Ch 2 Solutions Rev CF2.feb067

Ch 2 Solutions Rev CF2.feb067 - Financial Statement and...

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Unformatted text preview: Financial Statement and Cash Flow Analysis 5 Chapter 2: Financial Statement and Cash Flow Analysis Answers to End of Chapter Questions 2-1. Financial statement analysis provides information about the companys financial health, and its strengths and weaknesses. Using standardized GAAP rules does add validity by making comparisons between companies easier. 2-2. The Sarbanes-Oxley Act of 2002 (SOX) established the Public Company Accounting Oversight Board (PCAOB), which effectively gives the SEC authority to oversee the accounting professions activities. Possible shortcomings of relying solely on financial statement analysis include: If a company is in multiple lines of business it may be difficult to make comparisons The accounting data may not be accurate Average performance may not be a good measure, especially if the industry is in a slump It is possible to manipulate accounting numbers. 2-3. Data on a companys performance over a reporting period: income statement, statement of cash flows, statement of retained earnings (how much additional retained earnings will be added to existing retained earnings). Data on a companys performance about the companys current position: balance sheet. Notes to the financial statements contain details about the composition and cost of the companys debt, any liabilities such as lawsuits that are still pending, revenue recognition, taxes, significant clients, detailed breakdowns of fixed asset accounts, executive compensation, and descriptions of employee benefit plans. An example of a situation in which the notes would be essential to valuation would be a company that relied on a few clients, rather than a wide base of clients. The notes would detail current and expected revenue from those clients and how that revenue would be recognized. An analyst would need this information to develop a set of cash flows for the company which would provide the basis of a company valuation. 2-4. An analyst looking at granting a loan request would be most interested in the companys balance sheet which she could use to compute liquidity ratios (current and quick ratios) and debt ratios. A credit analyst would also want an income statement with EBIT and interest with which to compute times interest earned. Times interest earned is a measure of how well a company can pay its interest obligations, while liquidity and debt ratios show what assets are available to repay debt. 2-5. The two definitions are different because the new definition will be less than the textbook definition by interest expense*tax rate ( i.e. , the tax break generated by interest). Should the firm not have any debt, the two definitions are equal because the tax break from debt is zero....
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This note was uploaded on 02/23/2009 for the course BUSI 233 taught by Professor Harold during the Spring '07 term at Howard County Community College.

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Ch 2 Solutions Rev CF2.feb067 - Financial Statement and...

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