Reading 30: Applications of Financial Statement Analysis Flashcards
Describe adjustments related to property, plant, and equipment.
A company that uses accelerated depreciation methods and shorter estimated life assumptions for long-lived assets will report lower net income than a firm that employs longer useful life assumptions and uses straight-line depreciation. Depreciation and net fixed asset values must be assessed and necessary adjustments made to bring sets of financial statements on the same footing before making comparisons.
Explain the 4 Cs of a company.
Character refers to the quality of management.
Capacity refers to the ability of the issuer to fulfill its obligations.
Collateral refers to the assets pledged to secure a loan.
Covenants are limitations and restrictions on the activities of issuers.
Explain what analysts must keep in mind when applying a set of screens to filter investments.
Inputs to ratios are derived from financial statements. Companies within the analyst’s investment universe may differ with respect to (1) the set of standards they subscribe to (IFRS vs. U.S. GAAP), (2) specific accounting methods permitted within a particular set of standards, or (3) the estimates used in applying a particular accounting method.
Back-testing may not provide accurate predictions of future performance.
Implementation decisions can dramatically influence returns.
Explain what analysts should focus on in an analysis of a company’s past performance.
Important changes that have occurred in corporate measures of profitability, efficiency, liquidity, and solvency and the reasons behind these changes.
Comparisons of the company’s financial ratios with others from the same industry and the reasons behind differences.
Examination of performance aspects critical for a company to successfully compete in the industry and an evaluation of the company’s performance relative to its competitors’.
The company’s business model and strategy and how they influence its operating performance.
Explain adjustments related to inventory.
A last in, first out (LIFO) company’s financial statements must be adjusted to first in, first out (FIFO) terms before comparisons with FIFO companies can be undertaken. Important accounts affected by conversion from LIFO to FIFO are net income, retained earnings, inventory, cost of goods sold (COGS), and deferred taxes.
Distinguish between top-down analysis and bottom-up analysis.
Top-down analysis involves identifying attractive geographical and industry segments, and then choosing the most attractive investments from them.
Bottom-up analysis involves selecting specific investments within a specific investment universe.
List the 4 general categories of items financial statements use to calculate ratios used to evaluate the credit risk of a company.
- Scale and diversification of the business
- Operational efficiency
- Stability and sustainability of profit margins
- Degree of financial leverage
Differentiate among growth investors, value investors, and market-oriented investors.
Growth investors invest in those companies that are expected to see higher earnings growth in the future.
Value investors try to pay a low price relative to a company’s net asset value or earning prowess.
Market-oriented investors are an intermediate group of investors who cannot be categorized as growth or value investors.
Why are the calculations of estimated useful life, average age, and remaining useful life important?
They help identify older, obsolete assets that might make the firm’s operations less efficient.
They help forecast future cash flows from investing activities and identify major capital expenditures that the company might need to raise cash for in the future.
List what analysts must consider when forecasting cash flows.
Required increases in working capital.
Capital expenditures on new fixed assets.
Repayment and issuance of debt.
Repurchase and issuance of stock (equity).
