Financial Statement Analysis Workbook: Step-by-Step Exercises and Tests to Help You Master Financial Statement Analysis / Edition 3

by Martin S. Fridson, Fernando Alvarez

Overview

Whether you're evaluating a company's stock price, assessing itscredit quality, or determining valuations for a merger oracquisition, deciphering the messages embedded within a company'sfinancial statements is critical-especially after the recent demiseof so-called "solid" companies. This workbook will help you do thisand much more, by allowing you to hone your skills and test theknowledge you've gained from reading Financial Statement Analysis,Third Edition.

Question-and-answer sections within this workbook correspond toeach chapter of Financial Statement Analysis, Third Edition, so youcan use this guide in conjunction with the actual text.Alternatively, you can use the self-administered tests that arealso a part of this workbook to independently practice the skill ofreading and understanding financial statements. Either way, usingthe Financial Statement Analysis Workbook will help you expand yourskills in reading and analyzing financial statements-so you cansuccessfully put your hard-won knowledge to work in the real world.

Product Details

ISBN-13:	9780471409182
Publisher:	Wiley
Publication date:	07/29/2002
Series:	Wiley Finance , #79
Edition description:	3rd Edition
Pages:	168
Product dimensions:	5.96(w) x 9.04(h) x 0.41(d)

About the Author

MARTIN FRIDSON is Managing Director at Merrill Lynch & Companyand a member of Institutional Investor s All-America Fixed IncomeResearch Team. His other books include How to Be a Billionaire, ItWas a Very Good Year, and Investment Illusions, all published byWiley. He is a past governor of the Association for InvestmentManagement and Research.

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

Read an Excerpt

Financial Statement Analysis Workbook

Step-by-Step Exercises and Tests to Help You Master Financial Statement Analysis

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By Martin Fridson Fernando Alvarez

John Wiley & Sons

ISBN: 0-471-40918-9

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Chapter One

PART ONE

Questions

QUESTIONS ON EACH CHAPTER

Chapter 1: The Adversarial Nature of Financial Reporting

1. Three ways that corporations can use financial reporting to enhance their value are: a. _______________________________________________

b. _______________________________________________

c. _______________________________________________

2. Corporations routinely _____________ because the appearance of ___________ receives a higher __________ multiple.

3. The following are some of the powerful limitations to continued growth faced by companies:

a. _______________________________________________

b. _______________________________________________

c. _______________________________________________

4. ____________ reached its zenith of popularity during the __________ movement of the 1960s. However, by the 1980s, the stock market had converted the ________ into

a ___________.

5. The surprise element in Manville Corporation's 1982 bankruptcy was, in part, a function of ______________.

6. Some of the stories used to sell stocks to individual investors are:

a. _______________________________________________ b. A "play" in some current economic trend such as

i.____________________________________________

ii. ____________________________________________

c. _______________________________________________

7. The ostensible purpose of financial reporting is _______ of a corporation's earnings.

8. Over a two-year period, BGT paid L&H $35 million to develop translation software. L&H then bought BGT and the translation product along with it. The net effect was that instead ________, _________, L&H recognized _____________.

Chapter 2: The Balance Sheet

1, A study conducted on behalf of Big Five accounting firm Arthur Andersen showed that between ________ and __________, book value fell from __________% to __________% of the stock market value of public companies in the United States.

2. In the examples above, there is no accounting event because ___________.

3. As in the case of __________, the historical cost principle makes comparable companies appear quite dissimilar. The equally large _____________ of another company with low-cost debt will not be reflected on its balance sheet, simply because ____________.

4. Through stock-for-stock acquisitions, the sharp rise in equity prices during the late 1990s was transformed into ___________, despite the usual assumption that ______________.

5. A reasonable estimate of a low-profit company's true equity value would be ____________.

6. Determining the cost of capital is a notoriously controversial subject in the financial field, complicated by __________ and ____________.

7. Instead of striving for theoretical purity on the matter, analysts should adopt a _______________, using the measure of equity value ____________.

8. Users of financial statements can process only ____________, and they do not always have _____________.

9. Where feasible, users of financial statements should also solicit as ________________ regarding risks not spelled out __________.

Chapter 3 The Income Statement

1. Students of financial statements must keep up with ___________ of the past few years in transforming __________ into ____________.

2. Besides facilitating comparisons between a company's present and past results, the ____________ can highlight important facts _____________.

3. The more widely diversified pharmaceutical manufacturers can be expected to have ______________ percentage ____________, as well as _________________ percentage ____________ expenses, than industry peers that focus exclusively on ____________.

4. Executives whose bonuses rise ____________ have a strong incentive not only ________________, but also to use ________________.

5. Along with _______________, another major expense category that can be controlled through ______________ is ______________.

6. A company knows that creating ________________ expectations about _______________ can raise _______________ and lower _______________.

7. An extraordinary item is reported on an _____________ basis, below the _________________ from continuing operations.

8. In recent years, _______________ has become a catchall for charges that companies wish analysts to consider ____________, but which do not qualify for ________________.

9. The most dangerous trap that users of financial statements must avoid walking into, however, is inferring that the term restructuring connotes __________.

10. The purpose of providing pro forma results was to help analysts ____________ accurately when some event caused ___________ to convey a misleading impression.

11. Computer software producers got into the act by _______________ from the expenses considered in calculating _______________.

12. In fact, analysts who hope to forecast future financial results accurately must apply ___________________ and set aside genuinely __________________.

13. An older, but not obsolete, device for beefing up reported income is ________________.

14. A corporation can easily accelerate its sales growth by _______________ and ________________. Creating genuine value for shareholders though is more difficult, although unwary investors sometimes fail to recognize the distinction.

15. If Company A generates external growth by acquiring Company B and neither Company A nor its new subsidiary increases its profitability, then ____________ the merged companies is ___________________ than the sum of the two companies' values.

16. As synergies go, projections of economies of scale in combinations of companies _________________ tend to be more plausible than economies of scope purportedly available to companies in _________________ businesses.

17. Professor Beneish's statistical analysis shows that the presence of the following factors increases the probability of earnings manipulation:

a. ______________________________________________

b. ______________________________________________

c. ______________________________________________

d. ______________________________________________

Chapter 4: The Statement of Cash Flows

1. For financial reporting (as opposed to ___________) purposes, a publicly owned company generally seeks to maximize _______________, which investors use as a basis for valuing its shares.

2. In a classic LBO, a group of investors acquires a business by _________ and ____________ the balance.

3. Analysts evaluating the investment merits of the LBO proposal would miss the point if they focused on _________________ rather than __________________.

4. The essential idea of a _______________ is to acquire a business with a sliver of equity and a large amount of ____________, and then pay off the debt with ______________.

5. The EBITDA multiple may come down because _____________ perceive that the LBO organizers ______________ on capital spending during their stewardship, meaning that _____________ will be required going forward.

6. The ________________, rather than the _______________, provides the best information about a highly leveraged firm's financial health.

7. Revenues build gradually during the _____________ phase, when the company is just __________ and ___________________. Growth and profits accelerate rapidly during the ______________ phase, as the company's products begin to penetrate the market and the __________________. During the ______________ period, growth in sales and earnings decelerates as the _____________. In the _________________ phase, sales opportunities are limited to the replacement of products previously sold, plus _____________. Price competition often intensifies at this stage, as companies _______________. The _____________ stage does not automatically follow maturity, but over long periods some industries do get swept away by ______________. Sharply declining sales and earnings, ultimately resulting in ______________, characterize industries in decline.

8. ___________ are start-ups that survive long enough to reach the stage of entering the public market.

9. ______________, are past the cash strain faced by growth companies that must fund large programs.

10. By studying the cash flow statement, an analyst can make informed judgments on such questions as:

a. ______________________________________________

b. ______________________________________________

c. ______________________________________________

11. If corporation's financial strain becomes acute, the board of directors may take the comparatively extreme step of _______________________.

12. A company with a strong balance sheet can fund much of that cash need by increasing its _____________ (credit extended by vendors). External financing may be needed, however, if accumulation of unsold goods causes __________________ to rise disproportionately to _____________________. Similarly, if customers begin paying more slowly than formerly, _______________ can widen the gap between __________________ and _____________________.

13. Overinvestment has unquestionably led, in many industries, to prolonged periods of _____________________, producing in turn chronically ___________________. In retrospect, the firms involved would have served their shareholders better if they had ___________________ or ______________, instead of __________.

14. Another less obvious risk of eschewing financial flexibility is the danger of permanently losing ________________ through ________________ occasioned by recessions.

15. The cash flow statement is the best tool for measuring _______________, which, contrary to a widely held view, is not merely a security blanket for __________________. In the hands of an aggressive but prudent management, a cash flow cushion can enable a company to _______________ when competitors are forced to cut back.

Chapter 5: What Is Profit?

1. Profitability is a yardstick by which businesspeople can measure their _______________ and justify ______________.

2. When calculating ______________ profits, the analyst must take care to consider only genuine revenues and deduct all relevant costs.

3. There can be no bona fide profit without ______________. Bona fide profits are the only kind of profits ______________ in financial analysis.

4. Merely __________________, it is clear, does not increase wealth.

5. An essential element of genuinely useful financial statement analysis is: ________________. 6. The issuer of the statements can __________________ or _______________ its reported earnings simply by using its latitude to assume shorter or longer _______________.

7. The rate at which the tax code allows owners to write off property overstates ___________________.

8. In the _________________________, companies typically record depreciation and amortization expense that far exceeds physical wear-and-tear on assets.

9. In many industries, fixed assets consist mainly of __________. The major risk of analytical error does not arise from the possibility that _______________, but the reverse.

Chapter 6: Revenue Recognition

1. Many corporations employ _______________ practices that comply with GAAP yet __________________.

2. Analysts were questioning Informix's ______________; in particular, when Informix revealed that about $170 million of its 1996 sales to computer makers and ___________ represented _______________ that had not yet been ________________.

3. Some of the reasons software manufacturers defer recognition of revenue are:

a. ______________________________________________

b. ______________________________________________

c. ______________________________________________

d. ______________________________________________

4. Agreements with resellers that:

a. ______________________________________________

b. ______________________________________________

c. ______________________________________________

d. ______________________________________________

mean that license revenue from these transactions should not be recorded _______________; rather it should instead be recorded at the time ___________________.

5. The Informix affair teaches analysts not to construe __________ as an assurance of integrity in financial reporting. _________ reporting differs from fraudulent reporting, in a _____________, but a corporate culture that embraces the former can foster the latter.

6. Staying alert to evidence of flawed, __________, reporting is essential, even when the auditors _____________.

7. In 1994, KnowledgeWare began supplementing its own salesforce's efforts with agreements _____________. Almost immediately, the company started to encounter difficulties in ________________. In restating the results, management said that it had booked as revenues ______________.

8. The receivables-related bombshell that KnowledgeWare dropped on August 30, 1994, was telegraphed by _________ in KnowledgeWare's 10Q for the first fiscal quarter, received by the SEC way back on November 2, 1993.

9. Prior to the change in accounting practice, which FAS 101 made mandatory, Wal-Mart booked layaway sales __________. Under the new and more conservative method, the company began to recognize the sales ________________.

10. As in any sales situation, aggressive pursuit of new business could result in ______________. On average, the newer members might prove to be ______________ or less committed to physical fitness than ____________________.

11. Under GAAP, the general requirement was to spread membership fees _________________. If a company offered refunds, it could not ____________________ until the refund period expired, unless there was ________________ to enable management to estimate __________________ with reasonable confidence.

12. GAAP addresses the problem through the _______________, which permits the company to recognize revenue in ______________, rather than in line with its billing.

13. The SEC claimed that to inflate revenues and profits, management at Sequoia Systems:

a. ______________________________________________

b. ______________________________________________

c.

Continues...

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Table of Contents

PART 1: QUESTIONS.

Questions on Each Chapter.

Financial Statement Exercises.

Computational Exercises.

PART 2: ANSWERS.

Answers to Questions on Each Chapter.

Answers to Financial Statement Exercises.

Answers to Computational Exercises.