Chapter 12 Lecture - CHAPTER 12 CLASS NOTES FINANCIAL...

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CHAPTER 12 CLASS NOTES FINANCIAL STATEMENT ANALYSIS People use financial statement analysis in different ways dependent upon the information they need to make a specific business decision, such as a bank issuing a loan, a supplier granting credit to a customer, a person investing in the stock of a company, etc. It is critical to remember that you must understand the financial statements and take appropriate care before making comparisons of a company’s financial statements for two different periods, of a company’s financial statements with those of another company, or the company’s financial statements to industry data. The reader needs to be cognizant of alternate accounting policies such as inventory methods, revenue recognition policies, etc. The reader needs to watch for changes in accounting principles during the period under review to ensure that all periods being analyzed are consistent. The reader must be careful using industry data as companies are often in multiple industries. While these are precautions, they can be overcome easily if you do your analysis wisely and carefully. One of the ways of analyzing financial statements of the same company for different time periods is called Horizontal Analysis. One simply determines the changes from one period presented to the earlier period in dollar terms and then computes the change in percentage terms, i.e., the increase or decrease. Once this is accomplished, you search for the reasons why items changed from year to year, but only those where there was a significant change. It helps to narrow down you analysis. One can also analyze financial statements using Vertical Analysis or Common Size Financial Statements. You put everything in a given year as a percentage of the total and compare these percentages year to year to see where changes have occurred. It is a convenient way to focus your analysis and see where you need to research questions. For example, you could look at the makeup of current assets and see the relative importance of specific items---inventory is 20% of current assets in one year and rises to 25% ---why? If current assets rose $20,000 and cash was 10% of current assets in both years, the dollar increase is not important because cash balance is consistent. You are looking for the major changes that occurred. The above analyses focus on the company as a whole, however, companies are made up of operating segments that are often discrete types of operations. These are called segments. All public companies must report limited financial information related to their operating segments and so these can be analyzed in terms of assets, sales, operating income and other information. This is reported in a footnote to the financial statements.
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