Analyzing financial statements
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Analyzing Financial Statements. Financial Information Balance Sheet Income Statement Cash Flow Statement Financial Ratios Trends Industry Norms Industry/Competitive Analysis. Cooking the Books. Aggressive application of accounting rules Estimates Fraud. Overstating Revenues.

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Analyzing Financial Statements

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Analyzing financial statements

Analyzing Financial Statements

  • Financial Information

    • Balance Sheet

    • Income Statement

    • Cash Flow Statement

    • Financial Ratios

      • Trends

      • Industry Norms

  • Industry/Competitive Analysis


Cooking the books

Cooking the Books

  • Aggressive application of accounting rules

  • Estimates

  • Fraud


Overstating revenues

Overstating Revenues

  • Selling to Related Entities

    • The party must be an “arms length”

  • Stuffing the Channels

    • Excessive quantities to distributors/retailers

    • Extended credit terms

  • Installment sales at Low Interest Rates

    • Artificially low interest rate to calculated time-adjusted cash flows = higher recognized Revenues


Overstating revenues1

Overstating Revenues

  • Using funds from Over-funded Reserves

    • Reserves obligation will fluctuate

    • Using over-funded Reserves can result in under-funding at later accounting periods.

  • Treat Nonrecurring Dispositions as Ordinary Income

    • “Below-the-line” gains are nonrecurring

    • Can over-state Income from normal business operations


Overstating revenues2

Overstating Revenues

  • Record Income for Future Services

    • “Bundled price” includes deferred expenses

    • May underestimate value of future services to over-state current Revenues


Understating expenses

Understating Expenses

  • Unrealistic Depreciation/Amortization

    • Allowable to use a different method for public financial reports from Tax (IRS) reporting

  • Capitalize Questionable Expenses

    • Capitalization or Expense?

    • Capitalization = deferred expenses

    • Match Expenses to Revenues


Understating expenses1

Understating Expenses

  • Ignore the cost of Stock Options

    • When exercised

      • Increases outstanding shares and affects EPS

      • Loss of value to company if strike price below market price

    • How to value?

      • Must have some value to have meaning to recipient

      • Valuation methods require making assumptions


Overstate assets or understate liabilities

Overstate Assets or Understate Liabilities

  • Delay Recognizing Declining Asset Value

    • Dressing up the Balance Sheet

      • Accounts Receivable and Allowance for Doubtful Accounts

      • Loans Receivable and Allowance for Bad Debt

      • Inventory and Allowance for Obsolete Inventory

      • Fixed Assets and writing off obsolete assets

      • Investments and unrealistic market valuation

    • Conservatism requires the Accountant to understate assets


Failure to disclose liabilities

Failure to Disclose Liabilities

  • Must disclose all liabilities

    • Pending lawsuits

    • Pension costs

    • Toxic cleanup

    • Deferred Executive compensation

  • Use Unconsolidated Debt

    • Offload debt from one affiliated to another

    • Dresses up Balance Sheet

    • Relationships must be reported in footnotes


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