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Lecture Financial accounting in an economic context (9th edition): Chapter 5 – Jamie Pratt

Chapter 5 - Using financial statement information. In this chapter students will be able to: Describe the two basic uses of financial statements, describe the four elements of successful companies and how they link to the company’s overall financial performance. | 1 Chapter 5: Using Financial Statement Information 2 2 Control and Prediction Financial accounting numbers are useful in two fundamental ways: They help investors and creditors influence and monitor the business decisions of a company’s managers. They help to predict a company’s future earnings and cash flows. 3 3 Financial Accounting Numbers as Prediction Aids Financial statements do not reflect the company’s prospects within its business environment Statements are backward looking, not focusing on the future prospects. Financial statements are inherently limited Statements leave out some current and historical information such as human resources and the effects of inflation. Management prepares the financial statements in a biased manner Managers often choose accounting methods and estimates that make them look good. 4 4 Framework for Financial Statement Analysis 5 Book Value Add adjustments for: (1) business environment (2) unrecorded events (3) management bias = True Value 5 Elements of Financial Statement Analysis Five Issues: Assessing the business environment. Reading and studying the financial statements and footnotes. Assessing earnings quality. Analyzing the financial statements. Predicting future earnings and/or cash flow. 6 6 Assessing the Business Environment What is the nature of the company’s operations? What strategy is being employed to generate profits? What is the company’s industry? Who are the major players? Competition? What are the relationships between the company and its customers and suppliers? How are the company’s sales and profits affected by changes in the economy? 7 7 Reading and Studying the Financial Statements and Notes Read the audit report. Identify significant transactions. major acquisitions, discontinuance or disposal of a business segment, unresolved litigation, major write-downs of receivables or inventories, tender offers, extraordinary gains and losses, or changes in accounting principles Identify and analyze important . | 1 Chapter 5: Using Financial Statement Information 2 2 Control and Prediction Financial accounting numbers are useful in two fundamental ways: They help investors and creditors influence and monitor the business decisions of a company’s managers. They help to predict a company’s future earnings and cash flows. 3 3 Financial Accounting Numbers as Prediction Aids Financial statements do not reflect the company’s prospects within its business environment Statements are backward looking, not focusing on the future prospects. Financial statements are inherently limited Statements leave out some current and historical information such as human resources and the effects of inflation. Management prepares the financial statements in a biased manner Managers often choose accounting methods and estimates that make them look good. 4 4 Framework for Financial Statement Analysis 5 Book Value Add adjustments for: (1) business environment (2) unrecorded events (3) management bias = True Value 5 .