ch04 - Chapter 4 Analyzing Financial Statements Learning...

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Chapter 4 Analyzing Financial Statements Learning Objectives 1. Explain the three perspectives from which financial statements can be viewed. 2. Describe common-size financial statements, explain why they are used, and be able to prepare and use them to analyze the historical performance of a firm. 3. Discuss how financial ratios facilitate financial analysis, and be able to compute and use them to analyze a firm’s performance. 4. Describe the DuPont system of analysis and be able to use it to evaluate a firm’s performance and identify corrective actions that may be necessary. 5. Explain what benchmarks are, describe how they are prepared, and discuss why they are important in financial statement analysis. 6. Identify the major limitations in using financial statement analysis. I. Chapter Outline 4.1 Background for Financial Statement Analysis A. Stockholders’ Perspective Shareholders’ focus centers on the value of the stock they hold. 1
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Their interest in the financial statement is to gauge the cash flows that the firm will generate from operations. This allows them to determine the firm’s profitability, their return for that period, and the dividend they are likely to receive. B. Managers’ Perspective On one hand, management’s interest in the firm’s financial statement is similar to that of shareholders. Managers are responsible for running the business on a daily basis and must make decisions that will maximize stockholder wealth in the long run. In addition, management gets feedback on their investing, financing, and working capital decisions by identifying trends in the various accounts that are reported in the financial statements. C. Creditors’ Perspective Creditors or lenders are primarily concerned about getting their loans repaid and receiving interest payments on time. Their focus is on: Amount of debt the firm has. Firm’s ability to meet short-term obligations. Firm’s ability to generate sufficient cash flows to meet all legal obligations first and still have sufficient cash flows to meet debt repayment and interest payments. 2
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D. Guidelines for Financial Statement Analysis Identify whose perspective you are using to analyze a firm—management, shareholder, or creditor. Use only audited financial statements if possible. Perform analysis over a three- to five-year period— trend analysis. Compare the firm’s performance to its direct competitors—that is, firms that are similar in size and offer similar products. Perform a benchmark analysis. This involves comparing it to one or more of the most relevant competitors—American Air with Delta or United Airlines. 4.2
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ch04 - Chapter 4 Analyzing Financial Statements Learning...

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