1. Research: Financial Domain & Case Studies – Part 2
Welcome to Class 19
Research: Financial Domain & Case Studies – Part 2
Chapter 8

2. The Balance Sheet Assets = Debts = Equity =
Current
Noncurrent
Liabilities
Short-term
Long-term
Equity
Earned
Paid-in
Assets =
Tangible and intangible items or rights owned
(Current + Noncurrent)
Debts =
Financial obligations
(Short + Long-term)
Equity =
The difference between Assets and Debts
(Earned + Paid-in)

3. The Income Statement
Revenue
(-)
Costs
Gross Profit
Expenses
(+/-)
Other Items
Net Income
Reports revenues, expenses, net income, and related items for the current fiscal year (plus two or more prior years).
Net Income less dividends – is added to Retained Earnings which is on the Balance Sheet.

4. The Statement of Cash Flows
Operating
Activities
Investing
Financing
The Statement has three segments:
(1) Operating Activities
(2) Investing Activities
(3) Financing Activities
Each will indicate whether cash has been
“used in” or “provided by”
The Statement of Cash Flows bridges the informational gap between accrual accounting and the need to know how cash is flowing through the business.

5. “OPERATING” ACTIVITIES:
“Operating Activities” include cash used in or provided by:
 The routine process of day to day business activities.
NOT included in
“OPERATING” ACTIVITIES:
 Buying or selling equipment, facilities, patents, etc.
Transactions with stockholders and long-term creditors

6. Investing Activities
“Investing Activities” include cash used in or provided by:
 Acquiring subsidiary companies
 Selling subsidiary companies
 Investing in other companies
 Selling investments in other companies
 Buying or selling property, plant, and equipment
 Buying or selling other fixed, productive and/or intangible assets, etc.

7. Financing Activities
“Financing Activities” include cash used in or provided by:
 Selling or repurchasing a company’s own stock
 Issuing corporate notes or bonds
 Borrowing money from institutions – Banks, Insurance companies, etc.
 Debt repayment
 Payment of dividends, etc.

8. 1. Common-size financial data
Two (2) Step Harmony in Financial Analysis
1. Common-size financial data
(Convert currency data into percentages)
Enables comparison of firms of different sizes
Enables firms with different currencies to be compared
2. Separate performance into categories
The Financial Four are:
(1) Profit, Equity, & Share Value Management
(2) Debt Management
(3) Cash Management
(4) Asset Management $

9. Financial Four Categories 1) Profit, Equity, & Share Value Management
 Continuously expanding profitability
 Increasing equity balances
 Strengthening the value of traded shares
… are interrelated and tied closely to a firm’s ability to:
Achieve and sustain competitive advantages
Yield above average returns for stockholders

10. 2) Debt Management
Financial leverage is important to most (not all) firms.
The degree of leverage and the proper configuration (long-term and short-term) are crucial considerations.
Debt levels should be sufficient to:
Satisfy current financial requirements,
Amplify shareholder returns, and
Facilitate corporate growth.
BUT, caution is important since excessive levels of debt can shift corporate decision-making from TMTs to creditors.

11. 3) Cash Management Inadequate funds can lead to:
 Lost purchasing discounts (2% 10, n 30 = 36% apr)
Missed business opportunities
Alienation of suppliers, etc.
Excessive funds can lead to:
Lack of financial productivity
Increased risk of hostile takeover bids

12. It is possible for a firm to have:
4) Asset Management
Optimal Asset Managements means the firm has the appropriate amount of investment in the right type of assets.
It is possible for a firm to have:
Too much invested in non-current assets = unproductive
Too little invested in non-current assets = unproductive
Outdated non-current assets (need to upgrade) = unproductive
Slow payment by customers = unproductive
Slow sales of Inventory = unproductive

13. Financial Statements Analysis:
After data has been common-sized…
1. Prepare a list of performance questions
2. Perform multiple analyses:
Vertical analysis
Horizontal analysis
Cross-sectional analysis
Time-series analysis

14. Performance Questions
 Have revenues increased?
 Has gross margin improved?
 Has net income increased?
 Has EPS increased?
 Has the share price increased?
 Has total shareholder equity increased?
 Has retained earnings increased?
 Is return on equity adequate compared to a benchmark?
 How does return on assets compare to the benchmark?
 Is cash flow from operations positive (provided by) or negative (used in)?
 Does "times interest earned" (cost of capital) look appropriate?
 What does the independent auditor (Certified Public Accounting firm) say about the financial data?

15. These are potential signs of trouble
Look for Red Flags
These are potential signs of trouble
The Red Flags

16. The Red Flags
1) Management bonuses or stock options increase when profits decrease or are level
2) Acquisition of a competitor for a significant premium (Paying too much?)
3) Diversifications appear nonsensical – (unrelated or new ventures that appear to lack the opportunity for synergy)
4) Reverse stock splits
5) Dividends are declared even though the firm is losing money
6) Off Balance Sheet Financing
7) Debt Refinancing
8) Restructuring, reengineering, downsizing, rightsizing, resizing, and related euphemisms
9) Significant increases in Treasury Stock
10) Public statements about stock value or performance such as: “We know of no better investment than our own company so we will be reacquiring stock.”
11) Erratic or inconsistent decisions, actions, or achievements

17. The Red Flags 12) Disgruntled Board of Directors
13) Financial Statements that look a little too good or perhaps slightly incongruent when compared to other data
14) Unusual financial arrangements or joint-ventures that appear strangely complex
15) Assets that seem relatively too high or too low when compared by percentage to the benchmark
16) Rapid changes in assets or debts – (Unusual increases or decreases in Inventory, Receivables, Short-term Debt, etc.)
17) Restatement of earnings
18) Investigation by the SEC

18. The Red Flags
19) Changes in reported Net Income that seem inconsistent with changes in Cash position – (e.g. Net Income up significantly while Cash is down significantly)
20) Large or unusual non-operating expenses or income
21) Footnotes (endnotes) that seem unclear or ambiguous
22) Golden parachutes for executives that appear a little too generous
23) Extraordinary compensation packages for top management
24) The firm's independent auditors (CPAs) express a "reservation" in their opinion section of the annual report

19. Analysis Methods
1. Vertical Analysis 2. Horizontal Analysis 3. Cross-Sectional Analysis 4. Time-Series Analysis

20. End Financial Domain Lecture
Read Chapter Nine: Performance Perspective: A Stakeholder Perspective
Study these slides, some will be on the test.
Smile! 