Financial Accounting Analysis

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This year’s financial statement analysis memo requires you to integrate your knowledge of business and economic principles with the data you have compiled for your company.  This document provides examples of how you might meet that requirement.  In general, think about how you could connect the economic environment to the behavior and performance of your company.  Start by understanding supply and demand in the company’s product market, and in the market for the inputs it uses. 

 

In the Introduction, you are required to:  “Use your knowledge of economic principles to describe the macroeconomic environment in general, and how that economic environment affects your company’s industry in particular.”

 

Identify macroeconomic variables that affect your company.  For example: interest rates, unemployment, GDP, and inflation.  Explain how one or more of these variables have influenced your company, either positively or negatively, over the past three to five years.  For example, “Continued low interest rates have allowed the company to borrow at attractive rates and pursue a strategy of aggressive expansion.”  Or, “Slow growth in the overall economy has caused the company to seek growth through acquiring other companies rather than through launching new products.”  You might go on to say something about weak product demand.

 

Also in the introduction: Use your knowledge of business principles to summarize the business strategy your company has employed in order to accomplish its mission in this environment.

 

Business principles you might mention could range from the economic maxim of profit maximization to the business strategies of low-margin generic product sales versus high-margin premium branding.  Take your cue from what the company says about itself in its financial reports and on its website.  Relate their business approach to what you have identified in the economy and can see in the financial statements.  For example, “The Company has pursued a strategy of low-cost pricing, in order to generate sales volume that will compensate for lower profit margins.”  Or, “Because of increased competition from similar products, the Company has aggressively expanded its marketing efforts.”  You might go on to say something about an increase in supply of similar products from other producers.

 

In the Summary:  “Use your knowledge of economic and business principles to evaluate how effective company’s strategy has been in responding to the economic conditions you identified in your introduction.”

 

In your conclusion, refer back to the economic and business conditions from your introduction, and say something about whether the financial reporting result suggest success, or lack of success.  For example, “In light of the steady decrease in gross profit and net income, the increase in sales volume has not been enough to compensate for discount pricing.  Or, “While interest expense has increased steadily, so has profitability, suggesting that recent debt financing has been an effective strategy in this time of low interest rates.

 Your task here is not to come up with insights that would impress the talking heads on CNBC.  Rather, it is to connect basic economic and business principles to the behavior and financial reporting of the real-world business you analyze. 

 

 

Do NOT use analysts’ reports or others’ evaluations. Since the entire report will draw on your work, your ideas and be written using your own words, no language should be quoted.  Borrowing language from another source, published or unpublished will be treated as a violation of the Academic Integrity Code. If you are relying on information contained in a note to the financial statements, you should cite it in your discussion; e.g.: (note 4).

 

A hard copy (printout) is due in by the due date and time listed at the top of this document.  The print out should include both your report and a printout of each of the worksheets in your Excel workbook.  Make sure you adjust the print format so that each worksheet prints out legibly on a single page. Also submit a copy of your Word file no later than the due date and time via the appropriate assignment link in Blackboard.

 

Outline for the format of your report (copy and paste this outline):

 

I      Introduction

1.

2.

3.

 

II     Income Statement Analysis

1.

2.

3.

4.

 

III   Balance Sheet Analysis

1.

2.

3.

4.

 

IV    Cash Flows Analysis

1.

2.

3.

4.V     Ratio and Integrative Analysis

1.

2.

3.

 

VI    Summary

1.

2.

 

_______________

 

Content

 

I      Introduction

 

1.                     Explain what this report is about and give your reader a brief description of the company's products, services, industry and mission.

2.                     Use your knowledge of economic principles to describe the macroeconomic environment in general, and how that economic environment affects your company’s industry in particular.

3.                     Use your knowledge of business principles to summarize the business strategy your company has employed in order to accomplish its mission in this environment.

 

II     Income Statement Analysis

 

 

  1. Briefly explain what information this statement conveys (in general).
  2. What are the changes and trends in net income over the past three years? How do changes in significant income statement items, according to your vertical and horizontal analyses, help explain the change in net income?  Explain the changes to the best of your ability.  (100 words maximum.)  Be specific as to amounts and percentages. 
  3. According to the notes to the financial statements, how does your company determine the timing of revenue recognition? Why is this important to this particular business?
  4. What irregular, extraordinary or unusual items were experienced by your company in the three years disclosed in the income statements? How does the disclosure of such items influence your opinion of the company’s performance?
    1. Such items may be “irregular items, such as those described in pages 687 – 689 in your text).
    2. They may also be significant unusual items, such as restructuring charges, loss on debt retirement or extinguishment, acquisition or merger expenses, legal settlements or other items which generally do not recur and are significant enough to warrant disclosure on the face of the financial statements. (Hint - if the item is unfamiliar to you, it is probably "irregular".)

 

IIII Balance Sheet Analysis

 

  1. Briefly explain what information this statement conveys (in general).
  2. According to the notes to the financial statements, how is the net book value of property, plan and equipment determined? Explain how this approach enhances or impairs the consistency, comparability and relevance of the amounts in the financial statements.
    1. According to the notes to the financial statements, what significant legal and financial contingencies or risks does the company face that are not reflected in the financial statements? (Make sure you are referring to the footnotes and not to other parts of the annual report.)
    2. What asset categories are particularly important to this company's business and why? What are the changes and trends in significant balance sheet items, according to your vertical and horizontal analyses?  Are these assets growing as fast as revenues? Explain the changes to the best of your ability.  (150 words maximum.  Be specific as to amounts and percentages.) 

     

    IV   Cash Flows Analysis

     

     

    1. Briefly explain what information this statement conveys (in general).
    2. How does the trend in operating cash flow changes compare to the trend in net income changes over the past three years - discuss?
    3. Explain the importance of the current year's free cash flow (or lack thereof); discuss the trend in this item over the past two years.
    4. Offer an explanation (using only this statement) for any significant change in your company's cash balance over the past three years.

     

    V     Ratio and Integrative Analysis

     

    1. Select a measure of liquidity calculated in Part 3 and explain how your balance sheet analysis (above) supports the trend your ratio suggests.   (Your “trend” might be constant, i.e., no upward or downward trend.)
    2. Select a measure of profitability calculated in Part 3 and explain how your income statement analysis (above) supports the trend your ratio suggests.   (Your “trend” might be constant, i.e., no upward or downward trend.)
    3. Select a measure of solvency calculated in Part 3 and explain how your balance sheet analysis (above) supports the trend your ratio suggests.  (Your “trend” might be constant, i.e., no upward or downward trend.)

     

    VI    Summary

     

    1.     Summarize your company's performance, growth and resources in 150 words,

    2.     Use your knowledge of economic and business principles to evaluate how effective company’s strategy has been in responding to the economic conditions you identified in your introduction. 

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