Prentice Hall's one-day MBA in finance & accounting by Michael Muckian, Prentice-Hall, inc Page B
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the year just ended.
statements are presented. As a general rule, only a few ratios are presented in most financial reports. Thus investors and lenders have to calculate ratios or look in financial information sources that report the financial statement ratios for businesses.
The business in this example is a corporation that is owned by a relatively small number of persons who invested the capital to start the business some years ago. The business has over $39 million annual sales (see Figure 4.1). Many publicly owned corporations are much larger than this, and most privately owned businesses are smaller. Size is not the point, however.
45
F I N A N C I A L R E P O R T I N G
Capital
Retained
Stock
Earnings
Beginning balances (420,208 shares)
$4,402,500
$7,465,396
Net income for year
$1,585,587
Shares issued during year (2,615 shares)
$ 185,000
Dividends paid during year
($ 450,000)
Ending balances (422,823 shares)
$4,587,500
$8,600,983
FIGURE 4.4 Statement of changes in stockholders’ equity for the year just ended.
The techniques of financial analysis and the ratios discussed in the chapter are appropriate for any size of business.
LIMITS OF DISCUSSION
The chapter does not pretend to cover the broad field of securities analysis (i.e., the analysis of stocks and debt securities issued by public corporations that are traded in public marketplaces). This broad field includes the analysis of the competitive advantages and disadvantages of a business, domestic and international economic developments affecting a business, business combination possibilities, political developments, court decisions, technological advances, demographics, investor psychology, and much more. The key ratios explained in this chapter are the basic building blocks used in securities analysis.
The chapter does not discuss trend analysis, which involves comparing a company’s latest financial statements with its previous years’ statements to identify important year-to-year changes. For example, investors and lenders are very interested in the sales growth or decline of a business and the resulting impact on profit performance, cash flows, and financial condition. The chapter has a more modest objective—to explain the basic ratios used in financial statement analysis.
Only a handful of ratios are discussed in the chapter, but they are extremely important and widely used.
The business example does not include any extraordinary gains or losses for the year. Extraordinary means onetime, 46
I N T E R P R E T I N G F I N A N C I A L S T A T E M E N T S
nonrecurring events. For example, a business may sell off or abandon a major segment of its operations and record a large loss or gain. A business may record a substantial loss caused by a major restructuring or downsizing of the organization to recognize the cost of terminating employees who will receive severance packages or early-retirement bonuses. A business may lose a major lawsuit and have to pay a huge fine or damage award. A business may write off most of its inventories due to a sudden fall in demand for its products. The list goes on and on. These nonordinary, unusual gains and losses are reported separately from the ongoing, continuing operations of a company.
Extraordinary gains and losses are very frustrating in ana-DANGER!
lyzing profit performance for investors, creditors, and managers alike. Making matters worse is that many businesses record huge amounts of extraordinary losses in one fell swoop in order to clear the decks of these costs and losses in future years. This is called “taking a big bath.” Quite clearly, many managers prefer this practice. In public discussions, the investment community wrings their hands and lambastes this practice, as you see in many articles and editorials in the financial press. However, I think many investors would admit in private that they prefer that a business take a big bath in one year and thereby escape losses and
statements are presented. As a general rule, only a few ratios are presented in most financial reports. Thus investors and lenders have to calculate ratios or look in financial information sources that report the financial statement ratios for businesses.
The business in this example is a corporation that is owned by a relatively small number of persons who invested the capital to start the business some years ago. The business has over $39 million annual sales (see Figure 4.1). Many publicly owned corporations are much larger than this, and most privately owned businesses are smaller. Size is not the point, however.
45
F I N A N C I A L R E P O R T I N G
Capital
Retained
Stock
Earnings
Beginning balances (420,208 shares)
$4,402,500
$7,465,396
Net income for year
$1,585,587
Shares issued during year (2,615 shares)
$ 185,000
Dividends paid during year
($ 450,000)
Ending balances (422,823 shares)
$4,587,500
$8,600,983
FIGURE 4.4 Statement of changes in stockholders’ equity for the year just ended.
The techniques of financial analysis and the ratios discussed in the chapter are appropriate for any size of business.
LIMITS OF DISCUSSION
The chapter does not pretend to cover the broad field of securities analysis (i.e., the analysis of stocks and debt securities issued by public corporations that are traded in public marketplaces). This broad field includes the analysis of the competitive advantages and disadvantages of a business, domestic and international economic developments affecting a business, business combination possibilities, political developments, court decisions, technological advances, demographics, investor psychology, and much more. The key ratios explained in this chapter are the basic building blocks used in securities analysis.
The chapter does not discuss trend analysis, which involves comparing a company’s latest financial statements with its previous years’ statements to identify important year-to-year changes. For example, investors and lenders are very interested in the sales growth or decline of a business and the resulting impact on profit performance, cash flows, and financial condition. The chapter has a more modest objective—to explain the basic ratios used in financial statement analysis.
Only a handful of ratios are discussed in the chapter, but they are extremely important and widely used.
The business example does not include any extraordinary gains or losses for the year. Extraordinary means onetime, 46
I N T E R P R E T I N G F I N A N C I A L S T A T E M E N T S
nonrecurring events. For example, a business may sell off or abandon a major segment of its operations and record a large loss or gain. A business may record a substantial loss caused by a major restructuring or downsizing of the organization to recognize the cost of terminating employees who will receive severance packages or early-retirement bonuses. A business may lose a major lawsuit and have to pay a huge fine or damage award. A business may write off most of its inventories due to a sudden fall in demand for its products. The list goes on and on. These nonordinary, unusual gains and losses are reported separately from the ongoing, continuing operations of a company.
Extraordinary gains and losses are very frustrating in ana-DANGER!
lyzing profit performance for investors, creditors, and managers alike. Making matters worse is that many businesses record huge amounts of extraordinary losses in one fell swoop in order to clear the decks of these costs and losses in future years. This is called “taking a big bath.” Quite clearly, many managers prefer this practice. In public discussions, the investment community wrings their hands and lambastes this practice, as you see in many articles and editorials in the financial press. However, I think many investors would admit in private that they prefer that a business take a big bath in one year and thereby escape losses and
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