Analyzing Financial Statements

1
Analyzing Financial Statements

• Financial Information
• Balance Sheet
• Income Statement
• Cash Flow Statement
• Financial Ratios
• Trends
• Industry Norms
• Industry/Competitive Analysis

2
Cooking the Books

• Aggressive application of accounting rules
• Estimates
• Fraud

3
Overstating Revenues

• Selling to Related Entities
• The party must be an arms length
• Stuffing the Channels
• Excessive quantities to distributors/retailers
• Extended credit terms
• Installment sales at Low Interest Rates
• Artificially low interest rate to calculated
  time-adjusted cash flows higher recognized
  Revenues

4
Overstating Revenues

• Using funds from Over-funded Reserves
• Reserves obligation will fluctuate
• Using over-funded Reserves can result in
  under-funding at later accounting periods.
• Treat Nonrecurring Dispositions as Ordinary
  Income
• Below-the-line gains are nonrecurring
• Can over-state Income from normal business
  operations

5
Overstating Revenues

• Record Income for Future Services
• Bundled price includes deferred expenses
• May underestimate value of future services to
  over-state current Revenues

6
Understating Expenses

• Unrealistic Depreciation/Amortization
• Allowable to use a different method for public
  financial reports from Tax (IRS) reporting
• Capitalize Questionable Expenses
• Capitalization or Expense?
• Capitalization deferred expenses
• Match Expenses to Revenues

7
Understating Expenses

• Ignore the cost of Stock Options
• When exercised
• Increases outstanding shares and affects EPS
• Loss of value to company if strike price below
  market price
• How to value?
• Must have some value to have meaning to recipient
• Valuation methods require making assumptions

8
Overstate Assets or Understate Liabilities

• Delay Recognizing Declining Asset Value
• Dressing up the Balance Sheet
• Accounts Receivable and Allowance for Doubtful
  Accounts
• Loans Receivable and Allowance for Bad Debt
• Inventory and Allowance for Obsolete Inventory
• Fixed Assets and writing off obsolete assets
• Investments and unrealistic market valuation
• Conservatism requires the Accountant to
  understate assets

9
Failure to Disclose Liabilities

• Must disclose all liabilities
• Pending lawsuits
• Pension costs
• Toxic cleanup
• Deferred Executive compensation
• Use Unconsolidated Debt
• Offload debt from one affiliated to another
• Dresses up Balance Sheet
• Relationships must be reported in footnotes