production run, in anticipation of scrap losses.

Shrinkage factor

The expected loss of some proportion of an item during the
production process, expressed as a percentage.

Break-Even Analysis

An analytical technique for studying the relationships between fixed cost, variable cost, and profits. A breakeven chart graphically depicts the nature of breakeven analysis. The breakeven point represents the volume of sales at which total costs equal total revenues (that is, profits equal zero).

Factor

An agent who buys and sells goods on behalf of others for a commission.

Factoring

Type of financial service whereby a firm sells or transfers title to its accounts receivable to a factoring company, which then acts as principal, not as agent.

Financial Trend Analysis

Process of analyzing financial statements of a company for any continuing relationship.

Interest Factor

Numbers found in compound interest and annuity tables. Usually called the FVIF or PVIF.

Sales forecast

A key input to a firm's financial planning process. External sales forecasts are based on
historical experience, statistical analysis, and consideration of various macroeconomic factors.

extraordinary gains and losses

No pun intended, but these types of gains
and losses are extraordinarily important to understand. These are nonrecurring,
onetime, unusual, nonoperating gains or losses that are
recorded by a business during the period. The amount of each of these
gains or losses, net of the income tax effect, is reported separately in the
income statement. Net income is reported before and after these gains
and losses. These gains and losses should not be recorded very often, but
in fact many businesses record them every other year or so, causing
much consternation to investors. In addition to evaluating the regular
stream of sales and expenses that produce operating profit, investors
also have to factor into their profit performance analysis the perturbations
of these irregular gains and losses reported by a business.

unit-driven expenses

Expenses that vary in close proportion to changes
in total sales volume (total quantities of sales). Examples of these types of
expenses are delivery costs, packaging costs, and other costs that depend
mainly on the number of products sold or the number of customers
served. These expenses are one of the key factors in a profit model for
decision-making analysis. Segregating these expenses from other types
of expenses that behave differently is essential for management decisionmaking
analysis. The cost-of-goods-sold expense depends on sales volume
and is a unit-driven expense. But product cost (i.e., the cost of
goods sold) is such a dominant expense that it is treated separately from
other unit-driven operating expenses.