Financial Statement Analysis 3e: A Practitioner's Guide : University Edition - Brossura

Fridson, CFA Martin S.

Brossura

ISBN 10: 0471409170 ISBN 13: 9780471409175

Casa editrice: John Wiley &Sons, 2002

Riassunto

Praise for Financial Statement Analysis
A Practitioner's Guide
Third Edition
University Edition

"This is an illuminating and insightful tour of financial statements, how they can be used to inform, how they can be used to mislead, and how they can be used to analyze the financial health of a company."
-Professor Jay O. Light
Harvard Business School

"Financial Statement Analysis should be required reading for anyone who puts a dime to work in the securities markets or recommends that others do the same."
-Jack L. Rivkin
Executive Vice President (retired)
Citigroup Investments

"Fridson and Alvarez provide a valuable practical guide for understanding, interpreting, and critically assessing financial reports put out by firms. Their discussion of profits-'quality of earnings'-is particularly insightful given the recent spate of reporting problems encountered by firms. I highly recommend their book to anyone interested in getting behind the numbers as a means of predicting future profits and stock prices."
-Paul Brown
Chair-Department of Accounting
Leonard N. Stern School of Business, NYU

"Let this book assist in financial awareness and transparency and higher standards of reporting, and accountability to all stakeholders."
-Patricia A. Small
Treasurer Emeritus, University of California
Partner, KCM Investment Advisors

"This book is a polished gem covering the analysis of financial statements. It is thorough, skeptical, and extremely practical in its review."
-Daniel J. Fuss
Vice Chairman
Loomis, Sayles & Company, LP

Su questo libro

Informazioni sull?autore

MARTIN FRIDSON is Managing Director at Merrill Lynch & Company and a member of Institutional Investor’s All-America Fixed Income Research Team. His other books include How to Be a Billionaire, It Was a Very Good Year, and Investment Illusions, all published by Wiley. He is a past governor of the Association for Investment Management and Research.

FERNANDO ALVAREZ is Clinical Associate Professor in the Berkley Center for Entrepreneurial Studies at the Stern School of Business at NYU. His current research focuses on the management of cash flows resulting from changes in working capital requirements, the structure of cash flows, and the sources and uses of capital for the entrepreneurial firm. His research has been funded by the MacArthur Foundation, the Kaufman Foundation, U.S. Trust of Boston, and Wells Fargo Bank.

Dalla quarta di copertina

Praise for Financial Statement Analysis
A Practitioner?s Guide
Third Edition
University Edition

"This is an illuminating and insightful tour of financial statements, how they can be used to inform, how they can be used to mislead, and how they can be used to analyze the financial health of a company."
?Professor Jay O. Light
Harvard Business School

"Financial Statement Analysis should be required reading for anyone who puts a dime to work in the securities markets or recommends that others do the same."
?Jack L. Rivkin
Executive Vice President (retired)
Citigroup Investments

"Fridson and Alvarez provide a valuable practical guide for understanding, interpreting, and critically assessing financial reports put out by firms. Their discussion of profits??quality of earnings??is particularly insightful given the recent spate of reporting problems encountered by firms. I highly recommend their book to anyone interested in getting behind the numbers as a means of predicting future profits and stock prices."
?Paul Brown
Chair?Department of Accounting
Leonard N. Stern School of Business, NYU

"Let this book assist in financial awareness and transparency and higher standards of reporting, and accountability to all stakeholders."
?Patricia A. Small
Treasurer Emeritus, University of California
Partner, KCM Investment Advisors

"This book is a polished gem covering the analysis of financial statements. It is thorough, skeptical, and extremely practical in its review."
?Daniel J. Fuss
Vice Chairman
Loomis, Sayles & Company, LP

Estratto. © Ristampato con autorizzazione. Tutti i diritti riservati.

Financial Statement Analysis

A Practitioner's GuideBy Martin Fridson Fernando Alvarez

John Wiley & Sons

ISBN: 0-471-40917-0

Chapter One

The Adversarial Nature of Financial Reporting

Financial statement analysis is an essential skill in a variety of occupations including investment management, corporate finance, commercial lending, and the extension of credit. For individuals engaged in such activities, or who analyze financial data in connection with their personal investment decisions, there are two distinct approaches to the task.

The first is to follow a prescribed routine, filling in boxes with standard financial ratios, calculated according to precise and inflexible definitions. It may take little more effort or mental exertion than this to satisfy the formal requirements of many positions in the field of financial analysis. Operating in a purely mechanical manner, though, will not provide much of a professional challenge. Neither will a rote completion of all of the "proper" standard analytical steps ensure a useful, or even a nonharmful, result. Some individuals, however, will view such problems as only minor drawbacks.

This book is aimed at the analyst who will adopt the second and more rewarding alternative, the relentless pursuit of accurate financial profiles of the entities being analyzed. Tenacity is essential because financial statements often conceal more than they reveal. To the analyst who pursues this proactive approach, producing a standard spreadsheet on a company is a means rather than an end. Investors derive but little satisfaction from the knowledge that an untimely stock purchase recommendation was supported by the longest row of figures available in the software package. Genuinely valuable analysis begins after all the usual questions have been answered. Indeed, a superior analyst adds value by raising questions that are not even on the checklist.

Some readers may not immediately concede the necessity of going beyond an analytical structure that puts all companies on a uniform, objective scale. They may recoil at the notion of discarding the structure altogether when a sound assessment depends on factors other than comparisons of standard financial ratios. Comparability, after all, is a cornerstone of generally accepted accounting principles (GAAP). It might therefore seem to follow that financial statements prepared in accordance with GAAP necessarily produce fair and useful indications of relative value.

The corporations that issue financial statements, moreover, would appear to have a natural interest in facilitating convenient, cookie-cutter analysis. These companies spend heavily to disseminate information about their financial performance. They employ investor-relations managers, they communicate with existing and potential shareholders via interim financial reports and press releases, and they dispatch senior management to periodic meetings with securities analysts. Given that companies are so eager to make their financial results known to investors, they should also want it to be easy for analysts to monitor their progress. It follows that they can be expected to report their results in a transparent and straightforward fashion ... or so it would seem.

THE PURPOSE OF FINANCIAL REPORTING

Analysts who believe in the inherent reliability of GAAP numbers and the good faith of corporate managers misunderstand the essential nature of financial reporting. Their conceptual error connotes no lack of intelligence, however. Rather, it mirrors the standard accounting textbook's idealistic but irrelevant notion of the purpose of financial reporting. Even Howard Schilit (see the MicroStrategy discussion, later in this chapter), an acerbic critic of financial reporting as it is actually practiced, presents a high-minded view of the matter:

The primary goal in financial reporting is the dissemination of financial statements that accurately measure the profitability and financial condition of a company.

Missing from this formulation is an indication of whose primary goal is accurate measurement. Schilit's words are music to the ears of the financial statements users listed in this chapter's first paragraph, but they are not the ones doing the financial reporting. Rather, the issuers are for-profit companies, generally organized as corporations.

A corporation exists for the benefit of its shareholders. Its objective is not to educate the public about its financial condition, but to maximize its shareholders' wealth. If it so happens that management can advance that objective through "dissemination of financial statements that accurately measure the profitability and financial condition of the company," then in principle, management should do so. At most, however, reporting financial results in a transparent and straightforward fashion is a means unto an end.

Management may determine that a more direct method of maximizing shareholder wealth is to reduce the corporation's cost of capital. Simply stated, the lower the interest rate at which a corporation can borrow or the higher the price at which it can sell stock to new investors, the greater is the wealth of its shareholders. From this standpoint, the best kind of financial statement is not one that represents the corporation's condition most fully and most fairly, but rather one that produces the highest possible credit rating (see Chapter 13) and price-earnings multiple (see Chapter 14). If the highest ratings and multiples result from statements that measure profitability and financial condition inaccurately, the logic of fiduciary duty to shareholders obliges management to publish that sort, rather than the type held up as a model in accounting textbooks. The best possible outcome is a cost of capital lower than the corporation deserves on its merits. This admittedly perverse argument can be summarized in the following maxim, presented from the perspective of issuers of financial statements:

The purpose of financial reporting is to obtain cheap capital.

Attentive readers will raise two immediate objections. First, they will say, it is fraudulent to obtain capital at less than a fair rate by presenting an unrealistically bright financial picture. Second, some readers will argue that misleading the users of financial statements is not a sustainable strategy over the long run. Stock market investors who rely on overstated historical profits to project a corporation's future earnings will find that results fail to meet their expectations. Thereafter, they will adjust for the upward bias in the financial statements by projecting lower earnings than the historical results would otherwise justify. The outcome will be a stock valuation no higher than accurate reporting would have produced. Recognizing that the practice would be self-defeating, corporations will logically refrain from overstating their financial performance. By this reasoning, the users of financial statements can take the numbers at face value, because corporations that act in their self-interest will report their results honestly.

The inconvenient fact that confounds these arguments is that financial statements do not invariably reflect their issuers' performance faithfully. In lieu of easily understandable and accurate data, users of financial statements often find numbers that conform to GAAP yet convey a misleading impression of profits. Worse yet, outright violations of the accounting rules come to light with distressing frequency. Not even the analyst's second line of defense, an affirmation by independent auditors that the statements have been prepared in accordance with GAAP, assures that the numbers are reliable. A few examples from recent years indicate how severely an overly trusting user of financial statements can be misled.

Mercury Plunges

In January 1997, Mercury Finance's controller was reported to have disappeared after the company reduced its 1996 earnings to $56.7 million from an originally reported $120.7 million. The used-car loan company's cofounder and chief executive officer, John Brincat, contended that the irregularities necessitating the restatements were apparently "the result of unauthorized entries being made to the accounting records of the company by the principal accounting officer," the missing James A. Doyle. On January 28, the day before the earnings revision, Mercury's stock closed at $14.875 a share. When trading in the shares reopened on January 31, the price plunged to $2.125.

As the story developed, controller Doyle's attorney denied that his client had disappeared. Rather, "He decided with the advice of counsel to no longer participate in the charade taking place at Mercury Finance." Speaking through his lawyer, Doyle added that he was cooperating with a federal investigation of the company.

Thickening the plot was the provision in CEO Brincat's management contract whereby he was not entitled to any bonus in any year in which earnings per share rose by less than 20%. Doyle had no such bonus arrangement, leading some observers to wonder what motive he would have had to falsify the financials. Additional earnings revisions announced along with the 1996 restatement indicated that Mercury did not, after all, achieve the 20% target in 1994 or 1995, even though Brincat received bonuses of $1.4 million and $1.6 million, respectively, for those years. In any case, Brincat resigned as chief executive officer on February 3. A year later he stepped down from the company's board and agreed to repay part of his 1994-1996 bonuses.

Also in February 1998, Mercury announced that it would file for bankruptcy. By then, the company had revised its originally reported 1996 profit of $120.7 million to a net loss. In hindsight, the financial statements had incorporated unrealistic assumptions about the percentage of Mercury's low-income borrowers who would fail to keep up their loan payments. The auditors had certified the results, despite the telltale warning sign that the statements showed Mercury earning more than double the historical average return on equity (see Chapter 13) of other companies in its business. Securities analyst Charles Mills of Anderson & Strudwick likened such improbably superior performance to a human running a two-minute mile.

MicroStrategy Changes Its Mind

On March 20, 2000, MicroStrategy announced that it would restate its 1999 revenue, originally reported as $205.3 million, to around $150 million. The company's shares promptly plummeted by $140 to $86.75 a share, slashing chief executive officer Michael Saylor's paper wealth by over $6 billion. The company explained that the revision had to do with recognizing revenue on the software company's large, complex projects. Micro-Strategy and its auditors initially suggested that the company had been obliged to restate its results in response to a recent (December 1999) Securities and Exchange Commission (SEC) advisory on rules for booking software revenues. After the SEC objected to that explanation, the company conceded that its original accounting was inconsistent with accounting principles published way back in 1997 by the American Institute of Certified Public Accountants.

Until MicroStrategy dropped its bombshell, the company's auditors had put their seal of approval on the company's revenue recognition policies. That was despite questions raised about MicroStrategy's financials by accounting expert Howard Schilit six months earlier and by reporter David Raymond in an issue of Forbes ASAP distributed on February 21. It was reportedly only after reading Raymond's article that an accountant in the auditor's national office contacted the local office that had handled the audit, ultimately causing the firm to retract its previous certification of the 1998 and 1999 financials.

No Straight Talk from Lernout & Hauspie

On November 16, 2000, the auditor for Lernout & Hauspie Speech Products (L&H) withdrew its clean opinion of the company's 1998 and 1999 financials. The action followed a November 9 announcement by the Belgian producer of speech-recognition and translation software that an internal investigation had uncovered accounting errors and irregularities that would require restatement of results for those two years and the first half of 2000. Two weeks later, the company filed for bankruptcy.

Prior to November 16, 2000, while investors were relying on the auditor's opinion that Lernout & Hauspie's financial statements were consistent with generally accepted accounting principles, several events cast doubt on that opinion. In July 1999, short-seller David Rocker criticized transactions such as L&H's arrangement with Brussels Translation Group (BTG). Over a two-year period, BTG paid L&H $35 million to develop translation software. L&H then bought BTG and the translation product along with it. The net effect was that instead of booking a $35 million research and development expense, L&H recognized $35 million of revenue. In August 2000, certain Korean companies that L&H claimed as customers said that they in fact did no business with the corporation. In September, the Securities and Exchange Commission and Europe's Easdaq stock market began to investigate L&H's accounting practices. Along the way, Lernout & Hauspie's stock fell from a high of $72.50 in March 2000 to $7 before being suspended from trading in November. In retrospect, uncritical reliance on the company's financials, based on the auditor's opinion and a presumption that management wanted to help analysts get the true picture, was a bad policy.

THE FLAWS IN THE REASONING

As the preceding deviations from GAAP demonstrate, neither fear of antifraud statutes nor enlightened self-interest invariably deters corporations from cooking the books. The reasoning by which these two forces ensure honest accounting rests on hidden assumptions. None of the assumptions can stand up to an examination of the organizational context in which financial reporting occurs.

To begin with, corporations can push the numbers fairly far out of joint before they run afoul of GAAP, much less open themselves to prosecution for fraud. When major financial reporting violations come to light, as in most other kinds of white-collar crime, the real scandal involves what is not forbidden. In practice, generally accepted accounting principles countenance a lot of measurement that is decidedly inaccurate, at least over the short run.

For example, corporations routinely and unabashedly smooth their earnings. That is, they create the illusion that their profits rise at a consistent rate from year to year. Corporations engage in this behavior, with the blessing of their auditors, because the appearance of smooth growth receives a higher price-earnings multiple from stock market investors than the jagged reality underlying the numbers.

Continues...

Excerpted from Financial Statement Analysisby Martin Fridson Fernando Alvarez Excerpted by permission.
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Dettagli dell'edizione

• Editore: John Wiley &Sons
• Data di pubblicazione: 2002
• Lingua: Inglese
• ISBN 10: 0471409170
• ISBN 13: 9780471409175
• Rilegatura: Copertina flessibile
• Numero edizione: 3
• Numero di pagine: 444
• Contatto del produttore: non disponibile
• Persona responsabile: non disponibile