Financial Reporting and Analysis
Financial Reporting and Analysis
Financial Reporting and Analysis
and Analysis
2
CHAPTER
Financial Reporting
Environment
Regulators Industry Alternative Information
Practices Sources
Economy and Industry
Information
Analysts
Statutory Financial Reports
(Financial Statements)
Investors
and
Corporate
SEC Litigation Auditors Creditors
Governance
Other
Users
Enforcement and Monitoring Mechanisms Users
Form 10-K 10-Q
(Annual Report) (Quarterly Report)
20-F 8-K
(Registration Statement/ (Current Report)
Annual Report [Foreign])
14-A Other
(Proxy Statement/
Prospectus) SEC Filings
Earnings Announcements
FASB AICPA
Level III Emerging Issues Task Force Practice Bulletins
Provide input to
Setresponsibility
Main by International
for fair &Accounting
accurate reports
Applies accounting
Standards to reflect business
Board
activities
Not currently
Managerial accepted
discretion in U.S.
is necessary in
accounting
SEC
Major underonpressure
lobbyist GAAP to accept
IAS
Environmental Factors
Auditing
SEC
Set
requires Audit Report Accounting
by International
Audit opinion can
Standards be:
Board
- clean (fairly presented)
Not -currently accepted
qualified (except for) in U.S.
Auditors
- disclaimer (no opinion)
SEC under pressure to accept
Check Auditor quality & independence
IAS
Environmental Factors
Corporate Governance
Board
Set of
bydirectors oversightAccounting
International
Audit committeeBoard
Standards of the board
- oversee accounting process
-oversee
Not currently accepted in U.S.
internal control
- oversea internal/external audit
SEC under
Internal Auditor
pressure to accept
IAS
Environmental Factors
Managers Lenders
Officers Shareholders
Internal Auditors Governments
Sales Managers Labor Unions
Budget Officers External Auditors
Controller Customers
Environmental Factors
Equity Investors
Active & Speculative Investors rely on
financial reports
Creditors
Solvency & Liquidity analysis relies
on financial reports
Environmental Factors
Economic, Industry & Company News
Impacts current & future financial condition and
performance
Voluntary Disclosure
Many factors encourage voluntary disclosure by
managers
Information Intermediaries
Industry devoted to collecting, processing, interpreting
& disseminating company information
Includes analysts, advisers, debt raters, buy- and
sell-side analysts, and forecasters
Major determinant of GAAP
Financial Accounting
Objectives
Understandability
100%
80%
Explained
Book Value
60%
Earnings
40%
Combined
20%
0%
65 70 75 80 85 90 95
Year
Financial Accounting
Net Operating
= + Accruals
Income Cash Flow
Accruals--The Cornerstone
Foundations of Accrual Accounting
Free cash
+ flow
Operating
Financing
cash flow
cash flow Income
Investing
cash flow
Accruals--The Cornerstone
Comparison of Stock Price, Net Income, and Free Cash Flows
Fiscal year 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Wal-Mart
Stock price 4.22 5.33 8.25 13.47 16.28 13.25 11.44 10.19 11.87 19.91
Net income 0.18 0.24 0.28 0.35 0.44 0.51 0.58 0.60 0.67 0.78
Free cash flow 0.04 (0.01) (0.05) (0.17) (0.48) (0.50) (0.19) (0.21) 0.84 0.60
Kmart
Stock price 18.94 16.62 15.50 24.50 23.25 19.63 13.63 5.88 11.13 11.00
Net income 2.00 0.81 1.89 2.02 2.07 (2.13) 0.64 (1.24) (0.45) 0.51
Free cash flow 1.76 (2.26) 0.20 (0.47) (2.15) 1.29 2.71 0.48 0.61 1.35
Accruals--The Cornerstone
Relation between Stock Prices and Various Income and Cash
Flow Measures for a Large Sample of Companies
70.00
Percent of Price Explained
57.62
60.00
50.00 44.36
40.00 33.02 32.62
30.00
20.00
10.00
1.00
0.00
NIBX NI OCF FCF NCF
NIBX = Net Income before Extraordinary Items and Discontinued Operations; NI = Net Income;
OCF = Operating Cash Flow; FCF = Free Cash Flows; NCF = Net Cash Flow (Change in Cash).
Accruals--The Cornerstone
Relation between Stock Returns and both Income and Operating
Cash Flows for Different Horizons of a Large Sample of Companies
.
45.00
40.26
40.00
Percent of Stock Returns Explained
35.00
30.00
25.00 OCF
20.00 NI
16.20
15.00
10.88
10.00
Source: Dechow, P
Accruals--The Cornerstone
Accruals and Cash Flows --- Myths
• Myth: Since company value depends on future cash flows,
.
only current cash flows are relevant for valuation.
• Myth: Company value equals discounted future cash flows.
• Myth: All cash flows are value relevant.
• Myth: All accruals accounting adjustments are value
irrelevant.
• Myth: Cash flows cannot be manipulated.
• Myth: All income is manipulated.
• Myth: It is impossible to consistently
• manage income upwards in long run.
• Myth: Accounting rules are irrelevant
for valuation.
Accruals--The Cornerstone
Accruals and Cash Flows --- Truths