Contents:
1. What is Financial Analysis?
2. The Financial Environment
3. The Financial Statements
4. Quantitative Financial Analysis
Techniques: Using Financial Statement Information
5. Multi-period Quantitative
Financial Analysis
6. Quantitative Financial Analysis
Techniques: Incorporating Market Information
7. An Accounting Analysis Perspective
8. Accounting Analysis:
Specific Issues 1
9. Accounting Analysis:
Specific Issues 2
10. Business Combinations
11. Corporate Debt and Credit
Risk
12. Credit Analysis
13. Equity Investment Analysis
Chapter Summaries:
Chapter 1: A six-step process is used as a systematic
procedure for all financial analysis decisions:
Purpose of financial analysis
Overview of company analyzed
Financial analysis techniques used
for analysis
Detailed accounting analysis on specific
issues, potential earnings management and relative confidence in the financial
numbers
Comprehensive analysis, usually including
an executive summary
Financial analysis decision
A consistent approach for all financial dcisions is suggested,
modified for the specific analysis at hand.
Chapter 2: The financial analysis is complex. Capital markets include both primary and secondary markets, with most investment decisions taking place in the major stock exchanges. Since the 1930, capital markets have been regulated by the SEC. Accounting regulation (GAAP) expanded over the last 60 plus years. These regulations benefit investors, but make analysis more complex. A good understanding of ixisting GAAP and the standard-setting process is an important component of financial analysis. Financial and accounting theory suggest the existence of efficient markets, which has implications on how markets behave. Earnings management and other incentives by managers suggest certain behavior that may not be in the best interests of stockholders. A basic understanding of these theories can improve analyst decisions.
Chapter 3: A brief review of the balance sheet, income statement & cash flow statement.
Chapter 4: A thorough financial analysis provides substantial information on performance and most aspects of financial position and growth. Comparisons over time and across firms place the analysis in some perspective. Most numbers represent percentages, particularly useful for comparision analysis. Although limitations exist, this still represents the heart of the financial analysis process.
Chapter 5: Multi-period quantitative techniques including trend analysis, growth analysis & quarterly analysis.
Chapter 6: This chapter incorporates market information in the financial analysis process. Current stock prices and stock price trends are readily available in virtually any form desired. Assuming efficient markets, they are an unbiased estimate of the true value of the company. Therefore, stock price trends along with earnings and EPS projections provide considerable new information, new ratios and valuation methods.
Chapter 7: Accounting analysis is the in-depth analysis
of accounting policies and decisions beyond the financial statements.
Firms have considerable flexibility with revenue recognition, expense recongintion,
and balance sheet items that need further evaluation. A five-step
process is recommended for analysis:
Financial accounting overview
Evaluate reporting completeness
Evaluate the potential for earnings
management
Consider potential red flags
Reevaluate or restate financial information
Accounting decisions by firms can be a detriment to understanding
financial statement numbers. The purpose of the detailed accounting
analysis is to "undo" potential earnings management and better understand
economic reality of the the business firm.
Chapter 8: This chapter reviewed five accounting issues: marketable securities, inventory, fixed assets, income tax allocation, and leases. Each topic has unique issues and problems that may be firm or industry specific. The importance of each topic depends on the specific firm analyzed. An analysis of marketable securities is important for Dell, but leases are not. For most companies, makretable securities represent near cash, a way to earn a return on excess cash until it is needed for capital investment or other purposes. This can be significant to analysts as an indicator of liquidity and potential for future dividends. An acquiring firm also can use this near cash. Firms typically use either LIFO or FIFO for inventory. The choice depends on changing prices, industry practices, and business strategy characteristics. Fixed assets are the productive assets of a firm, particularly important to most manufactuing firms. The amount of fixed assets and relative age can be important to analysts to evaluate manufacturing productivity. Income tax allocation is important to understand the effective tax rates that the firm pays. This is an area of earnings management particularly important to the investor, since tax payments should be minimized. A lease is an important earnings management tool. Where substantial operating leases are present, analysts may recalculate the impact of these on leverage ratios.
Chapter 9: This chapter reviewed four acocunting issues requiring further analysis: stock options, segment reporting, foreign currency translation, and pensions and other post-employment benefits. The impact of any of these items tends to be firm or industry specific. Thus, the first three required analysis for Dell, but pensions and other post-employment benefits were non-issues.
Chapter 10: Business combinations continue to be one of the major factors in big business and economic activity. Since acquisitions tend to increase market share and reduce competition they have both investor and public policy aspects. The accounting for business combinations is complex and the analyst must understand the basic procedures and their impact on the financial position of the prospective merger. Particularly important is the difference between pooling of interests and the purchase method, which have substantially different effects on the financial statements and future operations (including tax aspects). The evaluation of past acquisitions can be difficult and relies on note disclosures and analyst estimates. The ability to forecast prospective merger candidates may improve financial analyst recommendations.
Chapter 11: This chapter considered the liaibility structure of corporations and indicators of credit risk. The major categories are defalut risk (the probability of missing principal and interest payments on liabilities) and bankruptcy (the probability the firm will declare bankruptcy). In addition to traditional financial and accounting analysis, Altman's Z-score and bond ratings are useful tools for evaluating default risk.
Chapter 12: Commercial bank lending is an important segment of the capital marekts and credit analysis a necessary step of lending decisions. A six-step process is suggested, similar to the general process specified in Chapter 1 and using the techniques from all earlier chapters. The difference is focus and degree of analysis. The key is the evaluation of credit risk; specifically, the probability that principal and interest payments will be paid when they come due. Since default is costly to creditors, lending contracts provide protection to the bank in the form of collateral, compensating balances, and debt covenants, as well as interes rates that factor in default risk.
Chapter 13: Equity investment analysis is perhaps
the most basic financial decision available, both as a prodessional analysis
or individual investor. Decisions should be based on specific investment
goals, from short-term to very long-term, and amount of risk that can be
tolerated. Mutual funds are an important investment area, providing
investment diversity and professional management. The hypothetical
Gotrocks Funds are used to consider growth and income funds and investment
fund analysis, using the basic six-step process appraoch introduced in
Chapter 1. Primary focus is on Dell as an investment vehicle in the
Gotrocks Growth Fund. Although concerns exist, analysis suggests
that increasing the holding of Dell may be a reasonable recommendation.