UNDERSTANDING FINANCIAL STATEMENTS ELEVENTH
EDITION
Lyn M. Fraser Aileen Ormiston
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10 9 8 7 6 5 4 3 2 1
ISBN 10: 0-13-387403-6 ISBN 13: 978-0-13-387403-7
For Eleanor —Lyn M. Fraser For Katelyn —Aileen Ormiston
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CONTENTS
Preface to the Eleventh Edition x Organization of the Eleventh Edition Uses for the Eleventh Edition xiii Acknowledgments xiv About the Authors xvi CHAPTER 1
xi
Financial Statements: An Overview
Map or Maze
1
1
Usefulness 4 Volume of Information 4 Global Economy 7 Where to Find a Company’ Company’ss Financial Statements 8 The Financial Statements 8 Notes to the Financial Statements 8 Auditor’s Report 10 Financial Reporting Reforms 11 Management Discussion Discussion and Analysis 12 Five-Year Five-Y ear Summary of Selected Financial Data and Market Data Pandora (a.k.a. “PR Fluff”) 14 Proxy Statement 15 Missing and Hard-to-Find Hard-to-Find Information 15 Characteristics, Assumptions, Principles and Basis of Accounting
Complexities and the Quality of Financial Reporting Accounting Choices 17 Timing of Revenue and Expense Recognition Discretionary Items 19
The Journey Through the Maze Continues APPENDIX 1A
Sage Inc.
14
16
17
18
19
20
Self-Test 32 Study Questions and Problems 35 Case 1.1 Intel Case 36 Case 1.2 Applied Materials Comprehensive Comprehensive Analysis Case Using the Financial Statement Analysis Template 37 Case 1.3 Mattel Inc. 38 Case 1.4 Biolase, Inc. 39
v
vi Contents CHAPTER 2
The Balance Sheet
Financial Condition
48
Consolidation 48 Balance Sheet Date 48 Comparative Data 50 Balance Sheet Format 50 Common-Size Balance Sheet
Assets
47
50
51
Current Assets 51 Cash and Cash Equivalents 53 Marketable Securities 53 Accounts Receivable 53 Inventories 56 Inventory Accounting Methods 57 Prepaid Expenses 60 Property, Plant, and Equipment 60 Straight line 61 Accelerated 61 Goodwill 63 Other Assets 63
Liabilities
64
Current Liabilities 64 Accounts Payable 64 Short-Term Debt 65 Current Maturities of Long-Term Debt 65 Accrued Liabilities 65 Unearned Revenue or Deferred Credits 66 Deferred Federal Income Taxes 67 Long-Term Debt 70 Capital Lease Obligations 70 Pensions and Postretirement Bene �ts 71 Commitments and Contingencies 72
Stockholders’ Equity
72
Common Stock 73 Additional Paid-In Capital 73 Retained Earnings 74 Other Equity Accounts 74
Quality of Financial Reporting—The Balance Sheet 75 Other Balance Sheet Items 76 Self-Test 76 Study Questions and Problems 81 Case 2.1 Intel Case 86 Case 2.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template 87
Contents
Case 2.3 Walgreen Co. and Subsidiaries Case 2.4 Hydrogenics Corporation 92 CHAPTER 3
88
Income Statement and Statement of Stockholders’ Equity 103
The Income Statement
104
Common-Size Income Statement 106 Net Sales 106 Cost of Goods Sold 108 Gross Pro �t 108 Operating Expense 111 Operating Pro �t 114 Other Income (Expense) 114 Equity Earnings 115 Earnings Before Income Taxes/Effective Tax Rate Special Items 117 Net Earnings 118 Earnings per Common Share 118 Comprehensive Income 118
116
The Statement of Stockholders’ Equity 120 Earnings Quality, Cash Flow, and Segmental Accounting APPENDIX 3A
A Guide to Earnings Quality
121
123
Self-Test 141 Study Questions and Problems 145 Case 3.1 Intel Case 148 Case 3.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template 149 Case 3.3 Logitech International S.A. 150 Case 3.4 Hydrogenics Corporation 154 CHAPTER 4
Statement of Cash Flows
161
Why Cash Flow is Important: An Example 162 Statement of Cash Flows: Basic Principle 163 Preparing a Statement of Cash Flows 165 Calculating Cash Flow from Operating Activities Indirect Method
170
Cash Flow from Investing Activities 173 Cash Flow from Financing Activities 173 Change in Cash 174 Analyzing the Statement of Cash Flows 175 Cash Flow from Operations Nocash Corporation 176
175
170
vii
viii Contents Sage Inc.: Analysis of the Statement of Cash Flows
178
Sage Inc. Analysis: Cash Flow from Operating Activities 178 Summary Analysis of the Statement of Cash Flows 179 Analysis of Cash In �ows 180 Analysis of Cash Out �ows 181
Qualitative Issues Relating to the Statement of Cash Flows Are We There Yet? 183 APPENDIX 4A
Statement of Cash Flows—Direct Method
182 184
Self-Test 188 Study Questions and Problems 191 Case 4.1 Intel Case 198 Case 4.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template 199 Case 4.3 Avnet Inc. 200 Case 4.4 Hydrogenics Corporation 202 CHAPTER 5
The Analysis of Financial Statements
Objectives of Analysis Sources of Information
205 206
Proxy Statement 206 Auditor’s Report 206 Management Discussion and Analysis Supplementary Schedules 207 Form 10-K and Form 10-Q 207 Other Sources 207
Tools and Techniques
204
207
209
Common-Size Financial Statements 210 Key Financial Ratios 210 Liquidity Ratios: Short-Term Solvency 211 Cash Conversion Cycle or Net Trade Cycle 216 Activity Ratios: Asset Liquidity, Asset Management Ef �ciency Leverage Ratios: Debt Financing and Coverage 218 Pro �tability Ratios: Overall Ef �ciency and Performance 221 Market Ratios 223
Analyzing the Data
225
Background: Economy, Industry, and Firm 226 Short-Term Liquidity 227 Operating Ef �ciency 229 Capital Structure and Long-Term Solvency 229 Pro �tability 233 Relating the Ratios—The Du Pont System 234 Projections and Pro Forma Statements 236 Summary of Analysis 236 Financial Statements: A Map 237
216
Contents
APPENDIX 5A
The Analysis of Segmental Data
ix
239
Self-Test 244 Study Questions and Problems 250 Case 5.1 Intel Case 256 Case 5.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template 257 Case 5.3 Facebook, Inc. 258 Case 5.4 Hydrogenics Corporation 268 APPENDIXES A Summary of Financial Ratios
B Solutions to Self-Tests C Glossary 274 Index
283
272
269
PREFACE
TO
THE
ELEVENTH
EDITION
Major changes have been incorporated into this eleventh edition of Understanding Financial Statements in order to continue improving the usefulness of the text for professors, students, and readers of the material. We have made many of the revisions in response to specific requests and comments from users of the text.
New to this Edition and basis of accounting. Facebook in Chapter 5. each chapter, and Chapters 2–5 include a comprehensive case of an international been added to the website. As always, our intent is to present the material in a way that helps readers make prac decision-making. Our preface to previous editions has included an update on our children, all of whom are now grown-up and leading interesting lives of their own, so our feature this year is of the new member of the team, Aileen’s granddaughter, Katelyn. While our children have all supported this work through its various iterations, Katelyn has responded to Understanding Financial Statements in a unique manner that should certainly encourage interest in our book. Lyn M. Fraser
x
O R G A N I Z AT I O N
OF
THE
ELEVENTH
EDITION
Chapter 1 provides an overview of financial statements and presents approaches to overcoming some of the challenges, obstacles, and blind alleys that may examples of specific problems encountered in such areas as the auditor’s report and the management discussion and analysis section as well as material that is complexity of the accounting rules that underlie the preparation and presenta in conventional financial statement presentations. Chapters 2, 3, 4, and 5 describe and analyze financial statements for a mythical but potentially real company, Sage Inc., which sells recreational products through retail outlets in the southwestern United States. The specifics of this particular firm should be helpful in illustrating how financial statement analysis can provide insight into a firm’s strengths and weaknesses. But the principles and concepts covered throughout the book apply to any set of published financial Because one company cannot provide every account and problem the user will encounter in financial statements, additional company examples are introduced throughout the text where needed to illustrate important accounting and analytical issues. Chapters 2 through 4 discuss in detail a basic set of financial statements: the stockholders’ equity in Chapter 3, and the statement of cash flows in Chapter 4. The emphasis in each of these chapters is on what the financial statements convey about the condition and performance of a business firm as well as how the numbers have been derived. Appendix 3A discusses and illustrates issues that relate to the quality of earnings—and thus the usefulness—of financial reporting. The chapter contains a step-by-step checklist of key items to help the analyst assess the quality of reporting, and real-company examples of each step are provided. With this material as background, Chapter 5 covers the interpretation and analysis of the financial statements discussed in Chapters 2 through 4. This process involves the calculation and interpretation of financial ratios, an examination of trends over time, a comparison of the firm’s condition and performance with its competitors, and an assessment of the future potential of the company based on its historical record. Chapter 5 also reviews additional sources of information that can enhance the analytical process.Appendix 5A shows how to evaluate the
xi
xii Organization of the Eleventh Edition segmental accounting data reported by diversified companies that operate in several unrelated lines of business. Self-tests at the ends of Chapters 1 through 5 provide an opportunity for the tests are given in Appendix B. For more extensive student assignments, study questions and problems are placed at the end of the chapters. Cases drawn from actual company annual reports are used to highlight in a case-problem format many of the key issues discussed in the chapters. Appendix A covers the computation and definition of the key financial ratios that are used in Chapter 5 to evaluate financial statements. Appendix B contains solutions to self-tests for Chapters 1 through 5. Appendix C presents a glossary of the key terms used throughout the book. The ultimate goal of this book is to improve the reader’s ability to translate financial statement numbers into a meaningful map for business decisions. It is hoped that the material covered in the chapters and the appendixes will enable each reader to approach financial statements with enhanced confidence and understanding of a firm’s historical, current, and prospective financial condition and performance.
USES
FOR
THE
ELEVENTH
EDITION
Understanding Financial Statements is designed to serve a wide range of readers and purposes, which include: 1. 2. Supplementary text for accounting, finance, and business management 3. Study material for short courses on financial statements in continuing 4. Self-study guide or course material for bank credit analysis training 5. Reference book for investors and others who make decisions based on the analysis of financial statements.
xiii
ACKNOWLEDGMENTS
We would like to acknowledge with considerable appreciation those who have contributed to the publication of this book. We would like to thank the reviewers who made critical comments and sugges We would like to thank the individuals who made critical comments and suggestions for the tenth edition. In particular, we would like to thank Terrence Willyard, Chris Prestigiacomo, University of Missouri. Many individuals have made critical comments and suggestions for the previous editions of the text. In particular, we would like to thank David K. Hensley,
xiv
Acknowledgments
xv
The authors would like to express grateful appreciation to Tim Carse for his careful and attentive proofreading of the manuscript during the production process. Special thanks go to Jacqui Jesse for her excellent and creative work in preparing PowerPoints to accompany the book. We would also like to thank the editorial, production, and marketing departments of Pearson for their assistance at each stage of the writing and production process. Rosalind Shahuna has been superb in meeting this schedule, and the authors are appreciative of her exceptionally efficient handling of the process in a patient and cordial manner. The list would be incomplete without mentioning the pets in our households who helped keep us in good humor throughout the revision of this edition: Toot, AddieMae, Escalante, Mooli, Teddy, Torin, and Tisha. Lyn M. Fraser Aileen Ormiston
ABOUT
THE
AUTHORS
Lyn M. Fraser has taught undergraduate and graduate classes in financial state on the subject for executive development and continuing education courses. A Certified Public Accountant, she is the coauthor with Aileen Ormiston of Understanding the Corporate Annual Report: Nuts, Bolts, and a Few Loose Screws Journal of Accountancy, the Journal of Commercial Bank Lending, the Magazine of Bank Administration, and the Journal of Business Strategies. She has been recognized for Distinguished Achieve and is a member of Phi Beta Kappa. Lyn’s most recent publication is a new mystery novel, Debits and Credits, published by Mainly Murder Press in 2014. Aileen Ormiston teaches in the Accounting Department in the W.P. Carey School of Business at Arizona State University and has taught in the MBA, honors, and online programs. She received her bachelor’s degree in accounting from University. Prior to embarking on her teaching career, Aileen worked in cost accounting and also as an auditor in public accounting. She taught accounting and general business courses for 30 years at Mesa Community College, one of 13 universities and colleges that received a grant from the Accounting Education Change Commission. As a result of her pioneering work in changing accounting education, she was the recipient of the “Innovator of the Year” award from the League for Innovation in the Community College. For her service to honors students, Aileen has been named a Phi Theta Kappa mentor.
xvi
CHAPTER
1
Financial Statements An Overview – maze (maz), n. 1. An intricate, usually confusing network of passages, some blind and some leading to a goal. 2. Anything made up of many confused or conflicting elements. 3. A mental state of confusion or perplexity.1
Learning Objectives After studying this chapter, you should be able to:
Map or Maze A map helps its user reach a desired destination through clarity of representation. A maze, on the other hand, attempts to confuse its user by purposefully introduc 1
The American Heritage Dictionary of the English Language , New York: American Heritage Publishing Co., Inc. 1969.
1
2 Financial Statements As a map, financial statements form the basis for understanding the financial Independent auditors attest to the fairness of financial statement presentations, but the the financial statements, some is difficult to find, and much is impossible to measure.
of a business enterprise that is as clear as possible for purposes of making sound business decisions about the firm. understanding of financial statements. While this book focuses on firms operating primarily in nonfinancial industries, many of the underlying principles discussed in serious economic crisis in modern history. all its editions is the importance of cash flow from operations as a key performance ity to generate cash from operations. Lehman Brothers is a classic case. Lehman Brothers reported steadily increasing and robust net income figures of
Financial Statements
3
Understanding the Corporate Annual Report—Nuts, Bolts, and a Few Loose Screws intended for use by those who want to learn more about the content and interpreta authors attempt to simplify and explain complex accounting and financial issues in a way that allows readers not only to understand the information presented in annual
The reader can expect more than a dull exposition of financial data and account tax laws to assess how well companies are actually performing. The chapters and appendixes in the book show how to approach financial statements to obtain practi cal, useful information from their content. Although the examples in the book are based on corporate financial statements, the discussion also applies to the financial statements of small business firms that use generally accepted accounting principles. The emphasis throughout the book is on analysis. In the first four chapters of the book, we will look at the contents of an annual report and break the financial state as a map to intelligent decision making. To fully analyze a firm, it is important to
4 Financial Statements Usefulness mation regarding the financial position of a company, the success of its operations, the policies and strategies of management, and insight into its future performance.
The financial statements and other data generated by corporate financial report tion contained in a corporate annual report. Annual reports in this book will refer to detailed document and is used by regulators, analysts, and researchers. The basic set of financial statements and supplementary data is the same for both documents, and Volume of Information well as material that is included in the report at the imagination and discretion of presentation of financial information that is understandable by users as well as rel
Financial Statements
5
lar filing of 2 for a better system to research accounting standards. The Codification includes not only Codification. All updates and prior standards will be organized by related topics.3 change its policies (inflation accounting, oil and gas accounting). Pressures on the 2
3 do not address recognition, measurement, or derecognition matters. Topics include income statement,
6 Financial Statements FIGURE 1.1
SEC
FASB/SEC Relationship
Gives power to set accounting rules
Passes on role of making accounting rules but retains veto power
CONGRESS
Lobbies for favorable accounting rules
FASB Uses accounting rules
REPORTING COMPANIES
compromise its stance on this issue.4 disclose in the notes to the financial statements the effects on profits of new compensation from profits once again resulted in congressional interference, delay 4
CFO, Journal of Accountancy,
Financial Statements
7
Global Economy would benefit from financial statements that are consistent and comparable regard is the adoption of uniform international accounting standards. Accomplishing this prepare more than one set of financial statements. The need for international account a comparable scandal when Italian dairy food giant Parmalat filed for bankruptcy 6
6 International Convergence of Accounting Standards-A Brief History Final Staff Report: Work Plan for the Consideration of Incorporating International Financial Reporting Standards
into the Financial Reporting System for U.S. Issuers
8 Financial Statements has been added to each chapter in the book to illustrate analysis of an international firm. Where to Find a Company’s Financial Statements than producing a separate annual report. Other firms send a slickly prepared annual report that includes the financial statements as well as other public relations material The Financial Statements A corporate annual report contains four basic financial statements, illustrated in 1. The balance sheet or statement of financial position 2. The income or earnings statement period. 3. The statement of stockholders’ equity reconciles the beginning and ending balances the income statement, which reconciles the beginning and ending balances of the retained earnings account. Companies choosing the latter format will generally 4. The statement of cash flows
later chapters of the book. Notes to the Financial Statements Immediately following the four financial statements is the section entitled Notes to gral part of the statements and must be read in order to understand the presentation on the face of each financial statement.
FIGURE 1.2
Financial Statements
9
Form 10-K Components
Item #
Item Title
Item 1.
Business
Item 1A.
Item 1B.
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Item 6.
Item 9.
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Item 11.
Item 12.
Item 13.
Item 14.
in a financial statement note. Other notes to the financial statements present details about particular accounts, such as
The notes also include information about
period
10 Financial Statements
showing financial information for each reportable segment. Auditor’s Report added to the annual report. In this report, management must state its responsibility ment of the company as well as the financial statements. 9 An unqualified financial statements present fairly, in all material respects, the financial position, the results of operations, and the cash flows for the accounting period, in conformity with called qualified the use of the following language in the opinion sentence: “In our opinion, except for the (nature of the departure explained), the financial statements present fairly. . .” If the then an adverse 9
Baltimore Business Journal, CA Magazine,
Financial Statements
11
disclaimer of opinion, which means the auditor them. Lack of independence by the auditor will also result in a disclaimer of opinion. unqualified opinion with explanatory language such as: a consistency departure due to a change in accounting principle, uncer that the auditor wishes to describe because they may present business risk and additional paragraphs to the standard report. Financial Reporting Reforms In theory, the auditing firm performing the audit and issuing the report is “independent” banks, PwC obscured some of the same accounting misconduct it was supposed to and conflicts of interest between companies and their hired auditors led to a series of directly impact the area of understanding financial reporting follows.11 for a particular audit client. Another issue relating to auditor independence occurs when
The New York Times 11
12 Financial Statements before an employee from the external audit firm may go to work for a client in the publicly owned company certify the accuracy of the financial statements. An officer who certifies a report that is later found to be inaccurate could face up to $1 million accounting fraud and financial statement misrepresentation. CFO magazine, Antar tells of his regret that he is no longer in the fraud game at a time when he claims corporate fraud is experiencing a resurgence. He states, because the economy tanked.”12 Based on such comments as well as recent history, the need for users of financial statements to gain a basic understanding of financial state Management Discussion and Analysis The Management Discussion and Analysis tion that cannot be found in the financial data. The content of this section includes the analyst can expect to find a discussion of the following: 1. 2. 3. Commitments for capital expenditures, the purpose of such commitments, and expected sources of funding 4. Anticipated changes in the mix and cost of financing resources 5. 6. 7.
12
CFO,
FIGURE 1.3
Financial Statements
13
MD&A Discussion Items: What Do They Mean?
Item
Translation
1. Internal and external sources
or through borrowing and sales of stock
and how they will be remedied.
continue to operate in the long term, what is it
3. Commitments for capital expenditures, the purpose of such commitments, and expected sources of funding.
How much is the company planning to spend
4. Anticipated changes in the mix and cost of financing resources.
the company borrow more or less, sell more
that affect income from continuing operations.
in the relationship between costs and
Will significant changes occur that cause without a corresponding change in expenses
increase the result of price increases (with
compiled by Audit Analytics and analyzed by CFO 13 We may not be able to expand, causing sales to decrease. We may not be successful in our marketing efforts. Our operating results may fluctuate, causing our stock price to decline. Our suppliers may not meet our demand for materials. 13
CFO
14 Financial Statements And on and on! These statements may be true, but an assessment of the probability will be used to open new stores. The funding sources will be cash from operations be a change in the mix and cost of financing resources. price decreases. Other information that can be obtained from this section of the Five-Year Summary of Selected Financial Data and Market Data in the marketplace. Pandora (a.k.a. “PR Fluff”)
Financial Statements
15
photographs and many pages before the reader could find any hard financial data. Proxy Statement proxy statement, as many shareholders do not attend shareholder meetings. The compensation and any proposed changes in compensation plans, the audit commit tee report, and a breakdown of audit and nonaudit fees paid to the auditing firm. This information is important in assessing who manages the firm and how manage option grants, and related party transactions. Missing and Hard-to-Find Information statements. These include such intangibles as employee relations with management, the morale and efficiency of employees, the reputation of the firm with its customers,
16 Financial Statements public perception of a firm, can also impact its performance. How firms handle prod with regard to sales, profits and stock prices. outstanding is disclosed on the face of the balance sheet in the noncurrent liability payments, the user must find and analyze the note to the financial statements on term debt instruments. Another important form of supplementary information is that reported by glomerates report financial information for the consolidated entity on the face of its ments, the analyst must use information in notes to the financial statement. Understanding the Corporate Annual Report—Nuts, Bolts, and a Few Loose Screws Characteristics, Assumptions, Principles, and Basis of Accounting
principles used to produce this data. Materiality refers to the fact that the dollar amount of the information must be significant enough to make a difference in a decision it is considered to be “immate rial”. Comparability allows users to compare financial information of an entity to other entities as well as comparing financial information of that entity to itself from one time period to another. Consistency is related to comparability and means that the same accounting methods and choices should be used from one time period to another. Changes in accounting choices can distort trends that would be helpful in analyzing companies. The Going Concern Assumption assumes that business entities will operate indefi considered to be going concerns.
Financial Statements
17
The Time Period Assumption indicates a specified time period that business firms The Monetary Unit Assumption is the assumed unit of measurement when prepar company operates is used for financial reporting purposes. The Revenue Recognition Principle The Matching Principle take place, without regard to receipt or payment of cash. The Accrual Basis of Accounting The Cash Basis of Accounting ognizes expenses when cash is paid. accrual and the cash basis of accounting.
Complexities and the Quality of Financial Reporting Interpreting financial statements can be challenging because of the complexities inher agement considerable discretion in applying the regulations. The potential exists for management to “manipulate” the bottom line (profit or loss) and other accounts in financial statements. Ideally, financial statements should reflect an accurate picture of both to assess the past and predict the future. The sharper and clearer the picture pre sented through the financial data and the closer that picture is to financial reality, the Accounting Choices
18 Financial Statements FIGURE 1.4
Accrual vs. Cash Basis of Accounting
Cost per cap
the cash basis of accounting.
Accrual Basis
( + 1
*
Cash Basis
1 caps)
Less expenses: Cost of caps (+ Booth fee
( + 1
*
3 caps)
Less expenses: *
1)
Cost of caps ( +
*
1)
Booth fee
Net Income
Net Loss
As you can see, the amount of profit is significantly different depending on whether the accrual basis or prepared, both accrual and cash basis information are presented. The balance sheet, income statement
include, for instance, assuming that the oldest, lowest cost of goods are sold first, or ing can also be impacted if the accounting choice does not reflect economic reality. financial data must be appropriated to particular time periods. Timing of Revenue and Expense Recognition for preparing financial statements is the matching principle: expenses are matched
Financial Statements
19
are recognized when earned and expenses are recognized when incurred, regardless appropriate allocations, these rules are not always precise. Discretionary Items tion. A company might elect to defer plant maintenance in order to boost current period earnings; ultimately, the effect of such a policy could be detrimental. marketing expenditures are essential to gaining and maintaining market share. computing and electronics, health, and auto. respect to these discretionary items through an examination of expenditure trends and contribute to an assessment of its ability to perform successfully in the future.
The Journey Through the Maze Continues Numerous other examples exist to illustrate the difficulty in finding and interpreting challenges. The remaining chapters in this book are intended to help readers find
20 Financial Statements
Appendix 1A: Sage Inc. Sage Inc. 2016 Annual Report
Financial Statements
21
Management’s Discussion and Analysis of Financial Condition and Results of Operations Net Sales prices on footwear products in order to increase sales. Gross Profit
gins resulting from realignment in the retail prices of athletic footwear. The gross profit Operating Expenses
were recorded in prior years. Higher costs associated with new store openings in efforts and closing of underperforming stores. store relocations and store closings. Other Income (Expense)
22 Financial Statements Income Tax
Liquidity and Capital Resources Operating Activities
(In Thousands)
2016
2015
6,464
2014
111
Cash flows from operations are seasonal, with the Christmas season being the Investing Activities
Financing Activities
ments for the next 12 months, including capital expenditures.
Financial Statements
23
Auditor’s Report
these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, statements. An audit also includes assessing the accounting principles used and sig opinion. operations and their cash flows for each of the three years in the period ended
24 Financial Statements SAGE INC. CONSOLIDATED BALANCE SHEETS
December 31, 2016 and 2015 (in Thousands) 2016
Assets Current Assets Prepaid expenses and other assets Total current assets Land Less accumulated depreciation and amortization Other Assets Total Assets Liabilities and Stockholders’ Equity Current Liabilities Accounts payable Accrued liabilities Income taxes payable Total current liabilities Total liabilities The accompanying notes are an integral part of these statements.
$9,333
2015
$14,294
4,366
49,363
32,363
Financial Statements
25
SAGE INC. CONSOLIDATED STATEMENTS OF EARNINGS
For the Years Ended December 31, 2016, 2015, and 2014 (in Thousands Except per Share Amounts) 2016
Net sales Cost of goods sold Impairment charges Operating profit Other income (expense) Interest income Interest expense Net earnings Basic Basic
129,364 19,243 422 $ 9,394
2015
61,121 33,493
$ 2.16 $ 2.12
$ 1.36 $ 1.33
$ 1.36 $ 1.33
4,429
4,442
4,342 4,431
The accompanying notes are an integral part of these statements.
2014
26 Financial Statements SAGE INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2016, 2015, and 2014 (in Thousands)
Cash Flows from Operating Activities—Indirect Method Net income Prepaid expenses Accounts payable Accrued liabilities Income taxes payable Net cash provided (used) by operating activities Cash Flows from Investing Activities Net cash provided (used) by investing activities Cash Flows from Financing Activities Net cash provided (used) by financing activities Cash paid for interest Cash paid for taxes
2016
2015
2014
$ 9,394
136
(229)
(3,339)
(2,331)
124 1,326
629 $ 6,464 $ 111 12,462 9,333 12,462
The accompanying notes are an integral part of these statements.
4,321
Financial Statements
27
SAGE INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2016, 2015, and 2014 (in Thousands) COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL
Balance at December 31, 2013 Net earnings Proceeds from sale of shares from exercise of stock options, net of tax benefit Balance at December 31, 2014 Net earnings Proceeds from sale of shares from exercise of stock options, net of tax benefit Balance at December 31, 2015 Net earnings Proceeds from sale of shares from exercise of stock options, net of tax benefit Balance at December 31, 2016
SHARES
AMOUNT
9
244 12
4,363
RETAINED EARNINGS
TOTAL
9 $33,636
$32,363 9,394
9,394
244 12
28 Financial Statements Note 1—Basis of Presentation and Summary of Significant Accounting Policies Operations: Fiscal Year: Principles of Consolidation: been eliminated in consolidation. Use of Estimates in the Preparation of Financial Statements: The preparation of mates and assumptions that affect the reported amounts of assets and liabilities at the during the reporting period. Actual results may differ materially from our estimates. Cash and Cash Equivalents: the date of purchase. Inventories: Property, Plant, and Equipment: Impairment Charges: undiscounted future cash flows. The amount of the impairment loss, if impairment exists, would be calculated based on the excess of the carrying amounts of the assets Goodwill: Other Assets: Revenue Recognition: tion of sales and cost of goods sold in the period that the related sales are recorded.
Financial Statements
29
Expenses of New Stores: charged to expense as incurred and include such items as rent, marketing, payroll, and recruiting costs. Advertising Costs: Selling and Administrative Expenses: store payroll and fringe benefits, bank card charges, information systems, legal, accounting, repairs and maintenance and other expenses associated with the opera Stock-Based Compensation: Note 2—Debt Short-term Debt: Long-term Debt: 2016
Less current maturities
2015
$22,943
as follows (in thousands): Fiscal Year
Thereafter . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . .
$22,943
30 Financial Statements Note 3—Commitments The Company leases substantially all of its stores, office facilities, and distribution (in thousands): Fiscal Year
Thereafter . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . .
Note 4—Income Taxes
Current:
2016
2015
2014
1,121
4,321
$4,141
19
124 12 136
as follows:
Other permanent items
2016
2015
2014
Financial Statements
31
Components of deferred tax assets (liabilities) consist of the following as of the fiscal years ended (in thousands):
Total deferred tax assets* Installment sales Total deferred tax liabilities Net deferred tax liabilities
2016
2015
$ 9 14 23
13
*Included in Prepaid expenses and other assets on the balance sheet.
Note 5—Contingencies its business. The outcome of these legal proceedings cannot be predicted with cer tion, or results of operations. Note 6—Segment Information ski and hiking boots.
32 Financial Statements Year Ended December 31,
Net sales: Total Operating profit: Corporate and other Total Depreciation and amortization: Corporate and other Total Identifiable assets: Corporate and other Total Capital expenditures: Corporate and other Total
2016
2015
2014
116,424
26,163
$ 19,243
$ 6,443 (124)
1,642 361
226
24,321
$ 13,463 29,444
$ 32 43
$ 24 16 $ 143
23 $ 144
SELF-TEST
________ 1. ments because auditors offer a report indicating whether the com pany is financially sound or not. (c) Learning to read and interpret financial statements will enable indi ________ 2.
________ 3.
________ 4.
________ 5.
________ 6.
________ 7.
________ 8.
Financial Statements
33
reporting standards. will follow. (c) To create a set of accounting rules for countries other than the held companies. (a) Balance sheet and income statement. (c) Balance sheet, income statement, and statement of cash flows. (d) Balance sheet, income statement, statement of cash flows, and state (b) Changes in accounting policies, if any. (a) The financial statements unfairly and inaccurately present the (b) The financial statements present fairly the financial position, the results of operations, and the changes in cash flows for the company. tinue as a going concern. accounting rules that would ultimately be used by all publicly traded companies worldwide. monitoring auditors of all publicly owned companies. and the chief financial officer of a publicly traded company to certify the accuracy of the financial statements. internal control system.
34 Financial Statements
________ 9.
________10.
________11.
________12.
________13.
________14.
________15.
(d) Auditor independence, which prohibits audit firms from offering (b) Commitments for capital expenditures. (a) Annual reports only contain glossy pictures. (b) Public relations material should be used cautiously. (c) Information on the breakdown of audit and nonaudit fees paid to the audit firm. (b) Net income. (d) Both (b) and (c). Which of the following are methods by which management can manip (a) Changing an accounting policy to increase earnings. (1) An attestation to the fairness of financial statements. term debt. (9) Anticipated commitments for capital expenditures.
Financial Statements
35
accounts. (b) Notes to the financial statements. STUDY QUESTIONS AND PROBLEMS 1.1. 1.2. 1.3. 1.4. 1.5. 1.6. 1.7. 1.8. 1.9. 1.10. 1.11. Writing Skills Problem
chief financial officer, but the director of marketing has asked you to write a memo in which you explain the key elements in an annual report so that marketing rep Required: between paragraphs) in which you describe the contents of an annual report so To the Student: In business writing, the primary elements are clarity and conciseness. communication. 1.12. Research Problem
to the financial statements. 1.13. Internet Problem
working on and the progress made to date.
36 Financial Statements
C A S E S
Case 1.1
Intel Case
www .pearsonhighered www .intc.com (a) (b) learned from this letter that might be useful to an analyst. (c) report. (d) (e)
Financial Statements
37
Case 1.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template learn the content of each chapter. financial statement analysis template at the following Web site: www.pearsonhighered . (a) tions. The tab for the instructions is at the bottom of your screen and is labeled (b) paper. (c) from reading this section.
38 Financial Statements
Case 1.3
Mattel Inc.
Required 1. 2. number(s) where the items can be found: a. Balance sheet b. Income statement e. Notes to the financial statements 3. 4. items from the financial statements:
a. b. e.
Assets Liabilities Net income or loss (specify if amount is income or loss)
Case 1.4
Financial Statements
39
Biolase, Inc.
pages 39–46.
Required (a) (b) (c) (d) Based on this section only, what is your assessment of the prospects for this
Overview Our proprietary dental laser systems allow dentists, periodontists, endodontists, oral surgeons, and other specialists to perform a broad range of dental procedures, including cosmetic and complex surgical applications. Our systems are designed to noses, applications, and procedures in dentistry and medicine. systems. Our flagship product category, the WaterLase system, uses a patented com bination of water and laser energy to perform most procedures currently performed using dental drills, scalpels, and other traditional dental instruments for cutting soft ity of which are related to our core WaterLase technology and dental and medical
40 Financial Statements cash from operations, the potential need for additional capital, and the uncertainties sur rounding our ability to raise additional capital, raises substantial doubt about our abil ity to continue as a going concern. Accordingly, the accompanying financial statements realize our assets and discharge our liabilities and commitments in the normal course of tions of liabilities that may result from our inability to continue as a going concern. of shares of common stock, preferred stock, and warrants with a total offering price tional medical markets, including general surgery, ophthalmology, dermatology, plastic
Financial Statements
41
neurosurgery, pulmonary surgery, cardiac surgery, thoracic surgery, urology, aesthet conditions of the eye, including presbyopia, glaucoma, retinal disorders, and cataracts, related patents and patent applications which complement our patent portfolio. We ophthalmology technologies for which we continue to seek strategic partnerships to assist in our entry into the ophthalmology laser market. We continue to reshape period we also restructured our sales and marketing department and its priorities, our operating expenses.
Comparison of Results of Operations Year Ended December 31, 2013 Compared With Year Ended December 31, 2012
Net Revenue. transition from primarily selling WaterLase dental lasers to selling a wide range of primarily focused on selling our core laser products.
42 Financial Statements and as we continue to increase in the number of sales professionals that will be pri marily focused on selling our imaging products. base and increased sales and marketing efforts in this part of our business. arrangement continues until the underlying patents expire unless terminated earlier Cost of Revenue. of lower laser system sales and increased imaging and international sales. Our laser Gross Profit.
Financial Statements
43
of licensed imaging systems, which generally carry lower margins than our laser prod ucts, increased international laser sales, which generally carry a lower margin than our Operating Expenses. ing operations and reducing payroll and payroll related expenses by approximately $1.3 million, net (unaudited), on an annualized basis, and reducing and rationalizing Sales and Marketing Expense. General and Administrative Expense. (refer to “Part I, Item 3. Legal Proceedings”), increased payroll and consulting related Engineering and Development Expense. Excise Tax Expense. Non-Operating Income (Loss) (Loss) Gain on Foreign Currency Transactions.
44 Financial Statements Interest Expense, Net. ing credit facilities, amortization of debt issuance costs and debt discount, and the financing of our business insurance premiums. Interest expense totaled approxi Provision (benefit) for Income Taxes. efits related to international operations due to expiring statutes and recognized tax Net Loss.
Liquidity and Capital Resources operations, the potential need for additional capital, and the uncertainties surround ing our ability to raise additional capital, raises substantial doubt about our ability to continue as a going concern. Accordingly, the accompanying financial statements be able to realize our assets and discharge our liabilities and commitments in the the amounts and classifications of liabilities that may result from our inability to continue as a going concern.
Financial Statements
45
is incorporated herein by reference. discharge our liabilities and commitments in the normal course of business, we must sell tions through increased sales, decrease expenses, and generate cash from operations or tributor relationships both domestically and internationally, forming strategic arrange ments within the dental and medical industries, educating dental and medical patients ures by streamlining operations and reducing payroll and payroll related expenses other things, the rate at which our business grows, demands for working capital, We may not be able to increase sales, reduce expenses, or obtain additional terms satisfactory to us. If we are unable to increase sales, reduce expenses, or raise sufficient additional capital, we may be unable to continue to fund our operations, in the normal course of business. These uncertainties raise substantial doubt about
46 Financial Statements from our independent registered public accounting firm on our consolidated finan cial statements contains an explanatory paragraph stating that there is a substantial doubt regarding our ability to continue as a going concern. basis that contemplates the realization of assets and the satisfaction of liabilities in the ties that might be necessary should we be unable to continue as a going concern.
Consolidated Cash Flows Years Ended December 31, 2013
2012
2011
$ (9,296) 31
$ (1,664) 39
(26)
$
1,613
Fiscal 2013 Compared to Fiscal 2012 ily caused by our transition from primarily selling WaterLase dental lasers to selling of $1.4 million.13 13
Commission. www.sec.gov.
CHAPTER
2
The Balance Sheet Old accountants never die; they just lose their balance. —A��������
Learning Objectives After studying this chapter, you should be able to:
statement of condition statement of financial position,
47
48
The Balance Sheet
inventory
Financial Condition on a particular date. owns owes Assets
�
Liabilities
�
Stockholders equity.
Consolidation in substance Balance Sheet Date
The Balance Sheet
EXHIBIT 2.1
Sage Inc. Consolidated Balance Sheets at December 31, 2016 and 2015 (in Thousands)
Assets Liabilities and Stockholders’ Equity
2016
2015
_______
_______
49
50
The Balance Sheet
Comparative Data Balance Sheet Format Common-Size Balance Sheet
The Balance Sheet
51
EXHIBIT 2.2 Sage Inc. Common-Size Balance Sheets (Percent)
Assets Liabilities and Stockholders’ Equity
2016
2015
2014
2013
2012
Assets Current Assets operating cycle
52
The Balance Sheet
EXHIBIT 2.3
Sage Inc. Consolidated Balance Sheets at December 31, 2016 and 2015 (in Thousands)
Assets
2016
2015
working capital net working capital
The Balance Sheet
53
Cash and Cash Equivalents Marketable Securities 1. Held to maturity 2. Trading securities s ecurities fair value 3. Securities available for sale Accounts Receivable allowance for doubtful accounts.
54
The Balance Sheet
2016 A A
+
A
9
+
2015 =
+
=
2016 2015 (In Thousands)
Growth Rate* Rate* (% Change)
-
The Balance Sheet
55
Sage Inc. Schedule II—Valuation and Qualifying Accounts December 31, 2016, 2015, and 2014 (in Thousands)
Balance at Beginning of Year
Additions Charged to Costs and Expenses
Deductions
Balance at End of Year
56
The Balance Sheet
Inventories EXHIBIT 2.4 Inventories as a Percentage of Total Assets
%
Source: Annual Statement Studies
The Balance Sheet
57
Inventory Accounting Methods assumption actual match FIFO LIFO average cost Unit
Cost per Unit
Accounting Method
Units Sold
[ ]
Units Remaining in Inventory
*
[ ]
*
58
The Balance Sheet
Accounting Method
Cost of Goods Sold (Income Statement)
Inventory Valuation (Balance Sheet)
FIGURE 2.1
Inventory Methods
Accounting Method
Cost of Goods Sold (Income Statement)
Inventory Valuation (Balance Sheet)
FIFO
First purchases
Last purchases (close to current cost)
LIFO
Last purchases (close to current cost)
First purchases
Average Cost Accounting
Average of all purchases Average of all purchases
Trends and Techniques,
The Balance Sheet
59
period of falling prices
60
The Balance Sheet
Prepaid Expenses Property, Plant, and Equipment tangible, long-lived, capital
The Balance Sheet
61
Straight line
$
-
$
Accelerated5
=
=
$
* $
=
$ * Straight line Balance Sheet Accelerated Balance Sheet
*
=
Income Statement
Income Statement
S $ $ A $ * $ =
=
62
The Balance Sheet
Land, Buildings Leasehold improvements construction in progress Equipment Amortization
The Balance Sheet
63
EXHIBIT 2.5 Net Fixed Assets as a Percentage of Total Assets
%
Source: Annual Statement Studies
Goodwill Other Assets
64
The Balance Sheet
Liabilities Current Liabilities Accounts Payable
EXHIBIT 2.6 Sage Inc. Consolidated Balance Sheets at December 31, 2016 and 2015 (in Thousands)
Liabilities and Stockholders’ Equity
2016
2015
_____
_____
The Balance Sheet
65
Short-Term Debt Current Maturities of Long-Term Debt Accrued Liabilities $
$ $ * *
=
$
=
$
=
$
Reserve accounts
66
The Balance Sheet
Unearned Revenue or Deferred Credits unearned revenue deferred credits.
The Balance Sheet
67
Deferred Federal Income Taxes temporary differences permanent differences
68
The Balance Sheet
valuation allowance
*
Tax
Reporting
FIGURE 2.2
Deferred Taxes—An Example
×
×
×
×
×
×
69
70
The Balance Sheet
Long-Term Debt
Capital Lease Obligations
The Balance Sheet
71
Pensions and Postretirement Benefits
CFO,
72
The Balance Sheet
Commitments and Contingencies Commitments off–balance sheet financing. Contingencies
Stockholders’ Equity
The Balance Sheet
73
Common Stock Additional Paid-In Capital 9 9
74
The Balance Sheet
Retained Earnings Beginning retained earnings t Net income (loss) − Dividends � Ending retained earnings
Other Equity Accounts Preferred stock accumulated other comprehensive income/(expense) treasury stock Equity attributable to noncontrolling interests
The Balance Sheet
75
EXHIBIT 2.7 Pfizer, Inc. Shareholders’ Equity at December 31 (in Millions, except preferred stock issued) 2013
2012
www.sec.gov.
Quality of Financial Reporting—The Balance Sheet
76
The Balance Sheet
Other Balance Sheet Items SELF-TEST
________ 1. ________ 2. A + S A + S S A + N - =
=
=
=
________
________
________
________
________
________
The Balance Sheet
77
3. 4. 5. 6. 7. 8.
78 ________
The Balance Sheet
9. ________ 10. Accounting Trends and Techniques ________ 11. Annual Statement Studies ________ 12. ________ 13. ________ 14. ________ 15.
The Balance Sheet
79
________ 16.
________ 17.
________ 18.
________ 19.
________ 20.
________ 21.
________ 22.
80
The Balance Sheet
23. 24.
STUDY QUESTIONS
2.1. 2.2. 2.3. 2.4. 2.5. 2.6.
2.7.
2.8.
2.9.
2.10.
2.11.
2.12.
2.13.
The Balance Sheet
81
AND PROBLEMS
2013
2012
Schedule II—Valuation and Qualifying Accounts Years Ended December 31, 2013 and 2012
Balance at Beginning of Period
Charged to Costs and Expenses
Deductions
Balance at End of Period
www.sec.gov
82
The Balance Sheet
2.14.
2.15. Number of Units
Unit Cost
Sale Price
2.16. (in Thousands)
2015
2014
83
2.17. 2.18. Retained Earnings Balances
The Balance Sheet
Year
Net Income
2.19.
2.20. Writing Skills Problem.
84
The Balance Sheet
Future Minimum Lease Payments (in millions)
Operating Leases
Capital Leases
9 9
Required: 2.21. Research Problem 2.22. Internet Problem
The Balance Sheet
85
86
The Balance Sheet
C A S E S
Case 2.1
Intel Case
(a) (b) (c) (d) (e) (f) (g)
The Balance Sheet
87
Case 2.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template (a) (b)
88
The Balance Sheet
Case 2.3 Walgreen Co. and Subsidiaries CONSOLIDATED BALANCE SHEETS
Walgreen Co. and Subsidiaries at August 31, 2013 and 2012 (in millions, except shares and per share amounts)
Assets Liabilities and Shareholders’ Equity
2013
2012
—
—
The Balance Sheet
89
The accompanying Notes to Consolidated Financial Statements are integral parts of these statements.
Notes to Consolidated Financial Statements 1. Summary of Major Accounting Policies
Description of Business
Allowance for Doubtful Accounts (In millions):
2013
2012
2011
Inventories 3. Leases
90
The Balance Sheet
(In millions)
Capital Le Leas ase e
Operating Leas ase e
WALGREEN CO. INFORMATION FROM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended August 31, 2013 and 2012 (in millions)
2013
2012
www.sec.gov.
Required: (a) (b) (c)
The Balance Sheet
91
(d) (e) (f) (g) (h)
92
The Balance Sheet
Case 2.4
Hydrogenics Corporation
Required: (a) (b) (c) (d) (e)
The Balance Sheet
93
HYDROGENICS CORPORATION CONSOLIDATED BALANCE SHEETS
(in thousands of US dollars)
December 31 2013
December 31 2012
Assets Current assets Non-current assets Total assets Liabilities Current liabilities Non-current liabilities Total liabilities Equity Total equity Total equity and liabilities
$ 11,823 635 5,391 – 12,821 979 31,649
1,389 1,684 100 5,248 8,421 40,070
13,193 1,912 6,348 1,075 22,528
$
$
3,095 981 7,305 33,909
333,312 18,449 (249) (345,351) 6,161 $ 40,070
94
The Balance Sheet
Excerpts from Notes to Consolidated Financial Statements (in thousands of US dollars, except share and per share amounts) Note 1—Description of Business Note 2—Basis of Preparation, Summary of Significant Accounting Policies, Judgments and Estimation Uncertainty Basis of preparation
Summary of significant accounting policies Inventories
Property, plant and equipment
The Balance Sheet
95
Leases
Out of period adjustments *
96
The Balance Sheet
Note 4—Trade and Other Receivables
December 31 2013
December 31 2012
$ 4,864 (139) 666 $ 5,391
Note 6—Property, Plant and Equipment December 31 2013
December 31 2012
Test Equipment
$ 4,682 (4,515) 167
Furniture and Equipment
4,743 (3,444) 1,299
Computer Hardware
651 (548) 103
Leasehold Improvements
1,275 (1,190) 85
Automobiles Total Property, Plant and Equipment
537 (507) 30 $ 1,684
97
The Balance Sheet
Test Equipment 2013 Carrying amount, beginning of year Carrying amount, end of year
$
Furniture and Equipment 2013
Computer Leasehold Hardware Improvements Automobiles 2013 2013 2013
15 194
$ 946 672
$ 126 $ 305 32 12 (3)
(34)
(348)
29
(8) $ 167
(53) 1
$ 7 28
(233)
$1,299 $ 103 $ 85
9
(5)
$ 30
1
$ - $9 $ - $ $ - $ Note 9—Trade and Other Payables
December 31 2013
$
$
3,115 3,871 1,402
3,182
465 270 83 13 792 13,193
98
The Balance Sheet
Note 11—Other Non-current Liabilities
December 31 2013
$ 2,260 309 526 $ 3,095
Note 20—Commitments - $9
$
1,083 1,085 1,023 794 692 – 4,677
Note 21—Contingencies
The Balance Sheet
99
Note 23—Guarantees $ - $99 Note 27—Risk Management Arising From Financial Instruments and Capital Management Liquidity risk
$ - $
100
The Balance Sheet
At December 31, 2013 Due within one year Trade and other payables Warrants Repayable government contributions Long-term debt
$
12,628 1,075 465 –
Due between one and two years $
– – 209 –
Due between three and five years $
Due between six and ten years
– –
$
317 2,196
– – – 3,035
Credit risk - $ 2013
91% 1 3 5 100%
The Balance Sheet
101
2013
74% 13 7 6 100%
2013
$
$
124 15 – 139
Management of capital $ - $9
102
The Balance Sheet
www.sec.gov
CHAPTER
3
Income Statement and Statement of Stockholders’ Equity Learning about earnings, the bottom line, Is very important most of the time. A phony number Just may encumber Those folks trying to make more than a dime. —A. O�������
Learning Objectives After studying this chapter, you should be able to:
103
104 Income Statement and Statement of Stockholders’ Equity income statement, statement of earnings, income, earnings, profit
The Income Statement multiple-step single-step
Income Statement and Statement of Stockholders’ Equity
EXHIBIT 3.1 Sage Inc. Consolidated Statements of Earnings for the Years Ended December 31, 2016, 2015, and 2014 (in Thousands Except per Share Amounts)
2016
2015
2014
EXHIBIT 3.2 Sage Inc. Consolidated Statements of Earnings for Years Ended December 31, 2016, 2015, and 2014 (in Thousands Except per Share Amounts)
2016
2015
2014
105
106 Income Statement and Statement of Stockholders’ Equity discontinued operations extraordinary transactions comprehensive income. Common-Size Income Statement Net Sales sales return sales allowance
Income Statement and Statement of Stockholders’ Equity
107
EXHIBIT 3.3 Sage Inc. Common-Size Income Statements (Percent)
2016
2015
2014
2013
2012
$ ./. * $.
108 Income Statement and Statement of Stockholders’ Equity Cost of Goods Sold cost of goods sold cost of sales. cost of goods sold percentage 2016 C N
=
2015
.
=
2014
.
=
.
Gross Profit gross profit gross margin. 2016 G N
=
2015
.
=
2014
.
=
.
Annual
Statement Studies,
FIGURE 3.1
Income Statement and Statement of Stockholders’ Equity
Understand the Math!
Year 1
COGS
Year 2
109
110 Income Statement and Statement of Stockholders’ Equity
FIGURE 3.2
Gross Profit Margin for Multiple Revenue Sources
2016
%
2015
%
2016
%
2015
%
Income Statement and Statement of Stockholders’ Equity
111
Operating Expense Selling and administrative Advertising 2016 A N
=
2015
.
=
2014
.
=
.
Lease payments Depreciation and amortization Depreciation Amortization depletion.
112 Income Statement and Statement of Stockholders’ Equity 2016 D
=
2015
.
=
.
Repairs and maintenance 2016
=
2015
.
=
.
Income Statement and Statement of Stockholders’ Equity
113
Impairment charges
114 Income Statement and Statement of Stockholders’ Equity Operating Profit Operating profit EBIT earnings before interest and taxes operating profit margin 2016 O N
=
2015
.
=
2014
.
=
.
Other Income (Expense)
Income Statement and Statement of Stockholders’ Equity
115
Equity Earnings
116 Income Statement and Statement of Stockholders’ Equity
Cost
Equity
$ * .
*
.
+ -
Earnings Before Income Taxes/Effective Tax Rate Earnings before income taxes
Income Statement and Statement of Stockholders’ Equity
117
effective tax rate 2016
=
.
2015
=
.
2014
=
.
Special Items
Special items Discontinued operations Extraordinary gains and losses
118 Income Statement and Statement of Stockholders’ Equity Net Earnings Net earnings, net profit margin 2016 N N
=
2015
.
=
2014
.
=
.
Earnings per Common Share Earnings per common share basic diluted. Comprehensive Income
Wall Street Journal,
Income Statement and Statement of Stockholders’ Equity
119
EXHIBIT 3.4 Applied Materials, Inc. Consolidated Statements of Comprehensive Income Fiscal Year
2013
2012 (In millions)
2011
foreign currency translation effects, unrealized gains and losses, additional pension liabilities, cash flow hedges. Foreign currency translation effects Unrealized gains and losses Additional pension liabilities cash flow hedges
120 Income Statement and Statement of Stockholders’ Equity
The Statement of Stockholders’ Equity stock dividends, stock splits, reverse stock splits
EXHIBIT 3.5 Sage Inc. Consolidated Statements of Stockholders’ Equity For the Years Ended December 31, 2016, 2015, and 2014 (in thousands) Common Stock and Additional Paid-in Capital
Balance at December 31, 2013 Balance at December 31, 2014 Balance at December 31, 2015 Balance at December 31, 2016
Shares
Amount
_____
______
_____
______
Retained Earnings
_____
______
Total
Income Statement and Statement of Stockholders’ Equity
121
Earnings Quality, Cash Flow, and Segmental Accounting
122 Income Statement and Statement of Stockholders’ Equity
Income Statement and Statement of Stockholders’ Equity
123
Appendix 3A: A Guide to Earnings Quality Qual-i-ty (n). Synonyms:
quality
124 Income Statement and Statement of Stockholders’ Equity EXHIBIT 3A.1 A Checklist for Earnings Quality
Using the Checklist I. Sales or Revenues 1. Premature Revenue Recognition
Income Statement and Statement of Stockholders’ Equity
125
Wall Street Journal,
126 Income Statement and Statement of Stockholders’ Equity 2. Allowance for Doubtful Accounts
Accounts Receivable (In Millions)
June 29, 2007
June 30, 2006
Wall Street Journal,
Income Statement and Statement of Stockholders’ Equity
127
Schedule II LOGITECH INTERNATIONAL S.A.VALUATION AND QUALIFYING ACCOUNTS For the Fiscal Years Ending March 31, 2010, 2009, and 2008 (in thousands) Fiscal Year
Description
Balance at Beginning of Period
Charged to Income Statement
Write-offs Charged to Allowance
Balance at End of Period
128 Income Statement and Statement of Stockholders’ Equity 3. Price Versus Volume Changes
2013
2012
4. Real Versus Nominal Growth
Income Statement and Statement of Stockholders’ Equity
129
Sales (in millions)
2013
C - C/ C * S A ./. * $ $
2012
Percentage Change
=
=
=
II. Cost of Goods Sold 5. Cost Flow Assumption for Inventory
130 Income Statement and Statement of Stockholders’ Equity 6. Base LIFO Layer Liquidations
7. Loss Recognitions on Write-Downs of Inventories
Income Statement and Statement of Stockholders’ Equity
131
Wall Street Journal,
132 Income Statement and Statement of Stockholders’ Equity III. Operating Expenses 8. Discretionary Expenses
9. Depreciation
Understanding the Corporate Annual Report: Nuts, Bolts and a Few Loose Screws,
Income Statement and Statement of Stockholders’ Equity
133
10. Asset Impairment
134 Income Statement and Statement of Stockholders’ Equity
Income Statement and Statement of Stockholders’ Equity
135
11. Reserves
12. In-Process Research and Development
Wall Street Journal, Wall Street Journal,
136 Income Statement and Statement of Stockholders’ Equity IV. Nonoperating Revenue and Expense 13. Gains (Losses) from Sales of Assets
Note 4. Other Expense
(In millions) Expense (income)
2013
2012
2011
14. Interest Income
Income Statement and Statement of Stockholders’ Equity
137
15. Equity Income
. 16. Income Taxes Consolidated
2013
2012
2011
—
—
—
138 Income Statement and Statement of Stockholders’ Equity 17. Discontinued Operations
Year Ended December 31 2013
2012
2011
Income Statement and Statement of Stockholders’ Equity
139
18. Extraordinary Items
V. Other Issues 19. Material Changes in Number of Shares Outstanding
140 Income Statement and Statement of Stockholders’ Equity 20. Operating Earnings, a.k.a. Core Earnings, Pro Forma Earnings, or EBITDA
What Are the Real Earnings?
Income Statement and Statement of Stockholders’ Equity
141
EXHIBIT 3A.2 Adjustments to Earnings (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)
SELF-TEST
________ 1. ________ 2. ________ 3. ________ 4.
142 Income Statement and Statement of Stockholders’ Equity ________
________
________
________
________
5. 6. 7. 8. 9.
Income Statement and Statement of Stockholders’ Equity
143
________ 10.
________ 11.
________ 12.
________ 13.
________ 14.
________ 15.
144 Income Statement and Statement of Stockholders’ Equity ________ 16.
________ 17. ________ 18. 19.
145
20.
STUDY QUESTIONS
Income Statement and Statement of Stockholders’ Equity
AND PROBLEMS
3.1. 3.2. 3.3. 3.4. 3.5. 3.6. 3.7. 3.8. 3.9. 3.10. 3.11.
146 Income Statement and Statement of Stockholders’ Equity Moon Company Income Statements for the Years Ended December 31, 2016, 2015 and 2014
2016
2015
2014
3.12.
3.13. Yarrick Company Income Statements for the Years Ending December 31, 2016, 2015, and 2014
2016
2015
2014
Income Statement and Statement of Stockholders’ Equity
147
3.14.
2016
2015
2014
3.15. Writing Skills Problem Elf Corporation Income Statements for the Years Ending December 31, 2016, 2015, and 2014
2016
2015
2014
Required: To the Student: 3.16. Research Problem 3.17. Internet Problem .
148 Income Statement and Statement of Stockholders’ Equity
C A S E S
Case 3.1
Intel Case
./. (a) (b)
Income Statement and Statement of Stockholders’ Equity
149
Case 3.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template (a) (b)
150 Income Statement and Statement of Stockholders’ Equity
Case 3.3
Logitech International S.A.
LOGITECH INTERNATIONAL S.A. CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts) Year ended March 31, 2013
2012
2011
—
—
—
—
$
—
$
—
Item 1. Business Company Overview
Income Statement and Statement of Stockholders’ Equity
151
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Net Sales Gross Profit
152 Income Statement and Statement of Stockholders’ Equity Operating Expenses Marketing and Selling Research and Development General and Administrative
Income Statement and Statement of Stockholders’ Equity
153
Required: (a) (b) (c)
154 Income Statement and Statement of Stockholders’ Equity
Case 3.4
Hydrogenics Corporation
Required: (a) (b)
155
Income Statement and Statement of Stockholders’ Equity
HYDROGENICS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Years ended December 31, (in thousands of US dollars, except for share and per share amounts) 2013
2012
Revenue Cost of sales Gross profit Operating expenses
$
Loss from operations Finance income (expenses) Finance (loss) gain, net Loss before income taxes Income tax expense Net loss for the year Items that will not be reclassified to net loss: Items that will be reclassified subsequently to net loss: Comprehensive loss for the year Net loss per share
42,413 30,352 12,061
16,275 2,566 3 18,844 (6,783)
11 (426) 517 (162) (2,065) (2,125) (8,908) (8,908)
$
509 (8,399)
$ (1.04) 8,592,600
156 Income Statement and Statement of Stockholders’ Equity Note 14. Expenses By Nature 2013
2012
$ 22,597 21,087 1,508 515 712 606 576 1,592 $ 49,193
Note 15. Employee Benefits Expense
2013
2012
$ 15,077 631 674 108 4,223 375 $ 21,087
Note 16. Research and Product Development Expenses 2013
$ 5,534 (2,968) $ 2,566
2013 Management’s Discussion and Analysis of Financial Condition and Results of Operations
A summary of our business and how we address our markets
2012
Income Statement and Statement of Stockholders’ Equity
157
How We Are Organized
OnSite Generation O H
Power Systems
158 Income Statement and Statement of Stockholders’ Equity
A detailed discussion of our operating results for 2013 and 2012
BUSINESS SEGMENT REVIEW OnSite Generation Summary Financial Analysis Percentage Favourable (Unfavourable)
Thousands of US dollars 2013
2012
2011
$24,078 3,681 15%
3,249 817 (386)
2013
2012
(12%) (3%)
2%
(34%) (178%)
Income Statement and Statement of Stockholders’ Equity
159
Revenues Gross Profit Selling, General and Administrative (“SG&A”) Expenses Power Systems Summary Financial Analysis Percentage Favourable (Unfavourable)
Thousands of US dollars 2013
2012
2011
$18,335 8,380 46% 4,201 1,722 2,457
2013 320% 470%
2012
(11%) 55% 140%
Revenues
160 Income Statement and Statement of Stockholders’ Equity Gross Profit SG&A Expenses
The outlook for our business in 2014
Current Market Environment
4
CHAPTER
Statement of Cash Flows “Joan and Joe: A Tale of Woe” Joe added up profits and went to see Joan, Assured of obtaining a much-needed loan. When Joe arrived, he announced with good cheer: “My firm has had an outstanding year, And now I need a loan from your bank.” Eyeing the statements, Joan’s heart sank. “Your profits are fine,” Joan said to Joe. “But where, oh where, is your company’s cash flow? I’m sorry to say: the answer is ‘no’.”
—L. F�����
Learning Objectives After studying this chapter, you should be able to:
161
162 Statement of Cash Flows
Why Cash Flow is Important: An Example From the Statement of Cash Flows. Lehman Brothers Holding Inc. Millions of U.S. Dollars for period ending Nov. 30,
2007
2006
2005
Statement of Cash Flows
163
operating activities, investing activities, financing activities.
Statement of Cash Flows: Basic Principle end changes
164 Statement of Cash Flows
Lehman Brothers Statement of Cash Flows at November 30, 2007, Millions of U.S. Dollars
Statement of Cash Flows
165
Preparing a Statement of Cash Flows flows changes over time rather than the absolute dollar amount of the accounts at a point in time. cash; inflows outflows; operating, financing, investing inflows less the outflows balance to and explain the change in cash.
166 Statement of Cash Flows FIGURE 4.1
How Cash Flows During an Accounting Period
Operating Activities
Inflows
Outflows
Investing Activities
Inflows
Outflows
Financing Activities
Inflows
Outflows
Total Inflows less Total Outflows
�
Change in cash for the accounting period
Cash cash equivalents. Operating activities
Statement of Cash Flows
167
EXHIBIT 4.1 Sage Inc. Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015, and 2014 (in Thousands)
2016 Cash Flows from Operating Activities—Indirect Method Net cash provided (used) by operating activities Cash Flows from Investing Activities Net cash provided (used) by investing activities Cash Flows from Financing Ac tivities Net cash provided (used) by financing activities
2015
2014
Investing activities Financing activities
168 Statement of Cash Flows Inflow
Outflow
+ +
+
-
- -
3 two transactions in one account.
3
Statement of Cash Flows
169
EXHIBIT 4.2 Sage Inc. Worksheet for Preparing Statement of Cash Flows (in Thousands)
Assets Liabilities and Stockholders’ Equity Stockholders’ Equity
2016
2015
Change (2016–2015)
Category
170 Statement of Cash Flows
Calculating Cash Flow from Operating Activities internally. external direct method indirect method Accounting Trends and Techniques, indirect method direct method Indirect Method
Accounting
Trends and Techniques,
Statement of Cash Flows
Sage Inc. Indirect Method
+ + - - + + - +
EXHIBIT 4.3 Net Cash Flow from Operating Activities—Indirect Method + + - + - - + - + + - + - + - + - + - + - + - + -
171
172 Statement of Cash Flows Depreciation and amortization deferred tax liability accounts receivable inventory prepaid expenses accounts payable accrued liabilities income taxes payable
Statement of Cash Flows
173
gains and losses from asset sales
Cash Flow from Investing Activities property, plant, and equipment other assets
Cash Flow from Financing Activities
long-term debt
retained earnings
174 Statement of Cash Flows payment declaration
Change in Cash cash cash equivalents
FIGURE 4.2
Comparison of Cash Flows
Statement of Cash Flows
175
Analyzing the Statement of Cash Flows
Cash Flow from Operations 1. 2. 3.
cash
Financial Analysts Journal,
176 Statement of Cash Flows Nocash Corporation Nocash Corporation Income Statement for Year 1 and Year 2
Year 1
Year 2
1. 2. 3.
Statement of Cash Flows
177
Nocash Corporation Balance Sheet at December 31 Year 1
Year 2
$ Change
( + +
(
(3 - + + 3 +3
+3
1.
2.
178 Statement of Cash Flows 3.
Sage Inc.: Analysis of the Statement of Cash Flows Sage Inc. Analysis: Cash Flow from Operating Activities
Statement of Cash Flows
179
EXHIBIT 4.4 Sage Inc. Cash Flows from Operating Activities for the Years Ended December 31, 2016, 2015, and 2014 (in Thousands)
Cash Flows from Operating Activities—Indirect Method
2016
2015
2014
Summary Analysis of the Statement of Cash Flows
180 Statement of Cash Flows EXHIBIT 4.5 Sage Inc. Cash Flows from Investing and Financing Activities for the Years Ended December 31, 2016, 2015 and 2014 (in Thousands)
Cash Flows from Investing Activities Net cash provided (used) by investing activities Cash Flows from Financing Activities Net cash provided (used) by financing activities
2016
2015
2014
Analysis of Cash Inflows
181
Statement of Cash Flows
EXHIBIT 4.6 Sage Inc. Summary Analysis Statement of Cash Flows
Inflows (dollars in thousands) Outflows (dollars in thousands) Change in cash and cash equivalents
2016
%
2015
%
2014
%
Analysis of Cash Outflows
182 Statement of Cash Flows
Qualitative Issues Relating to the Statement of Cash Flows
Statement of Cash Flows
183
Are We There Yet?
184 Statement of Cash Flows
Appendix 4A: Statement of Cash Flows—Direct Method Direct Method actual Sage Inc. Direct Method
333 -
-
+ -
-
3 -
Statement of Cash Flows
185
EXHIBIT 4A.1 Sage Inc. Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015, and 2014 (in Thousands) 2016
Cash Flow from Operating Activities—Direct Method Cash Flow from Investing Activities Cash Flow from Financing Activities Supplementary Schedule Cash Flow from Operating Activities—Indirect Method
2015
2014
186 Statement of Cash Flows
Statement of Cash Flows
187
EXHIBIT 4A.2 Sage Inc. Net Cash Flow from Operating Activities Direct Method
+ + - + - - + - + - + - - + + - + - + - + - + - + - + -
=
=
=
188 Statement of Cash Flows SELF-TEST
1. 2. 3. 4. 5. 6. 7. 8.
Statement of Cash Flows
189
9. 10. 11. 12. 13. 14. 15. 16.
190 Statement of Cash Flows 17. 18. 19. 20. 21. 22.
Statement of Cash Flows
191
23. 24. 25. 26. STUDY QUESTIONS
AND PROBLEMS
4.1. 4.2. 4.3. 4.4. 4.5.
192 Statement of Cash Flows
4.6. 4.7. 4.8.
Statement of Cash Flows
4.9.
2015
2014
Other expenses
193
194 Statement of Cash Flows
4.10.
Firm A
Firm B
Firm A
Firm B
+
+ +
(+
+ - + +
+ + + -
(+
+ - +
+
—
—
+
+
+3
+
-
+
Statement of Cash Flows
195
4.11. December 31,
2016
2015
196 Statement of Cash Flows
4.12. (In thousands)
2015
2014
4.13. Writing Skills Problem 4.14. Research Problem
Statement of Cash Flows
197
4.15. Internet Problem
198 Statement of Cash Flows
C A S E S
Case 4.1
Intel Case
. (a) (b)
Statement of Cash Flows
199
Case 4.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template (a) (b)
200 Statement of Cash Flows
Case 4.3
Avnet Inc.
Avnet, Inc. and Subsidiaries Consolidated Statements of Cash Flows Years Ended June 29, 2013
June 30, 2012
July 2, 2011
(Thousands)
— —
—
—
201
Statement of Cash Flows
—
—
Required: (a) (b) (c) (d)
202 Statement of Cash Flows
Case 4.4
Hydrogenics Corporation
(a) (b)
Cash and cash equivalents provided by (used in): Operating activities Cash used in operating activities
2013
2012
$ (8,908) 1,758
3 712 2,065 (120) 631
(934) 349 (97) 4,223 (8,879) (9,197)
203
Statement of Cash Flows
Investing activities Cash used in investing activities Financing activities Cash provided by financing activities Cash and cash equivalents - Beginning of year Cash and cash equivalents - End of year Supplemental disclosure
(939) (32) (971)
(393) 1,782 1,412 (1,412)
7,280 8,669 302 (1,197) 13,020 $ 11,823
$
-
3
Note 25. Consolidated Statements of Cash Flows 2013
2012
384 17 (973) (64)
(1,614) (6,629) $ (8,879) 4,223 $ (4,656)
$
CHAPTER
5
The Analysis of Financial Statements Ratios are tools, and their value is i s limited when used alone. The more tools used, the better the analysis. For example, you can’t use the same golf club for every shot and expect to be a good golfer. golfer. The more you practice with each club, however,, the better able you will be to gauge which club to use on one shot. however So too, we need to be skilled with the financial tools we use. —D����� M�������
Chief Executive Officer, Sage Inc.
Learning Objectives After studying this chapter, chapter, you should be able to:
204
The Analysis of Financial Statements
205
Objectives of Analysis creditor purpose for the borrowing capital structure source of debt repayment
investor performance record, future expectations? risk expected returns, competitive position?
206 The Analysis of Financial Statements well why operating areas strengths and weaknesses changes
Sources of Information Proxy Statement Auditor’s Report unqualified, qualified
The Analysis of Financial Statements
207
Management Discussion and Analysis Supplementary Schedules Form 10-K and Form 10-Q Other Sources
208 The Analysis of Financial Statements 1. Industry Norms and Key Business Ratios. 2. Annual Statement Studies.
1. 2. 3.
1. Mergent Manuals Mergent Handbook. 2. Corporation Records, The Outlook, Stock Reports, Industry Surveys. Standard and Poor’s NetAdvantage. 3. The Value Line Investment Survey. 4. Market Share Reporter. 5. Morningstar Guide to Mutual Funds.
1. 2. 3. 4. 5.
The Analysis of Financial Statements
209
Bloomberg, BusinessWeek, Forbes, Fortune, Wall Street Journal
Tools and Techniques
210 The Analysis of Financial Statements Common-Size Financial Statements Key Financial Ratios
The Analysis of Financial Statements
211
Liquidity Ratios: Short-Term Solvency Current Ratio 2016
8
=
2015
=
212 The Analysis of Financial Statements EXHIBIT 5.1 Sage Inc. Consolidated Balance Sheets December 31, 2016 and 2015 (in Thousands) 2016
Assets Liabilities and Stockholders’ Equity
2015
The Analysis of Financial Statements
213
Sage Inc. Consolidated Statements of Earnings for the Years Ended December 31, 2016, 2015 and 2014 (in Thousands Except per Share Amounts)
2016
2015
2014
Quick or Acid-Test Ratio 2016
-
8
-
2015 =
8
-
=
214 The Analysis of Financial Statements Cash Flow Liquidity Ratio 2016
+ M + F*
+
2015
+
=
8
+ +
=
Average Collection Period 2016
8
=
2015
8
=
Cash Flow, Journal of Accountancy, Journal of Accountancy, Journal of Accountancy
The Analysis of Financial Statements
215
Days Inventory Held 2016
=
2015
8
=
216 The Analysis of Financial Statements Days Payable Outstanding 2016
=
2015
8
=
Cash Conversion Cycle or Net Trade Cycle
2016
2015
Activity Ratios: Asset Liquidity, Asset Management Efficiency Accounts Reveivable Turnover 2016
8
=
2015
8
=
8
The Analysis of Financial Statements
217
Inventory Turnover 2016
=
2015
8
=
Accounts Payable Turnover 2016
=
2015
8
=
Fixed Asset Turnover 2016
=
2015
8
=
8
Total Asset Turnover 2016
T
8
=
2015
=
218 The Analysis of Financial Statements Leverage Ratios: Debt Financing and Coverage Debt Ratio 2016
8
T T
=
2015
8
8
=
Long-Term Debt to Total Capitalization 2016
2015
L@
L@ + +
=
+ 8
=
Debt to Equity 2016 T
=
2015
8 8
=
The Analysis of Financial Statements
219
Times Interest Earned 2016
8
=
2015
8
=
Cash Interest Coverage 2016
F
+
+
T
8 + 8 8
+
=
2015
=
+
+
220 The Analysis of Financial Statements Fixed Charge Coverage 2016
* + 8 + * 8 + 8
=
2015
+
=
8 + +
=
Cash Flow Adequacy
+ D + D
2016
2015
+ + 8 + 8
+ + 8
=
=
221
The Analysis of Financial Statements
Profitability Ratios: Overall Efficiency and Performance Gross Profit Margin 2016
8
=
2015
=
Operating Profit Margin 2016
=
2015
8
8
=
Net Profit Margin 2016
=
2015
=
222 The Analysis of Financial Statements Cash Flow Margin 2016
=
2015
=
Return on Total Assets (ROA) or Return on Investment (ROI) 2016
8
T
=
2015
=
8
Return on Equity (ROE) 2016
=
2015
8
=
Cash Return on Assets 2016
T
8
=
2015
=
The Analysis of Financial Statements
223
Market Ratios 2016
=
2015
88
=
2014
8
=
224 The Analysis of Financial Statements 2016 M
=
2015
=
2014
=
8
2016 D
=
2015
=
2014
=
2016 D M
=
2015
=
2014
=
FIGURE 5.1
The Analysis of Financial Statements
225
Summary of Financial Ratios Summary of Financial Statement Analysis How to Use Financial Ratios
Liquidity
Leverage
Operating Ef�ciency
Pro�tability
Market Measures
Short-Run Solvency
Liquidity of Current Assets
Amount of Debt
Coverage of Debt
Asset Management
Margins
Returns
Earnings per Share
Current Ratio
Average Collection Period
Debt Ratio
Times Interest Earned
Accounts Receivable Turnover
Gross Profit Margin
Return on Total Assets
Price/ Earnings
Quick Ratio
Days Inventory Held
Debt/Equity
Cash Interest Coverage
Inventory Turnover
Operating Profit Margin
Return on Equity
Dividend Payout
Cash Flow Liquidity Ratio
Days Payable Outstanding
Fixed Charge Coverage
Accounts Payable Turnover
Net Profit Margin
Cash Return on Assets
Dividend Yield
Cash Flow Adequacy
Fixed Asset Turnover
Cash Flow Margin
Cash Conversion Cycle
Long-Term Debt Total Capitalization
Financial Leverage Index
Total Asset Turnover
Return on Total Assets
Analyzing the Data
226 The Analysis of Financial Statements FIGURE 5.2
Steps of a Financial Statement Analysis
1. 2. 3. 4. 5.
Background: Economy, Industry, and Firm
The Analysis of Financial Statements
227
8 Short-Term Liquidity Industry Norms and Key Business Ratios, Annual Statement Studies, Industry Surveys, 8
228 The Analysis of Financial Statements Industry Average 2016
Sage Inc.
2016
2015
2014
2013
2012
*
*
The Analysis of Financial Statements
229
Operating Efficiency
Sage Inc.
2016
2015
2014
2013
2012
Industry Average 2016
Capital Structure and Long-Term Solvency
230 The Analysis of Financial Statements
Sage Inc.
2016
2015
2014
2013
2012
Industry Average 2016
EXHIBIT 5.2 Sage Inc. Summary Analysis Statement of Cash Flows (in Thousands) 2016
%
2015
%
2014
%
Inflows (dollars in thousands) Outflows (dollars in thousands)
Change in cash and cash equivalents
FIGURE 5.3
The Analysis of Financial Statements
231
Example of Financial Leverage
=
=
=
8
=
=
232 The Analysis of Financial Statements
=
F
+
T
-
2016
+ - T
+
2015
8 8
-
+
2016
=
8
2014
-
8
+
2015
=
-
2014
=
8
Sage Inc.
2016
2015
2014
2013
2012
Industry Average 2016
*
*
233
The Analysis of Financial Statements
Profitability
Sage Inc.
2016
2015
2014
2013
2012
Industry Average 2016
*
234 The Analysis of Financial Statements
Sage Inc.
2016
2015
2014
2013
2012
Industry Average 2016
*
Sage Inc.
2016
2015
2014
2013
2012
Relating the Ratios—The Du Pont System
The Analysis of Financial Statements
235
(1) Net profit margin
(2) Total asset turnover
*
T
*
(3) Return on investment
(4) Financial leverage
*
T
T
*
(3) Return on investment
=
T
=
(5) Return on equity
=
=
Du Pont System Applied to Sage Inc. (1) NPM
(2) TAT
: * * * * *
�
=
=
=
=
=
(3) ROI
(4) FL
: * * * * *
(5) ROE
�
=
=
=
=
=
236 The Analysis of Financial Statements Projections and Pro Forma Statements pro forma Summary of Analysis
The Analysis of Financial Statements
237
Strengths
1. 2. 3. 4. 5. 6. 7. Weaknesses
1. 2. 3. 4.
Financial Statements: A Map
238 The Analysis of Financial Statements
The Analysis of Financial Statements
239
Appendix 5A: The Analysis of Segmental Data
Analyzing Segmental Data: An Illustration 1. 2. 3. 4. 5. 6.
240 The Analysis of Financial Statements EXHIBIT 5A.1 Sage Inc. Note 6—Segment Information
Year Ended December 31 31 2016
2015
2014
Net sales:
Operating profit:
Depreciation and amortization:
Identifiable assets:
Capital expenditures:
The Analysis of Financial Statements
241
TABLE 5A.1
Contribution by Segment to Revenue (Percentages)
2016
2015
2014
TABLE 5A.2
Contribution by Segment Segment to Operating Operating Profit (Percentages) (Percentages)
2016
2015
2014
242 The Analysis of Financial Statements TABLE 5A.3
Operating Profit Margin by Segment (Percentages)
2016
2015
2014
TABLE 5A.4
Capital Expenditures by Segment (Percentages) 2016
2015
2014
TABLE 5A.5
Return on Investment by Segment (Percentages)
2016
2015
2014
The Analysis of Financial Statements
243
TABLE 5A.6 Ranking of Segments in 2016 Percentage of Total Segment Assets
Percentage Contribution to Operating Profit
Operating Profit Return on Margin Investment
Summary
Operating Segment—Definition 1. 2. 3.
1. 2. 3.
244 The Analysis of Financial Statements
Disclosure Requirements 1. 2.
3.
SELF-TEST
________ 1. ________ 2.
________
________
________
________
________
________
The Analysis of Financial Statements
245
3. 4. 5. 6. 7. 8.
246 The Analysis of Financial Statements ________
________
________
________
________
________
________
________
9. 10. 11. 12. 13. 14. 15. 16.
The Analysis of Financial Statements
247
________ 17.
________ 18.
________ 19.
________ 20.
________ 21.
________ 22.
________ 23.
248 The Analysis of Financial Statements ________ 24.
________ 25. ________ 26. ________ 27. JDL Corporation Selected Financial Data, December 31, 2013
________ 28.
________ 29.
The Analysis of Financial Statements
249
________ 30.
________ 31. RQM Corporation Selected Financial Data, December 31, 2013
________ 32.
________ 33. ________ 34. ________ 35.
250 The Analysis of Financial Statements STUDY QUESTIONS
AND PROBLEMS
5.1. 5.2. 5.3. 5.4. 5.5.
Financial Ratios
2014
2015
Income Statement for Year Ended 12/31/16
2016
Industry Averages 2016
Balance Sheet at 12/31/16
251
5.6.
The Analysis of Financial Statements
2016
2015
2014
Industry Averages 2016
5.7.
RareMetals Inc. Income Statements (in Thousands)
FIFO
LIFO
252 The Analysis of Financial Statements Required
5.8. Financial ratios
ABC
XYZ
Liquidity
Activity
Leverage
Profitability
Closing stock price
The Analysis of Financial Statements
253
Required
5.9.
Current Ratio
Quick Ratio
Net Working Capital
Debt Ratio
5.10.
254 The Analysis of Financial Statements
Required (a) (b)
5.11.
Financial ratios for the years ended January 31, Liquidity Activity Other information
2014
2013
The Analysis of Financial Statements
255
5.12. Financial ratios Leverage Profitability Other Information
2013
2012
5.13. Writing Skills Problem
Required: 5.14. Research Problem 5.15. Internet Problem
256 The Analysis of Financial Statements
C A S E S
Case 5.1
Intel Case
(a) (b) (c) Hint:
The Analysis of Financial Statements
257
Case 5.2 Applied Materials Comprehensive Analysis Case Using the Financial Statement Analysis Template (a) (b) (c)
258 The Analysis of Financial Statements
Case 5.3
Facebook, Inc.
FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS
(In millions, except for number of shares and par value) December 31,
Assets Total assets Liabilities and stockholders’ equity
2013
2012
—
259
The Analysis of Financial Statements
Total liabilities and stockholders’ equity
2013
2012
—
—
See Accompanying Notes to Consolidated Financial Statements.
FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share amounts) Year Ended December 31,
Revenue Costs and expenses: Total costs and expenses Income from operations Net income Net income attributable to Class A and Class B common stockholders
2013
2012
2011
Continued
260 The Analysis of Financial Statements Year Ended December 31,
Earnings per share attributable to Class A and Class B common stockholders: Weighted average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Share-based compensation expense included in costs and expenses:
2013
2012
2011
$
88
See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions) Year Ended December 31, 2013 Cash flows from operating activities
2012
2011
8
—
—
The Analysis of Financial Statements 2013
Net cash provided by operating activities Cash flows from investing activities Net cash used in investing activities Cash flows from financing activities Net cash (used in) provided by financing activities Cash and cash equivalents at end of period
2012
8
261
2011
—
—
—
—
—
8
262 The Analysis of Financial Statements FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions) Year Ended December 31, 2013 Supplemental cash flow data
2012
2011
$ —
See Accompanying Notes to Consolidated Financial Statement
Item 1. Business Overview
How We Create Value for People Who Use Facebook
Connect and Share with Friends. Discover and Learn. Express Yourself. Stay Connected Everywhere.
The Analysis of Financial Statements
263
How We Create Value for Marketers
How We Create Value for Developers
Note 9. Long-term Debt
Note 10. Commitments and Contingencies Commitments Leases
264 The Analysis of Financial Statements
Capital Leases
Operating Leases
Other contractual commitments
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Components of Results of Operations Revenue Cost of revenue.
The Analysis of Financial Statements
265
Results of Operations 2013 Compared to 2012.
2012 Compared to 2011.
266 The Analysis of Financial Statements
Cost of revenue 2013 Compared to 2012. 2012 Compared to 2011.
The Analysis of Financial Statements
267
Provision for income taxes 2013 Compared to 2012. 2012 Compared to 2011.
Required: (a) (b)
268 The Analysis of Financial Statements
Case 5.4
Hydrogenics Corporation
(a) (b)
APPENDIX
A
Summary of Financial Ratios Ratio
Method of Computation
Significance
Liquidity:
Current
Quick or acid-test
Current assets Current liabilities Current assets
-
inventory
Current liabilities
Cash flow liquidity
Average collection period
Days inventory held
Cash an cash equiva ents + mar eta e securities + cash flow from operating activities Current liabilities
Cash conversion or net trade cycle
Measures short-term liquidity more rigorously than the current ratio by eliminating inventory, usually the least liquid current asset. Measures short-term liquidity by considering as cash resources (numerator) cash plus cash equivalents plus cash flow from operating activities.
Net accounts receiva e Average daily sales
Indicates days required to convert receivables into cash.
Inventory
Indicates days required to sell inventory.
Average daily cost of sales Days payable outstanding
Measures short-term liquidity, the ability of a firm to meet needs for cash as they arise.
Average daily cost of sales
Indicates days required to pay suppliers.
Average collection period + days inventory held - days payable outstanding
Indicates the days in the normal operating cycle or cash conversion cycle of a firm.
ccounts paya e
269
270 APPENDIX A Summary of Financial Ratios Activity:
Accounts receivable turnover
Net sa es Net accounts receivable
Inventory turnover
Cost of goo s so Inventories
Payables turnover
Indicates how many times receivables are collected during a year, on average. Measures efficiency of the firm in managing and selling inventory.
Accounts payable
Measures efficiency of the firm in paying suppliers.
Fixed asset turnover
Net sa es Net property, plant, and equipment
Measures efficiency of the firm in managing fixed assets.
Total asset turnover
Net sa es Total assets
Measures efficiency of the firm in managing all assets.
Debt ratio
Tota ia i ities Total assets
Shows proportion of all assets that are financed with debt.
Long-term debt to total capitalization
Long@term e t
Measures the extent to which long-term debt is used for permanent financing.
Cost of goo s so
Leverage:
+
Debt to equity Financial leverage index
Long@term debt stockholders’ equity
Tota ia i ities Stockholders’ equity eturn on equity Adjusted return on assets
Times interest earned
Cash interest coverage
Cash flow adequacy
Indicates whether a firm is employing debt successfully.
Interest expense
Measures how many times interest expense is covered by operating earnings.
Cash f ow from operating activities + interest paid + taxes paid
Measures how many times interest payments are covered by cash flow from operating activities.
Operating profit
Interest paid Fixed charge coverage
Measures debt relative to equity base.
Operating profit
+
ease payments
Interest expense
+
lease payments
Cash f ow from operating activities Capital expenditures + debt repayments + dividends paid
Measures coverage capability more broadly than times interest earned by including operating lease payments as a fixed expense. Measures how many times capital expenditures, debt repayments, and cash dividends are covered by operating cash flow.
APPENDIX A
Summary of Financial Ratios
271
Profitability:
Gross profit margin
Gross profit Net sales
Operating profit margin
Operating profit Net sales
Effective tax rate
ncome taxes Earnings before income taxes
Net profit margin
Net profit Net sales
Cash flow margin
Cash f ow from operating activities Net sales
Return on total assets
et earnings Total assets
Return on equity
Net earnings Stockholders’ equity
Cash return on assets
Cash f ow from operating activities Total assets
Measures profit generated after consideration of cost of products sold. Measures profit generated after consideration of operating expenses. Measures the percentage the company recognizes as tax expense relative to income before taxes. Measures profit generated after consideration of all expenses and revenues. Measures the ability of the firm to generate cash from sales. Measures overall efficiency of firm in managing assets and generating profits. Measures rate of return on stockholders’ (owners’) investment. Measures the return on assets on a cash basis.
Market:
Earnings per common share Price to earnings
Net earnings Average common shares outstanding Mar et price of common stoc Earnings per share
Dividend payout
Divi en s per share Earnings per share
Dividend yield
Divi en s per share Market price of common stock
Shows return to common stock shareholders for each share owned. Expresses a multiple that the stock market places on a firm’s earnings. Shows percentage of earnings paid to shareholders. Shows the rate earned by shareholders from dividends relative to current price of stock.
APPENDIX
B
Solutions to Self-Tests
272
Chapter 1 1. (d) 2. (c) 3. (a) 4. (d) 5. (d) 6. (b)
7. (a) 8. (c) 9. (d) 10. (b) 11. (d) 12. (d)
13. (d) 14. (d) 15. (1) (2) (3) (4)
c b a c
Chapter 2 1. (b) 2. (a) 3. (c) 4. (b) 5. (b) 6. (a) 7. (d) 8. (c) 9. (b) 10. (c) 11. (d) 12. (a) 13. (c) 14. (b)
15. (d) 16. (c) 17. (b) 18. (b) 19. (d) 20. (d) 21. (c) 22. (a) (b) (c) (d) (e) (f) (g)
(h) (i) (j) 23. (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k)
C NC NC 4 5 8 7 1 2 2 5 8 5 3
Chapter 3 1. (c) 2. (d) 3. (a) 4. (c)
5. 6. 7. 8.
(d) (a) (c) (d)
NC C C C or NC NC C C
9. (d) 10. (b) 11. (b) 12. (a)
(5) (6) (7) (8) (9) (10)
b a d b d a or b
(l) 2 (m) 1 (n) 6 (o) 8 24. (a) 7 (b) 1 (c) 5 (d) 9 (e) 4 (f) 6 (g) 10 (h) 2 (i) 3 (j) 8
13. (a) 14. (c) 15. (d) 16. (c)
APPENDIX B 17. (b) 18. (d) 19. (a) (b) (c) (d) (e)
14 1 6 11 2 10 12
(m) 3 (n) 7 20. (1) c (2) d (3) a (4) c (5) d
Solutions to Self-Tests
4 9 13 8 5
(f) (g) (h) (i) (j) (k) (l)
(6) (7) (8) (9) (10) (11) (12)
Chapter 4 1. (d) 2. (a) 3. (b) 4. (a) 5. (c) 6. (d) 7. (b)
8. (c) 9. (c) 10. (b) 11. (b) 12. (c) 13. (a) 14. (d)
15. (d) 16. (c) 17. (d) 18. (d) 19. (b) 20. (d) 21. (c)
22. (b) 23. (a) 24. (b) 25. (a) 26. (d)
Chapter 5 1. (c) 2. (a) 3. (d) 4. (c) 5. (d) 6. (d) 7. (a) 8. (b) 9. (d)
10. (c) 11. (a) 12. (c) 13. (d) 14. (b) 15. (a) 16. (d) 17. (c) 18. (d)
19. (a) 20. (b) 21. (c) 22. (a) 23. (c) 24. (b) 25. (d) 26. (b) 27. (a)
28. (c) 29. (a) 30. (c) 31. (b) 32. (d) 33. (a) 34. (c) 35. (a)
a e c c b d c
273
APPENDIX
C
Glossary Accelerated Cost Recovery System The system established by the Economic Recovery Tax Act of 1981 to simplify depreciation methods for tax purposes and to encourage investment in capital by allowing rapid write-off of asset costs over predetermined periods, generally shorter than the estimated useful lives of the assets. The system remains in effect for assets placed in service between 1981 and 1986 but was modified by the Tax Reform Act of 1986 for assets placed in service after 1986. See Modified Accelerated Cost Recovery System. Accelerated depreciation An accounting procedure under which larger amounts of expense are apportioned to the earlier years of an asset’s depreciable life and lesser amounts to the later years. Accounting period The length of time covered for reporting accounting information. Accounting principles The methods and procedures used in preparing financial statements. Accounts payable Amounts owed to creditors for items or services purchased from them. Accounts receivable Amounts owed to an entity, primarily by its trade customers. Accounts receivable turnover See Summary of financial ratios, Appendix A. Accrual basis of accounting A method of earnings determination under which revenues are recognized in the accounting
274
period when earned, regardless of when cash is received, and expenses are recognized in the period incurred, regardless of when cash is paid. Accrued liabilities Obligations resulting from the recognition of an expense prior to the payment of cash. Accumulated depreciation A balance sheet account indicating the amount of depreciation expense taken on plant and equipment up to the balance sheet date. Accumulated other comprehensive income or loss An account that includes unrealized gains or losses in the market value of investments of marketable securities classified as available for sale, specific types of pension liability adjustments, certain gains and losses on derivative financial instruments, and foreign currency translation adjustments resulting when financial statements from a foreign currency are converted into U.S. dollars. Acid-test ratio See Summary of financial ratios, Appendix A. Activity ratio A ratio that measures the liquidity of specific assets and the efficiency of the firm in managing assets. Additional paid-in-capital The amount by which the original sales price of stock shares sold exceeds the par value of the stock. Adverse opinion Opinion rendered by an independent auditor stating that the financial statements have not been
APPENDIX C presented fairly in accordance with generally accepted accounting principles. Allowance for doubtful accounts The balance sheet account that measures the amount of outstanding accounts receivable expected to be uncollectable. Amortization The process of expense allocation applied to the cost expiration of intangible assets. Annual report The report to shareholders published by a firm; contains information required by generally accepted accounting principles and/or by specific Securities and Exchange Commission requirements. Asset impairment The decline in value of assets. Assets Items possessing service or use potential to owner. Auditor’s report Report by independent auditor attesting to the fairness of the financial statements of a company. Average collection period See Summary of financial ratios, Appendix A. Average cost method A method of valuing inventory and cost of products sold; all costs, including those in beginning inventory, are added together and divided by the total number of units to arrive at a cost per unit. Balance sheet The financial statement that shows the financial condition of a company on a particular date. Balancing equation Assets = Liabilities + Stockholders’ equity Basic earnings per share The earnings per share figure calculated by dividing net earnings available to common shareholders by the average number of common shares outstanding. Bonds payable Financial instruments used to raise cash which are traded in capital markets. Book value See Net book value. Calendar year The year starting January 1 and ending December 31. Capital assets See Fixed assets. Capital in excess of par value See Additional paid-in-capital. Capital lease A leasing arrangement that is, in substance, a purchase by the lessee, who accounts for the lease as an acquisition of an asset and the incurrence of a liability.
Glossary
275
Capital structure The permanent long-term financing of a firm represented by longterm debt, preferred stock, common stock, and retained earnings. Capitalize The process whereby initial expenditures are included in the cost of assets and allocated over the period of service. Cash basis of accounting A method of accounting under which revenues are recorded when cash is received and expenses are recognized when cash is paid. Cash conversion cycle The amount of time (expressed in number of days) required to sell inventory and collect accounts receivable, less the number of days to pay suppliers. Cash equivalents Security investments that are readily converted to cash. Cash flow adequacy See Summary of financial ratios, Appendix A. Cash flow from financing activities On the statement of cash flows, cash generated from/used by financing activities. Cash flow from investing activities On the statement of cash flows, cash generated from/used by investing activities. Cash flow from operating activities On the statement of cash flows, cash generated from/used by operating activities. Cash flow from operations The amount of cash generated from/used by a business enterprise’s normal, ongoing operations during an accounting period. Cash flow liquidity ratio See Summary of financial ratios, Appendix A. Cash flow margin See Summary of financial ratios, Appendix A. Cash flow return on assets See Summary of financial ratios, Appendix A. Cash interest coverage See Summary of financial ratios, Appendix A. Commercial paper Unsecured promissory notes of large companies. Commitments Contractual agreements that will have a significant impact on the company in the future. Common-size financial statements A form of financial ratio analysis that allows the comparison of firms with different levels of sales or total assets by introducing a common denominator. A common-size balance sheet expresses each item on the balance
276 APPENDIX C Glossary sheet as a percentage of total assets, and a common-size income statement expresses each item as a percentage of net sales. Common stock Shares of stock representing ownership in a company. Comparability Characteristic that allows users to compare financial information of an entity to other entities as well as comparing financial information of that entity to itself from one time period to another. Complex capital structure Capital structures including convertible securities, stock options, and warrants. Comprehensive income The concept that income should include all revenues, expenses, gains, and losses recognized during an accounting period, regardless of whether they are the results of operations. Conservatism The accounting concept holding that in selecting among accounting methods the choice should be the one with the least favorable effect on the firm. Consistency Characterisitc that means the same accounting methods and choices should be used from one time period to another. Consolidation The combination of financial statements for two or more separate legal entities when one company, the parent, owns more than 50% of the voting stock of the other company or companies. Contingencies Potential liabilities of a company. Contra-asset account An account shown as a deduction from the asset to which it relates in the balance sheet. Convertible securities Securities that can be converted or exchanged for another type of security, typically common stock. Core earnings See Pro forma earnings. Cost flow assumption An assumption regarding the order in which inventory is sold; used to value cost of goods sold and ending inventory. Cost method A procedure to account for investments in the voting stock of other companies under which the investor recognizes investment income only to the extent of any cash dividends received. Cost of goods sold The cost to the seller of products sold to customers. Cost of goods sold percentage The percentage of cost of goods sold to net sales.
Cost of sales See Cost of goods sold. Current (assets/liabilities) Items expected to be converted into cash or paid out in cash in one year or one operating cycle, whichever is longer. Current maturities of long-term debt The portion of long-term debt that will be repaid during the upcoming year. Current ratio See Summary of financial ratios, Appendix A. Days inventory held See Summary of financial ratios, Appendix A. Days payable outstanding See Summary of financial ratios, Appendix A. Debentures Unsecured debt backed by the company’s general credit standing. Debt ratio See Summary of financial ratios, Appendix A. Debt to equity ratio See Summary of financial ratios, Appendix A. Deferred credits See Unearned revenue. Deferred taxes The balance sheet account that results from temporary differences in the recognition of revenue and expense for taxable income and reported income. Depletion The accounting procedure used to allocate the cost of acquiring and developing natural resources. Depreciation The accounting procedure used to allocate the cost of an asset, which will benefit a business enterprise for more than a year, over the asset’s service life. Derivatives Financial instruments that derive their value from an underlying asset or index. Diluted earnings per share The earnings per share figure calculated using all potentially dilutive securities in the number of shares outstanding. Direct method On the statement of cash flows, a method of calculating cash flow from operating activities that shows cash collections from customers; interest and dividends collected; other operating cash receipts; cash paid to suppliers and employees; interest paid; taxes paid; and other operating cash payments. Disclaimer of opinion Independent auditor could not evaluate the fairness of the financial statements and, as a result, expresses no opinion on them.
APPENDIX C Discontinued operations The financial results of selling a major business segment. Discretionary items Revenues and expenses under the control of management with respect to budget levels and timing. Dividend payout ratio See Summary of financial ratios, Appendix A. Dividend yield See Summary of financial ratios, Appendix A. Double-declining balance method An accounting procedure for depreciation under which the straight-line rate of depreciation is doubled and applied to the net book value of the asset. Du Pont System An analytical technique used to evaluate the profitability and return on equity for a firm. EBITDA Earnings before interest, taxes, depreciation, and amortization. See Pro forma earnings. Earnings before income taxes The profit recognized before the deduction of income taxes. Earnings before interest and taxes The operating profit of a firm. Earnings per common share See Summary of financial ratios, Appendix A. Earnings statement See Income statement. Effective tax rate See Summary of financial ratios, Appendix A. Equity See Stockholders’ equity. Equity method The procedure used for an investment in common stock when the investor company can exercise significant influence over the investee company; the investor recognizes investment income of the investee’s net income in proportion to the percentage of stock owned. Expenses Costs incurred to produce revenue. Extraordinary transactions Items that are unusual in nature and not expected to recur in the foreseeable future. Financial Accounting Standards Board (FASB) The private-sector organization primarily responsible for establishing generally accepted accounting principles. Financial leverage The extent to which a firm finances with debt, measured by the relationship between total debt and total assets.
Glossary
277
Financial leverage index See Summary of financial ratios, Appendix A. Financial ratios Calculations made to standardize, analyze, and compare financial data; expressed in terms of mathematical relationships in the form of percentages or times. Financial statements Accounting information regarding the financial position of a firm, the results of operations, and the cash flows. Four statements comprise the basic set of financial statements: the balance sheet, the income statement, the statement of stockholder’s equity, and the statement of cash flows. Financing activities On the statement of cash flows, transactions that include borrowing from creditors and repaying the principal; obtaining resources from owners and providing them with a return on the investment. Finished goods Products for which the manufacturing process is complete. First-in, first-out (FIFO) A method of valuing inventory and cost of goods sold under which the items purchased first are assumed to be sold first. Fiscal year A 12-month period starting on a date other than January 1 and ending 12 months later. Fixed assets Tangible, long-lived assets that are expected to provide service benefit for more than one year. Fixed asset turnover See Summary of financial ratios, Appendix A. Fixed charge coverage See Summary of financial ratios, Appendix A. Foreign currency translation effects Adjustment to the equity section of the balance sheet resulting from the translation of foreign financial statements. Form 10-K An annual document filed with the Securities and Exchange Commission by companies that sell securities to the public. Form 10-Q A quarterly report filed with the Securities and Exchange Commission by companies that sell securities to the public. Generally accepted accounting principles The accounting methods and procedures used to prepare financial statements. Going concern assumption Assumption that business entities will operate indefinitely
278 APPENDIX C Glossary unless there is strong evidence to the contrary. Goodwill An intangible asset representing the unrecorded assets of a firm; appears in the accounting records only if the firm is acquired for a price in excess of the fair market value of its net assets. Gross margin See Gross profit. Gross profit The difference between net sales and cost of goods sold. Gross profit margin See Summary of financial ratios, Appendix A. Historical cost The amount of cash or value of other resources used to acquire an asset; for some assets, historical cost is subject to depreciation, amortization, or depletion. Impairment charges See Asset impairment. Income statement The financial statement presenting the revenues and expenses of a business enterprise for an accounting period. Indirect method On the statement of cash flows, a method of calculating cash flow from operating activities that adjusts net income for deferrals, accruals, and noncash and nonoperating items. Industry comparisons Average financial ratios compiled for industry groups. In-process research and development Onetime charges taken at the time of an acquisition to write-off amounts of research and development that are not considered viable. Intangible assets Assets such as goodwill that possess no physical characteristics but have value for the company. Integrated disclosure system A common body of information required by the Securities and Exchange Commission for both the 10-K Report filed with the Securities and Exchange Commission and the annual report provided to shareholders. Interim statements Financial statements issued for periods shorter than one year. International Accounting Standards Board (IASB) The international organization responsible for establishing accounting standards and promoting worldwide acceptance of those standards. International Financial Reporting Standards (IFRS) The accounting standards
established by the International Accounting Standards Board. Inventories Items held for sale or used in the manufacture of products that will be sold. Inventory turnover See Summary of financial ratios, Appendix A. Investing activities On the statement of cash flows, transactions that include acquiring and selling or otherwise disposing of (1) securities that are not cash equivalents and (2) productive assets that are expected to benefit the firm for long periods of time; lending money and collecting on loans. Last-in, first-out (LIFO) A method of valuing inventory and cost of goods sold under which the items purchased last are assumed to be sold first. Leasehold improvement An addition or improvement made to a leased structure. Leverage ratio A ratio that measures the extent of a firm’s financing with debt relative to equity and its ability to cover interest and other fixed charges. Liabilities Claims against assets. Line of credit A prearranged loan allowing borrowing up to a certain maximum amount. Liquidity The ability of a firm to generate sufficient cash to meet cash needs. Liquidity ratio A ratio that measures a firm’s ability to meet needs for cash as they arise. Long-term debt Obligations with maturities longer than one year. Long-term debt to total capitalization See Summary of financial ratios, Appendix A. Lower of cost or market method A method of valuing inventory under which cost or market, whichever is lower, is selected for each item, each group, or for the entire inventory. Management Discussion and Analysis (MD&A) of the Financial Condition and Results of Operation A section of the annual and 10-K report that is required and monitored by the Securities and Exchange Commission in which management presents detailed coverage of the firm’s liquidity, capital resources, and operations.
APPENDIX C Market ratio A ratio that measures returns to stockholders and the value the marketplace puts on a company’s stock. Marketable securities Cash not needed immediately in the business and temporarily invested to earn a return; also referred to as short-term investments. Matching principle The accounting principle holding that expenses are to be matched with the generation of revenues to determine net income for an accounting period. Materiality The significance of the dollar amount of an item that would make a difference in decision-making. Merchandise inventories Goods purchased for resale to the public. Minority interest Claims of shareholders other than the parent company against the net assets and net income of a subsidiary company. Modified accelerated cost recovery system (MACRS) A modification of the accelerated tax recovery system (ACRS) in the Tax Reform Act of 1986 for assets placed in service after 1986. Monetary unit assumption The unit of measurement that is assumed when preparing financial statements. Multiple-step format A format for presenting the income statement under which several intermediate profit measures are shown. Net assets Total assets less total liabilities. Net book value of capital assets The difference between original cost of property, plant, and equipment and any accumulated depreciation to date. Net earnings The firm’s profit or loss after consideration of all revenue and expense reported during the accounting period. Net income See Net earnings. Net profit margin See Summary of financial ratios, Appendix A. Net sales Total sales revenue less sales returns and sales allowances. Net trade cycle See Cash conversion cycle and Summary of financial ratios, Appendix A. Noncurrent assets/liabilities Items expected to benefit the firm for/with maturities of more than one year.
Glossary
279
Notes payable An obligation in the form of a promissory note to suppliers or financial institutions. Notes to the financial statements Supplementary information to financial statements that explain the firm’s accounting policies and provide detail about particular accounts and other information such as pension plans. Off–balance-sheet financing Financial techniques for raising funds that do not have to be recorded as liabilities on the balance sheet. Operating activities On the statement of cash flows, transactions that include delivering or producing goods for sale and providing services; the cash effects of transactions and other events that enter into the determination of income. Operating cycle The time required to purchase or manufacture inventory, sell the product, and collect the cash. Operating efficiency The efficiency of a firm in managing its assets. Operating expenses Costs related to the normal functions of a business. Operating lease A rental agreement wherein no ownership rights are transferred to the lessee at the termination of the rental contract. Operating profit Sales revenue less the expenses associated with generating sales. Operating profit measures the overall performance of a company on its normal, ongoing operations. Operating profit margin See Summary of financial ratios, Appendix A. Options See Stock options. Par value The floor price below which stock cannot be sold initially. Payables turnover See Summary of financial ratios, Appendix A. Plant and equipment See Fixed assets. Preferred stock Capital stock of a company that carries certain privileges or rights not carried by all outstanding shares of stock. Premature revenue recognition Recording revenue before it should be recorded in order to increase earnings.
280 APPENDIX C Glossary Prepaid expenses Expenditures made in the current or prior period that will benefit the firm at some future time. Price-earnings ratio See Summary of financial ratios, Appendix A. Principal The original amount of a liability. Prior period adjustment A change in the retained earnings balance primarily resulting from the correction of errors made in previous accounting periods. Pro forma earnings Alternative earnings numbers that adjust net income in some way for items not expected to be part of ongoing business operations. Pro forma financial statements Projections of future financial statements based on a set of assumptions regarding future revenues, expenses, level of investment in assets, financing methods and costs, and working capital management. Profitability ratio A ratio that measures the overall performance of a firm and its efficiency in managing assets, liabilities, and equity. Property, plant, and equipment See Fixed assets. Proxy statement A document required by the SEC that companies use to solicit shareholders’ votes and that contains information about directors, director and executive compensation plans, and the audit committee report. Public Company Accounting Oversight Board (PCAOB) A private, nonprofit organization with the authority to register, inspect, and discipline auditors of all publicly owned companies. Publicly held companies Companies that operate to earn a profit and issue shares of stock to the public. Qualified opinion An opinion rendered by an independent auditor when the overall financial statements are fairly presented “except for” certain items (which the auditor discloses). Quality of financial reporting A subjective evaluation of the extent to which financial reporting is free of manipulation and accurately reflects the financial condition and operating success of a business enterprise.
Quick ratio See Summary of financial ratios, Appendix A. Raw materials Basic commodities or natural resources that will be used in the production of goods. Replacement cost The estimated cost of acquiring new and substantially equivalent property at current prices. Reported income The net income published in financial statements. Reserve accounts Accounts used to estimate obligations, recorded as accrued liabilities; also to record declines in asset values, recorded as contra-asset accounts. Restructuring charges Costs to reorganize a company. Retained earnings The sum of every dollar a company has earned since its inception, less any payments made to shareholders in the form of cash or stock dividends. Return on equity See Summary of financial ratios, Appendix A. Return on investment See Return on total assets, Appendix A. Return on total assets See Summary of financial ratios, Appendix A. Revenue The inflow of assets resulting from the sale of goods or services. Revenue recognition principle The principle that requires the following four conditions be met in order to record revenue: (1) the revenues must be earned (the sale is complete), (2) the amount of the revenue must be measurable, (3) the costs of generating the revenue can be determined, and (4) the revenue must be realizable. Reverse stock split Decreasing the number of shares of outstanding stock to existing stockholders in proportion to current ownership, usually to increase the market price of a firm’s stock. Sales allowance A deduction from the original sales invoice price. Sales return A cancellation of a sale. Salvage value The amount of an asset estimated to be recoverable at the conclusion of the asset’s service life. Sarbanes-Oxley Act of 2002 Legislation passed by the U.S. Congress in hopes of ending future accounting scandals
APPENDIX C and renewing investor confidence in the marketplace. Securities and Exchange Commission (SEC) The public-sector organization primarily responsible for establishing generally accepted accounting principles. Segment A component of a business enterprise that sells primarily to outside markets and for which information about revenue and profit is accumulated. Segment operating expenses Expenses relating to unaffiliated customers and segment revenue; expenses not directly traceable to segments are allocated to segments on a reasonable basis. Segment operating profit/loss Segment revenue less all operating expenses. Segment revenue Sales of products and services to unaffiliated customers and intersegment sales, with company transfer prices used to determine sales between segments. Selling and administrative expenses Costs relating to the sale of products or services and to the management function of the firm. Short-term Generally indicates maturity of less than a year. Single-step format A format for presenting the income statement under which all items of revenue are grouped together and then all items of expense are deducted to arrive at net income. Stated value The floor price below which stock cannot be sold initially; see also par value. Statement of cash flows The financial statement that provides information about the cash inflows and outflows from operating, financing, and investing activities during an accounting period. Statement of financial position See Balance sheet. Statement of retained earnings The financial statement that presents the details of the transactions affecting the retained earnings account during an accounting period. Statement of stockholders’ equity A financial statement that summarizes changes in the shareholders’ equity section of
Glossary
281
the balance sheet during an accounting period. Stock dividends The issuance of additional shares of stock to existing shareholders in proportion to current ownership. Stock options A contract that conveys the right to purchase shares of stock at a specified price within a specified time period. Stock splits The issuance of additional shares of stock to existing shareholders in proportion to current ownership, usually to lower the market price of a firm’s stock. Stockholders’ equity Claims against assets by the owners of the business; represents the amount owners have invested including income retained in the business since inception. Straight-line depreciation An accounting procedure under which equal amounts of expense are apportioned to each year of an asset’s life. Structural analysis Analysis looking at the internal structure of a business enterprise. Summary of financial ratios See Summary of financial ratios, Appendix A. Tangible Having physical substance. Taxable income The net income figure used to determine taxes payable to governments. Temporary differences Differences between pretax accounting income and taxable income caused by reporting items of revenue or expense in one period for accounting purposes and in an earlier or later period for income tax purposes. Time period assumption The assumption that specifies the time period that business firms use to report financial information. Times interest earned See Summary of financial ratios, Appendix A. Total asset turnover See Summary of financial ratios, Appendix A. Treasury stock Shares of a company’s stock that are repurchased by the company and not retired. Trend analysis Evaluation of financial data over several accounting periods. Unearned revenue A liability caused by receipt of cash in advance of earning revenue.
282 APPENDIX C Glossary Units-of-production method An accounting method under which depreciation expense is based on actual usage. Unqualified opinion An opinion rendered by an independent auditor of financial statements stating that the financial statements have been presented fairly in accordance with generally accepted accounting principles. Unqualified opinion with explanatory language An opinion rendered by an independent auditor of financial statements stating that the financial statements have been presented fairly in accordance with generally accepted accounting principles, but there are items which the auditor wishes to explain to the user.
Unrealized gains (losses) on marketable equity securities The gains (losses) disclosed in the equity section resulting from the accounting rule that requires investments in marketable equity securities to be carried at the lower of cost or market value. Warrant A certificate issued by a corporation that conveys the right to buy a stated number of shares of stock at a specified price on or before a predetermined date. Warranties Nonmonetary liabilities that promise the delivery of goods or services during a specified warranty period. Work-in-process Products for which the manufacturing process is only partially completed. Working capital The amount by which current assets exceed current liabilities.
Index A accelerated method of depreciation, 61–62, 67 accounting principles underlying financial statements, 17–19 Accounting Series Releases of SEC, 5 accounts payable, 64–65, 172 accounts payable turnover, 217 accounts receivable, 53–56, 172 accounts receivable turnover, 216 accrual method of accounting, 17–18, 135 accrued liabilities, 65–66, 172 acid-test ratio, 213 Active Power Inc., 174 activity ratios, 216–218 adjustments to earnings, 140 adverse opinion, 10 advertising costs, 111 allowance for doubtful accounts accounts receivable and, 53 checklist for earnings quality, 126–127 examples of, 89, 90 Amazon.com, 137 amortization, 111–112 analysis. See also analysis of financial statements; analysis of segmental data; Management Discussion and Analysis (MD&A) section of annual report; tools and techniques of analysis of business climate, 225–228 of cash flow from operations, 2, 175–176, 178–179 of cash inflow, 180 of cash outflow, 168, 181–182 liquidity, 228–229 of profitability, 233–234 analysis of financial statements accounting choices, 17–18
activity ratios, 216–218 capital structure and long-term solvency, 229–233 cash conversion cycle or net trade cycle, 216 common-size financial statements, 210 Du Pont System, 234–236 economy, industry, and firm, 226–227 key financial ratios, 210–211 leverage ratios, 218–221 liquidity ratios, 211–216 market ratios, 223–225 objectives of, 205–206 operating efficiency, 229–230 profitability, 233–234 profitability ratios, 221–223 projections and pro forma statements, 236 short-term liquidity, 227–229 sources of information, 206–209 steps of, 226 summary of, 236–238 tools and techniques, 209 analysis of segmental data disclosure requirements, 244 example of, 239–243 operating segment, 243 annual report. See also Management Discussion and Analysis (MD&A) section of annual report; Notes to Financial Statement auditor’s report, 10–12, 23, 206–207 description of, 4 example of, 20–32 financial statements in, 8 finding, 8 five-year summary of selected data, 14 PR fluff, 14–15
proxy statements, 15, 206 volume of information, 4–6 Applied Materials Inc., 118 asset impairment, 133–135 assets. See also depreciation of assets; inventories accounts receivable, 53–56, 172 cash and cash equivalents, 53 current, 51–52 gains or losses from sales of, 136 goodwill, 63 marketable securities, 53 net fixed, as percentage of total, 63 other, 63 overvaluation of, 75 prepaid expenses, 60, 172 property, plant, and equipment, 60–63 auditor’s report, 10–12, 23, 206–207 average collection period, 214–215 average cost, 57–59 Avnet Inc., Form 10-K, 200–201
B balance sheet. See also assets common-size, 50, 210 date of, 48, 50 description of, 8, 47 Facebook, Inc. example, 258 financial condition and, 48–50 Hydrogenics corporation, 92–102 Intel Corporation example, 66 liabilities, 64–72 quality of financial reporting, 75–76 Sage Inc. examples, 24, 48–49, 52, 64 statement of cash flows and, 163, 165 stockholders’ equity, 72–74 Walgreen Co. example, 88 balancing equation, 48
283
284 Index base LIFO layer liquidations, 130 basic earnings per share, 118 Best Buy Inc., 139 bill-and-hold transactions, 125 Biolase, Inc., 39–46 Blockbuster, 183 bonds payable, 65, 70 buildings as assets, 62 business climate, analysis of, 225–229
C capital, additional paid-in, 73 capital expenditures, 242 capital lease obligations, 70–71, 76 capital structure, 229–233 cash calculating change in, 174 definition of, 165 cash account, 53 cash basis of accounting, 17–18 cash conversion cycle, 216 cash equivalents account, 53 cash flow. See also cash flow from operations/operating activities; statement of cash flows during accounting period, 166 comparison of, 174 from financing activities, 167 from investing activities, 173 cash flow adequacy, 220 cash flow from operations/operating activities (CFO) analysis of, 2, 175–176, 178–179 direct method of calculating, 184–187 indirect method of calculating, 170–173 cash flow hedges, 119 cash flow liquidity ratio, 214 cash flow margin, 222, 233 cash interest coverage, 219 cash method of accounting, 17–18 cash return on assets, 222, 234 CFO. See cash flow from operations/operating activities checklist for earnings quality cost of goods sold, 129–131 material changes in number of shares outstanding, 139–140 nonoperating revenue and expense, 136–139 operating earnings, 140 operating expenses, 132–136 sales or revenues, 124–129 chief executive officer (CEO), 12 chief financial officer (CFO), 11–12 Cognex Corporation, 132 commitments description of, 72 examples of, 75
common-size balance sheet, 50, 51, 210 common-size income statement, 106, 210 common stock account, 73 common stock shares outstanding, 139 comparability, 16 comparative data, 50 comparative industry ratios, 227 comprehensive income, 74, 106, 118–119 comprehensive loss, 74 Computer Associates, 125–126 consistency, 16 consolidated statement, 48 construction in progress account, 62 Consumer Price Index (CPI), 128–129 contingencies description of, 72 examples of, 75 convertible debt, 70 core earnings, 140 cost flow assumption for inventory, 129–130 cost method of accounting, 115 cost of goods sold accounting methods and, 57–59 base LIFO layer liquidations, 130 cost flow assumption for inventory, 129–130 gross profit margin and, 108 on income statement, 108 loss recognitions on write-downs of inventories, 130–131 creditor, 205 current assets, 51–52 current liabilities, 64 current ratio, 211
D date of balance sheet, 48, 50 days inventory held, 215 days payable outstanding, 216 debentures, 70 debt, mismatching of, 75 debt ratio, 218 debt to equity ratio, 219 deferred credits, 66 deferred federal income taxes, 67–70 deferred tax liability account, 172 defined benefit plan, 71 deflation and LIFO, 59 Dell Inc., 125, 135 depletion, 111 depreciation of assets earnings quality and, 132–133 on income statement, 112
methods of calculating, 60–62 Diebold Inc., 125 diluted earnings per share, 118 direct method of calculating cash flow from operating activities, 170–173 disclaimer of opinion, 11 discontinued operations, 117, 138–139 discretionary expenses, 132 discretionary items, 19 dividend payout ratio, 224–225 dividend yield, 224 Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 12 Dun & Bradstreet Information Services, 208 Du Pont System, 234–236
E earnings. See also checklist for earnings quality; income; profit adjustments to, 140 equity, 115–116 before income taxes, 116–117 net, 118 per common share, 118, 139–140 pro forma, 121 retained, 74, 121 earnings before interest and taxes (EBIT), 114 earnings before interest, tax, depreciation, and amortization (EBITDA), 140 earnings per common share, 223 effective tax rate, 116–117 Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database, 8, 208 Enron, 11–13, 16, 75 equipment as asset, 62 equity account. See stockholders’ equity equity attributable to noncontrolling interests, 75 equity earnings, 115–116 equity income, 137 equity method of accounting, 115–116 eSys, 126–127 expenses. See also nonoperating revenue and expense; operating expenses administrative, 111 discretionary, 132 prepaid, 60, 172 timing of recognition of, 18–19 extraordinary gains and losses, 117–118, 139
Index
F Facebook, Inc. Form 10-K, 258–267 fair value, 53 FIFO (first in, first out) cost flow assumption for inventory accounting, 57–59, 108, 129 Financial Accounting Standards Board (FASB) Accounting Standards Codification, 5 description of, 5 disclosure requirements, 239, 244 IASB and, 6, 7 operating segment definition, 243 SEC and, 5–6 September 11 and, 117 financial condition and balance sheet, 48–51 financial leverage, 230–231 financial leverage index (FLI), 232 financial ratios. See key financial ratios financial reporting reforms, 11–12 Financial Reporting Rulings of SEC, 5 financial statement. See also analysis of financial statements; balance sheet; income or earnings statement; Notes to Financial Statement; statement of cash flows; statement of stockholders’ equity accrual basis of accounting, 17 in annual report, 8, 16–17 cash basis of accounting, 17 characteristics, 16 example of, 20–32 finding, 8 global economy, 7–8 going concern assumption, 16 information not found in, 15–16 interpreting, 17 as map or maze, 1–4 matching principle, 17 monetary unit assumption, 17 quality of information in, 17–19 revenue recognition principle, 17 time period assumption, 17 usefulness of, 4 volume of information in, 4–6 financing activities, 165, 173–174 five-year summary of selected data, 14 fixed assets, 60–63 fixed asset turnover, 217 fixed charge coverage, 219–220 Ford Motor Company, 129–131
foreign currency translation effects, 119 Form 10-K report Applied Materials, 37, 87, 149, 199, 257 Avnet Inc., 200–201 Biolase, Inc., 39–46 components of, 9 Facebook, Inc., 258–267 finding, 8 Hydrogenics corporation, 92–102, 154–160, 202–203, 268 Intel, 36, 86, 148, 198, 256 Logitech International S.A., 150–153 as required by SEC, 4 as source of information for analysis, 207 Mattel Inc., 38 Walgreen Co., 88–91 Form 10-Q report, 207
G GAAP. See generally accepted accounting principles gains extraordinary, 117–118, 139 from sales of assets, 136 unrealized, 119 General Electric, 137–138 generally accepted accounting principles (GAAP) description of, 4 FASB and, 5 management discretion within, 16–19 matching principle, 17, 18 going concern assumption, 16 goodwill, 63 Goodyear Tire & Rubber Company, 136–137 gross profit, 108–110, 221, 233 gross profit margin, 108
H Hasbro Inc., 133 held to maturity, 53 Huntsman Corporation, 139 Hydrogenics corporation, 92–102, 154–160, 202–203, 268
I impairment charges, 113 income. See also earnings; income or earnings statement; profit comprehensive, 74, 106, 118–119 equity, 137 interest, 136–137
285
income or earnings statement. See also quality of reported earnings Applied Materials Inc. example, 119 common-size, 106, 210 cost of goods sold, 108 description of, 8, 104, 106 earnings before income taxes, 116–117 earnings per common share, 118 equity earnings, 115–116 Facebook, Inc. example, 259–260 gross profit, 108–110 Hydrogenics corporation example, 154–160 net earnings, 118 net sales, 106–107 operating expenses, 111–113 operating profit, 114 other income (expense) category, 114 quality of financial reporting, 121 Sage Inc. example, 25, 105 special items, 117–118 income taxes, 137–138 indirect method of calculating cash flow from operating activities, 170–173 inflation and LIFO, 58 inflow, 168 inflow of cash, analysis of, 180 in-process research and development, 135–136 Intel Corporation balance sheet, 66 interest income, 136–137 internal control report, 10 International Accounting Standards Board (IASB), 6–7 Internet sites for information about companies, 208 inventories accounting methods for, 57–59 cost flow assumption for, 129–130 description of, 56 loss recognitions on writedowns of, 130–131 as percentage of total assets, 56 Walgreen Co. example, 89 inventory turnover, 217 inventory valuation, 18, 57–59 investing activities, 165, 173 investor, 205
J Johnson & Johnson, 135–136
286 Index K key financial ratios activity, 216–218 leverage, 218–221 liquidity, 211–216 market, 223–225 overview of, 210–212 profitability, 221–223 relating with Du Pont System, 234–236 summary of, 236 Kumar, Sanjay, 125–126
long-term debt, 65, 70 long-term debt to total capitalization ratio, 219 long-term solvency, 229–233 long-term warranties, 70 losses comprehensive, 75 extraordinary, 117, 139 net operating, 136 from sales of assets, 136 unrealized, 119 loss recognitions on write-downs of inventories, 130–131
L
M
LaBarge Inc., 131 land as asset, 62 leasehold improvements, 62 lease payments, 111 leases capital lease obligations, 70–71, 76 operating, 72, 76 Walgreen Co. example, 90–91 Lehman Brothers cash account, 162, 164 cash flow from operations, 2 collapse of, and corporate reforms, 11 PR fluff, 14–15 leverage ratios, 218–221 liabilities accounts payable, 64, 172 accrued, 65–66 capital lease obligations, 70–71, 76 commitments and contingencies, 72, 75 current, 64 current maturities of long-term debt, 65 deferred federal income taxes, 67–70 long-term debt, 70 pensions and postretirement benefits, 71–72 short-term debt, 65 unearned revenue or deferred credits, 66 library resources for information about companies, 208 LIFO (last in, first out) cost flow assumption for inventory accounting base LIFO layer liquidations, 130 description of, 57–59 FIFO and average cost assumptions compared to, 108, 129 liquidity analysis, 228–229 Liquidity and Capital Resources section of MD&A, 12–14, 22–23 liquidity ratios, 211–216 Logitech International S.A. Form 10-K, 127, 150–153
maintenance, 112 Management Discussion and Analysis (MD&A) section of annual report Biolase, Inc., 39–46 description of, 12–14 Facebook, Inc., 258–267 Liquidity and Capital Resources section, 12–14, 22–23 Logitech International S.A, 150–153 Results of Operations section, 14, 21–22 Sage Inc., 21–22 as source of information for analysis, 206–209 map, financial statement as, 1–4 marketable securities, 53 market ratios, 223–225 matching principle, 17, 18 material changes in number of shares outstanding, 139 materiality, 16 Mattel Inc., 133 maze, financial statement as, 1–4 McKesson Corporation, 131 Micron Technology Inc., 128 Modified Accelerated Cost Recovery System, 67 monetary unit assumption, 17 mortgage, 65, 70 multiple-step format for income statement, 104, 106
N net cash flow from operating activities direct method, 187 indirect method, 171 net earnings, 118 Netflix, 183 net operating losses, 117 net profit margin, 221, 233 net sales, 106–107 net trade cycle, 216 net working capital, 52
nonoperating revenue and expense discontinued operations, 138–139 equity income, 137 extraordinary items, 139 gains (losses) from sales of assets, 136 income taxes, 137–138 interest income, 136–137 notes payable, 64–65, 70 Notes to Financial Statement description of, 8–11 Facebook, Inc., 159–162 Logitech International S.A., 150–153 Sage Inc., 21–23 Walgreen Co., 88–91
O objectives of analysis of financial statements, 205–206 off-balance sheet financing, 72 operating activities, 166. See also cash flow from operations/ operating activities operating cycle, 51 operating efficiency, 229 operating expenses asset impairment, 133–134 depreciation, 132–133 discretionary expenses, 132 on income statement, 111–113 in-process research and development, 135–136 reserves, 135 operating lease, 72, 76 operating profit, 114, 140, 241 operating profit margin, 221, 233, 241–242 operating segment, 243. See also segmental disclosures outflow of cash, analysis of, 168, 181 overvaluation of assets, 75 ownership equity. See stockholders’ equity
P pension liabilities, 119 pensions, 71–72 periodical sources of information about companies, 208 permanent differences, 67 Pfizer, Inc., 75, 76 postretirement benefits, 71 preferred stock, 74 premature revenue recognition, 124–126 prepaid expenses, 60, 172 PR fluff in annual report, 14–15
Index price-to-earnings (P/E) ratio, 223 price versus volume changes, 128 Proctor & Gamble Company, 127 profit. See also earnings; income gross, 108–110 operating, 114, 140 profitability, analysis of, 233–234 profitability ratios, 221–223 pro forma earnings, 140 pro forma financial statement, 236 projections, 236 proxy statement, 15, 206 Public Company Accounting Oversight Board, 11 PVH Corporation, 130
Q qualified report, 10 quality of financial reporting balance sheet, 75–76 financial statement, 17–19 income statement, 121 quality of reported earnings adjustments to earnings, 140 checklist for, 124 cost of goods sold, 129–131 description of, 123–124 material changes in number of shares outstanding, 139 nonoperating revenue and expense, 136–139 operating earnings, 140 operating expenses, 132–136 sales or revenues, 124–129 quick ratio, 213
R real versus nominal growth, 128–129 repairs, 112 reputation of firm, 15–16 research and development, inprocess, 135–136 reserve account, 65, 135 Results of Operations section of MD&A, 12–14, 21–22 retained earnings, 74, 121 return on assets, 234 return on equity, 222, 234 return on investment, 222, 242 return on total assets, 222 revenue. See also nonoperating revenue and expense; sales or revenues and earnings quality premature recognition of, 124–126 timing of recognition, 19 unearned, 66 revenue recognition principle, 17
reverse stock split, 121 Risk Management Association, 208
S Sage Inc. analysis of statement of cash flows, 178–182 business climate for, 225–228 cash flows from investing and financing activities, 180 cash flows from operating activities, 179 common-size balance sheets, 51 common-size income statements, 107 consolidated balance sheets, 48–51, 64, 212 consolidated statements of cash flows, 167, 185 consolidated statements of earnings, 105, 213 consolidated statements of stockholders’ equity, 120 direct method of calculating cash flow from operating activities, 184 indirect method of calculating cash flow from operating activities, 170 Management Discussion and Analysis section, 21–22 net cash flow from operating activities direct method, 187 Notes to Financial Statement, 28–32 Segment Information, 239–240 summary analysis statement of cash flows, 214, 230 valuation and qualifying accounts, 81 worksheet for preparing statement of cash flows, 169 sales allowance, 106 sales or revenues and earnings quality allowance for doubtful accounts, 126–127 premature revenue recognition, 124–126 price versus volume changes, 128 real versus nominal growth, 128–129 sales return, 106 Sarbanes-Oxley Act of 2002 (SOX), 10–12 Seagate Technology, 126–127
287
Securities and Exchange Commission (SEC) EDGAR Database, 8, 208 FASB and, 5–6 Public Company Accounting Oversight Board, 11 reports required by, 5 securities available for sale, 53 segmental disclosures, analysis of, 239–243 selling and administrative expenses, 111 short-term debt, 65 short-term investment, 53 short-term liquidity analysis, 227–229 short-term solvency, 211–216 single-step format for income statement, 104, 105 sources of information for analysis of financial statements, 206–209, 228 special items, 117–118 statement of cash flows analysis of, 178–182 Avnet Inc. example, 200–201 as change in cash between accounting periods, 163–164 description of, 8 Facebook, Inc. example, 258–262 Hydrogenics corporation, 202–203 importance of, 162–163 preparing, 165–170 qualitative issues related to, 182–183 reading and interpreting, 161–162, 175–182 Sage Inc. examples, 167, 185 summary analysis of, 179–180 statement of condition. See balance sheet statement of earnings. See income or earnings statement statement of financial position. See balance sheet statement of stockholders’ equity, 8, 104, 120–121. See also stockholders’ equity stock dividends, 120 stockholders’ equity, 72–75. See also statement of stockholders’ equity stock split, 120–121 straight-line method of depreciation, 61–62 subprime mortgage crisis, 12, 75 Supervalo Inc., 130 supplementary schedules, 207
