Reading and Understanding Public Company Financial Statements
Bowers
Fall 2013
Financial Statements
· Unresolved staff comments – comments from SEC asking companies to make changes to the 10K
· Legal proceeding – must be significant & pending (not threatened)
· MDNA – management discussion of the company – good supplement
· For final projects – read biz section, MDNA, etc. – compares year to year
· Make sure to read footnotes to financial statements
· Commitment & contingency section – important to look at
· Auditor’s opinion letter – you want an unqualified opinion letter – everything seems good
· Changes in or disagreements with its accountants – want to make sure company didn’t fire accountant (for bad reasons, animosity)
· Want to glance at quarterly statements to make sure there hasn’t been a dramatic change
· Form 8k – “current report” – important time sensitive issues
Balance sheet
· Want to see cash increasing, but for right reasons
· They decreased the amount they have in short term investments. Why? But cash & short term investments are basically equivalent so probably just keeping more cash than short term investments
· Look to see if accounts receivable are growing. Increasing? Why? Making more sales? Good. People aren’t paying bills on time? Not good.
· Allowance for bad debts – company has made estimate of who might not pay their industry. The amount they think they are going to get. It’s an estimate – can manipulate financials this way.
· When looking at an actual number, is it an actual number? An estimate? If so, there is freedom to muck with it.
· Sales & Revenues – if they go down but A/R goes up, probably not good.
· Inventory – product that company produces or buys from someone else and resells. Services (law firm) don’t have inventory or minimal inventory (office supplies, etc.).
· Look at footnote for inventory – did they change the way they calculated inventory? How did that impact the financial statements
o If you manage your inventory well, you will have more cash. If you need more cash, need to manage inventory process better.
· Prepaid expenses – you’ve prepaid for something (malpractice insurance – pay for a whole year ahead of time) – if we cancel it, we are entitled to a refund (rent, insurance, phone, etc.)
o Dig through footnotes to figure out what’s included (probably insurance coverage on Southwest planes, or potential crash)
· Long term assets – AKA fixed assets, long lived. Can’t be turned into cash within 12 months. Biggest is property, plant & equipment (recorded at actual purchase price – not the actual value, could be more or less). Assets the company uses to run its business .The value depletes (driving car off the lot)
· Depreciation – tangible/actual property (buildings & equipment can be depreciated, LAND CANNOT)
· Amortization – intangibles (patents, trademarks lose value over time). Secret processes. (moral & employee skills are also intangible but can’t be included on balance sheet)
o Nothing to do with fair market value, just the idea of wear & tear
o Can muck with numbers (Waste Management) – changing the useful life of assets – trucks can last longer than they previously calculated at – extending the life of something so depreciating less each year. Just need a good justification for the accountants.
· Goodwill – Southwest bought AirTran – when you buy another company, the company has a book value but you pay a premium on that. The difference is goodwill.
o No longer is amortized – companies used to have to deplete the goodwill. Now they don’t. Companies want to shift more of the value into goodwill than the assets because you have to reduce those but goodwill will stay the same.
o Check if goodwill is due to an acquisition – did they value the assets appropriately?
· Short terms investments, publicly traded stock/funds get adjustments – must be listed at fair market value
· Capita
would need to look at footnotes
· Treasury Stock – stock that the company bought back. It is reflected at the cost paid for it.
· Book value of company – what shareholders actually paid for their shares
· Market value – what someone is willing to pay for it when they buy it
Ratios
· Current ratio = current assets/current liabilities – do they have enough assets to pay their liabilities – want this ratio to be at least 1, where they have enough assets to pay their liabilities. If below 1, we’re concerned because the company can’t pay its bills.
· Overall Liabilities/Net Income
Income Statement
· AKA consolidated statement of income, profit & loss statement (smaller, private company), operating statement, earnings statement
· You have opportunity to manipulate results on income statement – lots of estimates going on.
· If consolidated, it is the income statement for the entire company
· Shows the company’s profit for a given period of time – not saying how much cash they received or spent (that is in the cash flow statement)
· Measures revenues/sales for the company – when a company sells its product or service – doesn’t matter if they’ve been paid.
· Costs & expenses – attributed to those particular sales above – even if you don’t pay it in the same year. Don’t get to show the expense until you actual sell item
· Profit – Different than retained earnings (that’s accumulation of profits, that’s hw much the company has made since its inception)
· Shows sales, costs & the difference between the 2 is the profit or loss
