Understanding Financial Statements

PART 1: GENERAL INFORMATION

The requested general information may be disclosed in several places in the corporation’s annual report. Answer the following questions about the annual report you have selected:

In which city and state is (are) the corporate headquarter(s) located?

__________________

When is the fiscal year end of the corporation?

__________________________________

What is (are) the primary product(s) of the corporation?

Indicate SIC code(s). If SIC code(s) is (are) not provided, find it out from the sources available in the library and state the source that you used.

____________________________________________________________________

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What SIC code means and why it is important?

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Publicly traded corporations are required to have an annual audit. The auditor attests to the credibility of a corporation’s financial statements. Who is the corporation’s auditor?

______________________________________

There are four types of audit report: unqualified, qualified, denial, no opinion. Which one was issued for this company? If there was any specific explanation in the audit report, explain it.

Opinion: _________________________________

___________________________________________________________________ _________________________________________________________________

Shares of publicly traded corporations are traded in organized exchange markets (maybe more than one stock market).

Indicate the exchange market(s) on which the corporation’s shares are traded:

——————————————-

——————————————

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List the source from which you obtained the information about market listing?

Source: ————————————

The ticker symbol is an abbreviation that identifies the corporation’s shares on the stock exchange. What is (are) the ticker symbol(s) used to identify the corporation on the stock exchange(s)?

Ticker symbol (s): —————————————

Source of information: ———————————-

The first note in the annual report usually summarizes the significant accounting policies used by the corporation in the preparation of its financial statements. This note gives key information that investors require in order to be able to compare the financial statements of different companies. It is here that you will find information about the firm’s choice of inventory cost flow assumption (e.g., FIFO, LIFO, etc.) and important revenue recognition policies. Look at this note and briefly explain what is “significant” to note about how your company accounts for its transactions and operations. Attach a separate sheet if you need more space.

The Management Discussion and Analysis (MD&A) is usually presented as a separate section and entitled as such. It is a requirement of the Security Exchange Commission (SEC) as well as many other exchanges. It is an opportunity for management to explain their perceptions of the operating results to the investors and other financial statement users. Answer the following questions concerning the MD&A.

Management may use the discussion and analysis as an opportunity to highlight certain financial events such as significant changes in revenues or costs. Management may use the discussion to highlight certain non-financial events such as the opening of new retail outlets, sale or purchase of a subsidiary. What highlights are mentioned by management for your company?

Is the tone of the management discussion optimistic or pessimistic? Give a few examples to support your response.

______________________________________________________________________________________________________________________________________________________________________________________________________

Management may use the discussion as a forum for predicting events or stating the goals of the corporation. What predictions or goals were stated in the discussion and analysis section?

PART 2: THE BALANCE SHEET

The balance sheet summarizes the company’s assets, liabilities and equity. Assets are usually grouped into one of the following categories: current assets, investments, capital assets (property, plant and equipment and intangible assets), and other assets. Liabilities are grouped into current and long-term.

On what page of the annual report does the balance sheet appear? ____

Explain what the accounting equation is and how the balance presents this equation (pick up the appropriate numbers from the balance sheet):

Asset Growth

The “size” of a corporation is commonly measured by the amount of total assets on the corporation’s balance sheet. A corporation is considered “growing” if total assets increase from one year to the next. The rate of growth is measured by the change in total assets divided by the total assets of the previous year:

Determine the percentage growth in assets for this company. ____

Computation:

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Identify the balance sheet accounts most significant in explaining the change in total assets of the corporation? What events might explain the reasons for the changes in these accounts?

Common-size Analysis

Common size analysis is used to analyze the relative importance of each item on the balance sheet. Specific items are usually expressed as a percentage of total assets. These percentages are often compared to the percentage of previous years or to the percentages calculated for another corporation in the same industry. Complete common-size analysis for the following items for your company’s balance sheet.

Current Assets

Investments

Property, Plant & Equip.

Intangible Assets

Other Assets

Total Assets

Current Liabilities

Total Liabilities

Shareholders’ Equity

Current Year

______________

Previous Year

______________

Explain what you can infer from the common size analysis:

Assessing Working Capital

Current assets are called “current” because they are converted into cash during the operating cycle. Current liabilities are liabilities liquidated by current assets or other current liabilities within the operating cycle. Working capital is equal to current assets minus current liabilities. In other words, working capital is the amount of current assets remaining after the current liabilities have been paid.

Working capital is considered a measure of the solvency of a corporation because a negative working capital indicates the corporation is not able to pay current liabilities maturing in the next operating cycle. Calculate working capital for the corporation as follows:

Current Assets

Minus: Current Liabilities

Working Capital

Current Year

_______________

Previous Year

_____________

By how much did the amount of working capital increase or decrease compared to the previous year?___________

What balance sheet accounts explain the most significant changes in working capital?

What can you infer from the working capital analysis?

PART 3: THE INCOME STATEMENT

The income statement or statement of earnings summarizes corporate revenues and expenses for a period of time. Presentation of several years permits comparisons to previous years’ results.

On what page in the annual report does the income statement appear? _____

Growth in Sales and Profits
Sales growth is indicated by calculating the percentage increase (decrease) of sales in comparison with the previous year.

Indicate the growth in sales during the current year (show your computations):

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Did sales increase or decrease? An explanation of the change in sales is often contained in the Management Discussion and Analysis (MD&A). What reasons did management give for the change?

Trends in corporate profits are determined by calculating the percentage increase (decrease) of income from continuing operations over the previous year. Income from continuing operations is net income without the effects of any discontinued operations, extraordinary items, or cumulative effects of accounting changes.

Determine the growth in profits during the current year: _____

(Show computations)

What can you infer from the analysis of growth in profit?

Common-Size Analysis

Common-size (or percentage) analysis expresses items in a financial statement as a percentage of a single item. This analysis permits comparisons between two or more years, or between two or more corporations. For an income statement, certain items are usually expressed as a percentage of sales. Perform common-size analysis in relation to sales for the following items in the income statement for the current and previous years:

Sales

Cost of Goods Sold

Gross Profit

Operating Expense

R & D Expense

Income Tax Expense

Income from Continuing Operations

Net Income

Current Year

100.0%

___________

Previous Year

100.0%

__________

Based on your common-size analysis, compare current operating results in terms of cost control, debt servicing, and profitability. Information concerning the reasons for change may be found in the management discussion and analysis.

Cost Control – a) Did the effect of cost of goods sold change in the current year in comparison to the previous year? What are possible explanations for changes, if any, that may have occurred?

Cost Control – b) Did the effect of operating expenses change in the current year in comparison to the previous year? What are possible explanations for changes, if any, that may have occurred?

How did the cost of debt (interest expense) change compare to the previous year? What are possible explanations for changes, if any?

Profitability – How did the overall profitability of the corporation change in the current year? What items in the income statement explain the change in income from continuing operations as a percentage of sales?

Generally accepted accounting principles require amounts related to discontinued operations and extraordinary items to be shown, net of taxes, at the bottom of the income statement. If any of these items are present, describe the nature and amount.

Earning per share (EPS):

EPS is an important item on the income statement. It is an indicator of the firm’s financial performance. Some investment evaluation models relate changes in EPS to the changes in stock prices such as E/P ration (where E is earnings per share and P is stock price).

What is EPS for your company?

Previews year: ________

Current year: _________

Show how these numbers are calculated. (There are two types of EPS: simple and fully diluted. Use simple EPS for this report)

___________________________________________________________

What can you infer from the change in EPS?

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PART 4: EVALUATION OF THE CORPORATION’S DISCLOSURES

Segment reporting is a useful requirement that requires firms to disclose their major customers, markets and products. Study this part of the financial statement and explain how it helps you to understand the company’s financial situation better. Be specific.

As a user of the corporation’s financial statements, is there information that you expected to see but which was not disclosed in the financial statements? Limit your comments to the information needed to complete this project.

Based on the corporation’s presentation of the information, which disclosures did you find most difficult to understand? Explain.

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What impressed you the most about the information that you had to examine? Be specific.

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What surprised you the most about the corporation’s disclosures? Be specific.

SECTION B:

ANALYSIS OF FINANCIAL STATEMENT

Compute the major ratios related to the firm’s liquidity situation and comment on the firm’s liquidity situation.

Compute the major ratios related to the firm’s solvency situation and comment on the firm’s solvency situation.

Compute the major ratios related to the firm’s profitability and comment on the firms profitability situation.

Compute the major ratios related the firm’s market performance situation and comment on the firm’s market performance situation.

Part C: Executive Summary and Class Presentation of The High Lights:

Select your major findings from your analysis of this company and prepare an executive summary with some graphs. Submit the executive summary with your report. Also, prepare a 15 to 20 minutes presentation to present your findings to the class. You sh

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Understanding Financial Statements

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