Handout 11 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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Copyright © 2010 1 You may only share these materials with current term students I NTRODUCTION TO F INANCIAL A CCOUNTING 33:010:272 S ECTIONS 08 09 |FALL 2011 PROFESSOR JULIAN YEO Class Notes 11: Structured Approach to Financial Statement Analysis A comprehensive discussion of financial statement analysis (FSA) requires a full course. This handout contains a short review, which is intended to: (1) improve our understanding of the financial statements, and (2) introduce ratios that we will later use as we discuss the implications of different accounting choices. In this document, you will find: 1. The need to reformulate financial statements 2. Overview of Financial Statement Analysis 3. Profitability Ratios 4. Growth Ratios 5. Short Term Liquidity Risk Ratios 6. Long Term Solvency Risk Ratios Upon completion of this topic, you should be able to: 1) Understand the difference between operating and non-operating assets, liabilities, income, and expense and how to use this distinction to reformulate financial statements. 2) Understand why return on equity (ROE) is the summary measure of firm profitability. 3) Understand the accounting decomposition of ROE and how to use the decomposition to evaluate firm performance. 4) Understand the types of ratios used for to analyze factors other than firm profitability: growth prospects, short-term liquidity risk, and long-term solvency risk. 1.0. T HE N EED TO R EFORMULATE F INANCIAL S TATEMENTS Before we begin to perform our financial statement analysis, we need to reformulate the financial statements to help us distinguish between operating and non-operating assets and liabilities. The reformulation effectively aligns the financial statements with the activities (operating, investing, and financing) of the business.
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Copyright © 2010 2 You may only share these materials with current term students Simplified Operating/Nonoperating Balance Sheet Current Operating Assets Long-Term Operating Assets Financial Assets (Nonoperating) Current Operating Liabilities Long-Term Operating Liabilities Financial Obligations (Nonoperating) Equity Stockholders Equity Total Liabilities and Equity Total Assets Liabilities Assets Net Operating Assets (NOA) (Assets – Liabilities) Net Financial Obligations (NFO) (Liabilities – Assets) Equity (NOA – NFO) As the diagram on the previous page indicates, non-operating assets and liabilities are primarily financial in nature and include short and long-term investments in marketable securities, discontinued operations, and borrowings of interest-bearing debt (short term notes and interest payable, current portion of long-term debt, bonds and notes payable, and capitalized lease obligations), and stockholders’ equity. GAAP Balance Sheet
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Handout 11 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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