advanced financial statmeent analysis questions n answerss (2)

8/14/2019 Advanced Financial Statmeent Analysis Questions n Answerss (2)

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Question 10

DDM

Advantages:

It is an easy concept: dividends are what shareholders get, so forecastthem.

Predictability: Dividends are usually fair stable in the short run sodividends are easy to forecast (in short run).

Disadvantages:

Relevance: Dividend pay-out is not related to value, at least in theshort run. Dividend forecasts the capital gain component of payoffs.

Forecast horizon: Typical requirement is for forecasts for longperiod. Terminal values for shorter periods are hard to calculate with

any reliability.

When it works best:

Dividend pay-out is permanently tied to the value generation in the firm

(i.e. fixed dividend pay-out rate in term of earnings, return on corporate

investment (Barker 2001)

DCF

Advantages

Cash flows are free from earnings managementDisadvantages

Free cash flow does not measure value added in the short run; valuegained is not matched with value give up.

Investment is treated as loss of value, but the firm will worth more ifit invests profitably.

Free cash flow is partly a liquidation concept; firms increase free cashflow by cutting back on investments.


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seller has no further control over the good sold

Question 9 (incomplete)

Red flag - This involves reviewing financial statement ratios for

warning signs.

Red Flag Indicators

Slower sales growth

Declines in order backlog

Increasing Accounts Receivable/Sales (this ratio may indicate customers

are having credit problems o the firm is having difficulties making sales).

Increasing Inventory/Sales (this ratio may indicate inventory is building

up due to difficulties in making sales. But it may also indicate a production

buildup in anticipation of higher sales in the future).

Deterioration in Gross margin/Sales

Increasing Selling and Administrative Expenses/ Sales

Large non-recurring items

Build up of financial assets

Managers announcements about whether they could meet their estimated

earnings targets.

Each of the following features of financial statements may indicate aspects

of the current operational profitability that will not persist into the future.

They are flags that cue the analyst to investigate cause and ask whether

those causes indeed indicate that current operating income is notindicative of future income.

Usually high sales growth rates. High sales growth rate typically donot persist, as fade diagram suggest

Usually large change in core RNOA. Large changes in core RNOA oftendont persist, as fade disagrams suggest.

Usual changes in RNOA componenets. PM componenets such as GMratio, advertising to sales ratio or R&D to sales ratio.


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RNOA is different from the industry average. Operating profitabilitytypically reverts to the average for the industry.


GAAP quality: is GAAP accounting deficient? (covered in past

lectures, Chs.2 and 8)

2. Audit quality: is the firm violating GAAP or committing outright

fraud? (referring to auditors report)

3. GAAP application quality: is the firm using GAAP accounting to

manipulate reports?

4. Business transaction timing quality: is the firm manipulating

business to accommodate the accounting figures?

a. Revenue timing

b. Expenditure timing

5. Disclosure quality: are disclosures adequate to analyze the

business? (referring to accounting policy in annual report)

a. Disclosures that distinguish operating items from a financial items in the

statements

b. Disclosures that distinguish core operating profitability from unusual

items

c. Disclosures about the accounting policy used


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Financial analysis (W Rees 1995)

It is the procedure that financial analysts use to interpret publicly

available financial information for economic decision making. It requires asynthesis of a demanding mix of interdisciplinary techniqueswhich

incorporate a broad spectrum of methodologies and theories.

Financial statement analysis:

An essential part of business analysis

A process of applying analytical techniques systematically on a companys

financial statements and related information in order to understand its

current financial situation, drivers of profitability, to derive forecasts and

net present value of the company.

Shows strengths and weaknesses of internal operations

Consists of accounting, financial and prospective analysis.

Financial statement analysis for calculating the net present value of a

firm, is called fundamental analysis.

Question 14

Limitations of accounting information

Timeliness

Frequency

Forward-looking

The properties of accounting standards(outcome of political process, historic cost principle, conservatism, etc)

Accounting standards leave opportunities for managers discretions

(i.e. LIFO & FIFO, depreciation/amortisation methods, provision for

restructuring/reorganisation charges, etc)

Estimation errors(provision for bad debts, etc.)

Earnings management/creative account


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(i.e. restructuring charges, shifting the time of recognising revenues &

expenditures, capitalized the expenditures-WorldCom., etc.), for the

purposes of smoothing income figures, meeting analysts forecasts,

maintaining stock prices.

advanced financial statmeent analysis questions n answerss (2)

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