Financial Accounting:

A Managerial Perspective
Fourth Edition
Prepared by
R. Narayanaswamy
Indian Institute of Management Bangalore

28 June 2013

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Chapter 11
Financial Statement Analysis

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Objectives of Financial Statement

Analysis

What is financial statement analysis?

Evaluating past performance and
current position

Predicting future performance

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Monitoring management
Past as a guide to the future
Forecasting

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Sources of Information

Company reports

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Directors report, MD&A

Financial statements
Schedules and notes
Auditors report

Stock exchanges
Business periodicals and television
Information services
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Standards of Comparison

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Rule-of-thumb indicators
Past performance
Internal standards
Industry standards

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Earnings Quality

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What is earnings quality?

Why is earnings quality important?
Choice of accounting policies
Prior period errors
Discontinued operations
Changes in accounting policies
Non-operating and non-recurring
items
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Earnings Quality

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Techniques of Financial Statement

Analysis

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Horizontal analysis
Trend analysis
Vertical analysis
Ratio analysis

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Profitability Ratios

Profit margin

Asset turnover
Return on assets
Return on equity

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Operating profit

Effect of leveraging

Earnings per share

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The DuPont Chart

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Liquidity Ratios

Current ratio
Quick ratio
Debtor turnover

Inventory turnover

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Debt collection period

Inventory holding period

Operating cycle
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Solvency Ratios

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Debt-to-equity ratio
Liabilities-to-equity ratio
Interest cover

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Understanding Annual Reports

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Capital Market Standing

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Price-earnings ratio
Price-to-book ratio
Dividend yield
Beta

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Corporate Disclosure Policy

Why disclosure regulation?

Mandatory vs. voluntary disclosure
Forces that drive voluntary disclosure

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Capital market
Product market
Managerial labour market
Shareholder litigation

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Efficient Market Hypothesis

Understanding market efficiency

Implications of market efficiency

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Accounting information and stock prices

Accounting method differences
Effect of mandatory disclosures

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Earnings Management

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Defining earnings management

Factors affecting managerial
judgement
Income-increasing and incomedecreasing earnings management
Big bath
Why are accounting frauds few and
far between?
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End of Chapter 11
Financial Statement Analysis

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