L7_Analysing_Financial_Statements

L7_Analysing_Financi - Analysing Financial Statements 1 Valuation Techniques Equities Fundamental Analysis Using economic and company specific

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1 Analysing Financial Statements
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2 Valuation Techniques: Equities Fundamental Analysis: Using economic and company specific information to try to predict future earnings etc. and valuing the firm / equity based on these. Quantitative Analysis: Using statistical and mathematical techniques to extrapolate historical relationships, values, share prices etc. to get to a value for the equity. Technical Analysis: Interpreting trends and relationships in share market information (prices, volumes etc) graphically and predicting the future share prices based on these.
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3 Importance of Financial Statements Critical source of information for fundamental (and sometimes quantitative) analysis Objective: convert accounting numbers into economic numbers (a realistic economic reflection of the business and it future earnings capacity ) Economic ( real ) financial information and predictions should be the basis of valuation and not accounting information (which depend solely on accounting convention and rules and not necessarily on reality)
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4 Why adjust financial statements? Accounting picture only approximation of business Management discretion in defining accounting picture Accounting picture distorted by atypical events / entries Are the numbers shown sustainable ?
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5 Defining Earnings Valuation based on economic earnings capacity of business Key objective of analyst: adjust accounting numbers to better reflect economic (market) reality
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6 Sources of Earnings Variation (and manipulation) Inventory Accounting Pension Liabilities Share Options Revenue Recognition Depreciation Recognition Inter-Corporate Investments Capitalisation vs. Expensing And many more…
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7 Inventory Accounting: Basics LIFO (Last-in-First-Out ) COS : cost of most recent identical item bought Ending inventory : cost of first purchases / manufactured products FIFO (First-in-First-Out) COS : cost of oldest identical item bought Ending inventory : cost of most recent purchases / manufactured products
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8 Link between Inventory and Earnings Decreasing COS → Increases GP → Increases Earnings COGS = Purchases + Beginning Inv. – Ending Inv. Crux: Inventory numbers affect earnings. Sales 52 Less Cost of Sales 22 Purchases 20 Less: Ending Inventory 5 Plus: Beginning Inventory 3 Gross Profit 30 Less Expenses, Tax etc. 16 Net Earnings 14
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9 LIFO with Inflation… With inflation, newer stock is more expensive than old stock. LIFO (relative to FIFO) COS higher during inflation ary periods, which reduces net earnings COGS = Purchases + Beginning Inv. – Ending Inv. Earlier purchases (lower) COGS higher (recent purchases assigned to it)
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10 FIFO with Inflation… With inflation, newer stock is more expensive than old stock.
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This note was uploaded on 06/01/2011 for the course FIN 3026W taught by Professor Drtoerien during the Summer '09 term at University of Cape Town.

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L7_Analysing_Financi - Analysing Financial Statements 1 Valuation Techniques Equities Fundamental Analysis Using economic and company specific

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