2015, Study Session # 10, Reading # 34

FINANCIAL STATEMENT ANALYSIS: APPLICATIONS

N.I = Net Income
CF = Cash Flows
FS = Financial Statements

OP = Operating Profit
GP = Gross Profit
R&D = Research & Development

34.a

Trends in ratios & difference b/w firm & competitors or industry avg. indicate firms business strategy.
Ratio of GP/OP will higher for a firm that spends largely on R&D.
If firm going to improve EPS by cost cutting, examine operating & gross margins.
Non-U.S companies that use any accounting standards other than IFRS or U.S. GAAP & file with the U.S SEC
were previously required to reconcile their net income & equity accounts to U.S. GAAP.

34.b

Forecast of future N.I & CF begins with forecast of future sales (top down approach).

Analyst estimates company sales by multiplying projected industry sales with projected
market share.

Simple forecasting model historical avg. or trend adjusted measure of profitability.

Complex forecasting model each I.S & B.S item estimated based on separate assumptions
about its growth to revenue growth.

To estimate CF make assumptions about future sources & uses of cash.

34.c

Three Cs to credit analysis

Character

Collateral

Managements professional
reputation & history of debt
repayment.

Reduce lender risk

Capacity to repay
Close examination of FS &
ratios

Categories Considered by rating agencies

Scale & diversification

Larger companies, wider
variety of product line &
greater geographical
diversification less credit
risk.

Operational efficiency
Greater vertical
diversification,

efficiency with better
debt ratings.

Margin Stability
Indicate a higher
probability of
repayment.

Leverage
Greater earnings in
relation to debt &
interest expenses, less
credit risk.

34.d

Portfolio stocks from large universe of equity investments are selected based on accounting items & ratios.

Multiple criteria are used instead of single factor in order to avoid other undesirable characteristics.

Back testing using a specific set of criteria to screen historical data to determine how portfolios will perform.

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2015, Study Session # 10, Reading # 34

34.e

F.S must be adjusted for different accounting methods to make them comparable.

Important differences b/w IFRS & U.S. GAAP are: effect of exchange rate changes,
treatment of internally generated intangible assets etc.

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