Introduction
Course Overview ......................................................................................... vii
Course Objectives ...................................................................................... viii
The Workbook...............................................................................................ix
Unit 1: Accounting Issues in Financial Analysis
Introduction..................................................................................................1-1
Unit Objectives ............................................................................................1-1
Branches of Accounting..............................................................................1-2
Managerial Accounting....................................................................1-2
Tax Accounting................................................................................1-2
Financial Accounting .......................................................................1-3
Generally Accepted Accounting Principles ........................1-3
Effects of Inflation................................................................1-4
Financial Accounting Basics...............................................1-5
Accounting Exercise .......................................................................1-6
“Getting Behind the Numbers” ....................................................................1-9
Contextual Factors..........................................................................1-9
Macroeconomic Effects......................................................1-9
Sector Accounting Norms ................................................1-10
Consolidated Numbers.....................................................1-10
Seasonality........................................................................1-11
Asset / Liability Valuation...............................................................1-12
Intangible Assets ...........................................................................1-13
Contingent Liabilities .....................................................................1-15
Summary...................................................................................................1-16
Progress Check 1 .....................................................................................1-19
Adjusting for Inflation .....................................................................1-25
Effects of Inflation on the Balance Sheet..........................1-25
Effects of Inflation on the Income Statement....................1-26
Inflationary Accounting......................................................1-27
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Unit 1: Accounting Issues in Financial Analysis (Continued)
Constant Currency Accounting ........................................1-28
Comprehensive Monetary Correction (MC).....................1-29
Additional Adjustments for Inflation...................................1-31
Comparative Financial Statements ..................................1-32
The Brazilian Experience..................................................1-32
Financial Analysis Spreadsheets ..............................................................1-33
Summary.......................................................................................1-35
Progress Check 1.2 ..................................................................................1-37
Unit 2: Basic Concepts of Financial Analysis
Introduction..................................................................................................2-1
Unit Objectives ............................................................................................2-1
Liquidity........................................................................................................2-2
Degree of Liquidity...........................................................................2-2
Importance of Liquidity ....................................................................2-2
Increasing Liquidity..........................................................................2-3
Liquidity and Balance Sheet Structure............................................2-3
Types of Capital ..........................................................................................2-3
Working Capital...............................................................................2-3
Permanent Capital ..........................................................................2-6
Third Party and Own Capital...........................................................2-7
Third Party Capital ..............................................................2-8
Own Capital.........................................................................2-8
Difference Between Liability and Net Worth Financing...................2-9
Summary...................................................................................................2-10
Progress Check 2.1 ..................................................................................2-13
Sources and Uses of Funds .....................................................................2-27
Sources and Uses in the Balance Sheet......................................2-27
Operating / Non-Operating............................................................2-29
Operating Sources and Uses ...........................................2-29
Non-Operating Sources and Uses ...................................2-30
Sources and Uses in the Income Statement................................2-30
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Unit 2: Basic Concepts of Financial Analysis (Continued)
Funds Generation Statement........................................................2-31
Summary of Sources and Uses ...................................................2-33
Funds Flow Analysis .....................................................................2-33
Summary...................................................................................................2-34
Progress Check 2.2 ..................................................................................2-35
Unit 3: Financial Statement Analysis
Introduction..................................................................................................3-1
Unit Objectives ............................................................................................3-1
Financial Statement Limitations ..................................................................3-2
Business Risk Assessment........................................................................3-3
Economic Environment...................................................................3-3
Market Conditions............................................................................3-4
Type of Business ............................................................................3-4
Management....................................................................................3-5
Progress Check 3.1 ....................................................................................3-7
Analysis Techniques ...................................................................................3-9
Vertical Analysis ........................................................................................3-10
Purpose.........................................................................................3-10
Balance Sheet...............................................................................3-10
Income Statement.........................................................................3-12
Summary.......................................................................................3-13
Progress Check 3.2 ..................................................................................3-15
Horizontal Analysis ....................................................................................3-25
Purpose.........................................................................................3-25
Technique......................................................................................3-26
Sales Growth.................................................................................3-27
Analyzing Net Sales Growth..........................................................3-27
Progress Check 3.3 ..................................................................................3-29
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Unit 4: Financial Ratios — Liquidity
Introduction..................................................................................................4-1
Unit Objectives ............................................................................................4-1
Financial Ratios...........................................................................................4-2
Types of Financial Ratios................................................................4-2
Liquidity Ratios ............................................................................................4-3
Current Ratio...................................................................................4-3
Acid Test .........................................................................................4-6
Other Liquidity Indicators.................................................................4-8
Progress Check 4.1 ....................................................................................4-9
How Liquidity Ratios Change ....................................................................4-17
Progress Check 4.2 ..................................................................................4-21
Unit 5: Financial Ratios — Leverage
Introduction..................................................................................................5-1
Unit Objectives ............................................................................................5-1
Total Indebtedness (Leverage) ...................................................................5-2
Calculation.......................................................................................5-2
Leverage Analysis ...........................................................................5-3
Incidence of Fixed Assets ..................................................5-3
Effect of Seasonality ...........................................................5-4
Financial Leverage..............................................................5-5
Tangible Net Worth .............................................................5-7
Revaluation Surplus ............................................................5-8
Other Adjustments ..............................................................5-9
Consolidations and Minority Interest ................................5-10
Current and Long-Term Indebtedness Ratios ..........................................5-12
Fixed Assets Covered by Own Resources ..............................................5-13
Coverage Ratios .......................................................................................5-14
Funds From Operations — Interest Coverage .............................5-14
Funds From Operations — Long-Term Debt Coverage ..............5-15
Debt Service Ratio ........................................................................5-15
Summary.......................................................................................5-16
Progress Check 5 .....................................................................................5-19
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Unit 6: Financial Ratios — Turnover
Introduction..................................................................................................6-1
Unit Objectives ............................................................................................6-2
Receivables Turnover / Days Receivable...................................................6-2
Receivables Turnover Ratio............................................................6-2
Days Receivable.............................................................................6-4
Summary.........................................................................................6-6
Progress Check 6.1 ........................................................................6-9
Inventory Turnover or Days Inventory .......................................................6-13
Inventory Turnover.........................................................................6-13
Days Inventory...............................................................................6-14
Summary.......................................................................................6-17
Progress Check 6.2 ..................................................................................6-19
Payables Turnover or Days Payable ........................................................6-23
Payables Turnover........................................................................6-23
Days Payable................................................................................6-24
Common Variation............................................................6-25
Seasonality........................................................................6-26
Interpreting the Number ....................................................6-27
Summary.......................................................................................6-28
Progress Check 6.3 ..................................................................................6-29
Unit 7: Financial Ratios — Profitability
Introduction..................................................................................................7-1
Unit Objectives ............................................................................................7-1
Profitability Ratios........................................................................................7-2
Return on Sales ..............................................................................7-2
Return on Assets ............................................................................7-3
Return on Equity (Return on Capital)..............................................7-4
Progress Check 7.1 ....................................................................................7-7
Integrated Analysis ....................................................................................7-11
Return on Assets ..........................................................................7-11
Return on Equity............................................................................7-12
Application of DuPont Formulas ...................................................7-12
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Unit 7: Financial Ratios — Profitability (Continued)
Summary.......................................................................................7-15
Progress Check 7.2 ..................................................................................7-17
Summary of Financial Ratios....................................................................7-21
Unit 8: Applied Financial Analysis — Case Studies
Introduction..................................................................................................8-1
Unit Objectives ............................................................................................8-1
The Bank Spreadsheet Financial Analysis Model.......................................8-2
Case Study: Mindy Garment Factory.........................................................8-9
Exercise 8.1 ..................................................................................8-15
Case Study: The Tower Stores ...............................................................8-39
Exercise 8.2 ..................................................................................8-51
Appendices
Appendix A...................................................................................................A-1
Appendix B ..................................................................................................B-1
Appendix C — Glossary..............................................................................C-1
Index