Professional Documents
Culture Documents
Financial Statement Analysis
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02/02/2015
Semester and Staff
Staff
Subject Co‐ordinator and Lecturer:
Dr Trenton Milner
trenton@uow.edu.au
Consulting:
Monday: 12:30 pm (Sydney)
Wednesday: 3:30 pm (Sydney)
Thursday: 2:30 pm (Wollongong)
Or by appointment
Contact Expectations (yours & mine)
Semester
11 weeks of lectures and tutorials
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My Teaching Style
Interaction
The art of common courtesy
Engagement
Approachable
Helpful hints
Beyond the textbook
LET’S HAVE FUN while you learn!
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What I need from YOU!!
A willingness to interact
Your commitment to your own learning
A positive attitude
Sufficient time allowance
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Key Expectations and Requirements
Learning is an active (not passive) process
Learning is something you do, not something we impart!
People do not learn through a process of osmosis
Students are expected to attend all lectures and tutorials
Students are also expected to prepare for each class and to verbally
contribute to every class , as required
Academic staff are learning facilitators:
We have a responsibility to the business community to maintain a high
standard of graduates
We all have a broader social responsibility to perform to the best of
our abilities and to add value to the community
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This Unit: FIN 924
Textbook:
Palepu et al. (2010), Business Analysis & Valuation using
Financial Statements, 1st Asia Pacific Edition, Cengage
Australia.
Also highly recommended:
Emerson, Writing Guidelines for Business Students, 4th
Edition, Cengage.
Moodle / SOLS / eLearn
Who has access?
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Assessment
In Session Test ‐ Week 6:
20% (individual)
Major Assignment ‐ Week 10:
20% (group)
Tutorial tasks ‐ Mystery Week:
10% (individual)
Exam ‐ Week 13 (TBC):
50% (individual)
Time requirement: minimum of 12.5 hours per week
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Each Week
We are going to go through a case study that should
help with your assignment
If you go home each week & do your assignment, it will
be easy
Each week we will go through part of your exam too
The exercises are designed for you to undertake in your
exam
So if you skip class…
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Why Financial Statement Analysis?
Financial statements are an important source of information to the
capital markets and business analysts.
Financial Statement provides most publicly available data, Help in
addressing questions about
Performance of the firm – current and future value of stock
Credit risk involved in lending
Structure of the industry in which the firm operates
Proper valuation of the firm. If undervalued firm may be
target for takeover
Accounting policies and accrual estimates of the firm
Analyzing financial statements addresses a number of issues of interest
to external stakeholders and company insiders.
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The Role of Financial Reporting in
Capital Markets
Financial reporting provide much‐needed information to capital
market participants
Entrepreneurs have better information than investors in capital
markets
Information problems can lead to “lemons”, a problem which can
breakdown the capital markets
The intermediaries – Financial and Information ‐ can prevent market
breakdown
Financial Intermediaries – banks, venture capitalists, mutual funds, and
insurance companies
focus on funds from individuals.
Information Intermediaries – financial analysts, auditors, financial press
provide information
Financial intermediaries depend upon the information in financial
statements to evaluate investment opportunities.
Information intermediaries assure the quality of financial statement
representations.
Relevant and reliable financial information is essential for the functioning
of capital markets.
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How Capital Markets Function
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From Business Activities to
Financial Statements
Financial statements measure and summarize the
economic consequences of business activities.
Accounting systems facilitate information quality.
The role of accrual accounting.
The need for generally accepted accounting principles
(GAAP).
Auditing and the quality of financial information.
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Accounting System
Selects, measures and aggregate financial information
data
Financial Reports are prepared on accrual rather than
cash basis
Economic transactions are recorded on the basis of
expected not actual cash receipts and payments
(Accrual)
Periodic performance measurements through accrual
accounting
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Accounting Standards and Auditing
Accounting standards limits distortions that can be
introduced in reporting
AASB and IASB standardise the reporting ability of
managers
Uniformity, however, reduces flexibility
Auditing helps in the verification of the integrity of
the financial statements, improves quality of data
Legal environment – threat of lawsuits can help in
improving disclosures
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Manager’s Reporting Strategy
Managers have accounting discretions in the real world.
Managers have choice of accounting and disclosures
policies
Manager’s use financial statements to provide information
to investors and can also manipulate information to
influence investors
Variation in accounting quality across businesses provides
challenges and opportunities to analysts in separating
noise and gain valuable insights
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Financial Statements and Business
Analysis
Business intermediaries use financial statements to
accomplish four key objectives:
Four Step Process
Business Strategy Analysis – Industry Analysis and
competitive strategy analysis
Accounting Analysis ‐ Assess accounting policies and
estimates
Financial Analysis – Evaluate performance using ratios and
cash flow analysis
Prospective Analysis – Make forecast and value business
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Business Application
Credit Analysis – Ratings, cost of capital, financial
distress
Securities Analysis‐ Earning and price forecasts. More
accurate than models used.
Mergers & Acquisition Analysis‐ Combining resources,
economies of scale, capturing tax benefits, increasing
product‐market returns.
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Summary
Financial statements are source of widely available data on
publicly traded corporations.
Accrual accounting attempts to accurately reflect
expectations of economic performance, but requires
careful analysis.
This chapter has outlined a useful framework for business
analysis using financial statements.
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Emergency Procedures
• Sydney Business School staff will be informed by the Building Managers what type of
emergency has occurred and what the procedure is.
• Sydney Business School staff members (wearing a yellow or red helmet) will instruct
all staff and students in the SBS premises on what to do in an emergency.
• If leaving the building take all your belongings with you and leave in an orderly but
prompt manner.
• In a fire emergency the assembly point is at First fleet Park which is the open park
between the Museum of Contemporary Art and Circular Quay.
• In the case of another type of emergency, the assembly point will be advised by the
Building Managers, and this will be communicated to students and staff via staff
members.
• Staff and students may not re-enter the building until advised by the building
managers or security staff.
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Assembly Area
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Emergency Procedures
• Sydney Business School staff will be informed by the Building Managers what
type of emergency has occurred and what the procedure is.
• Sydney Business School staff members (wearing a yellow or red helmet) will
instruct all staff and students in the SBS premises on what to do in an
emergency.
• If leaving the building take all your belongings with you and leave in an orderly
but prompt manner.
• In a fire emergency the assembly point is shown on the next slide.
• In the case of another type of emergency, the assembly point will be advised
by the Building Managers, and this will be communicated to students and staff
via staff members.
• Staff and students may not re-enter the building until advised by the building
managers or security staff.
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Case Study. Dot.Com Crash of 2000
This case helps in understanding the role of key
intermediaries‐ venture capitalists, investment banks,
sell‐side and buy‐side analysts, professional managers
and public accountants in the functioning of capital
markets
The case focuses on the potential value these
intermediaries create and some of the governance and
incentive challenges they face
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Scient Corporation
The firm was founded in Nov.1997. It provided services in Information
technology and System design, strategy consulting
The company grew to 2000 employees in 3 yrs
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Venture Capitalists
Screen early stage investment opportunities
Develop risky but promising ventures through investment,
support and oversight
Reward tied to returns at liquidation of stake in public or
M&A market
Driven by IPO market
Focus on short‐term behaviour of stock market
Venture capitalists funded too many flawed ideas.
Entrepreneurs pursued flawed strategy by putting growth
and market share over profits
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Investment Banks
Help companies in raising capital in public markets by
underwriting and distributing new issues
Incentives by way of proportion of capital raised in public
issues
Represent the interest of seller rather than the buyer of
securities
Reputation suffers if security overpriced or public
companies turn out to be lemons
Willing to exploit hot market on the potential of internet to
underwrite and market at inflated prices.
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Sell‐side analysts
Provide research reports and investment recommendations
to individual and professional investors on new and
existing securities.
Rewards tied to accuracy of earning forecasts and
investment banking fess generated
Bias in favour of seller of securities to maintain access to
information and to obtain investment banking deals
Focus on short term earning forecasts
Mostly affiliated with brokerage houses and investment
banks. Commission used to fund research.
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Buy‐side Analysts
Provide proprietary research reports and recommendations
to fund managers.
Rewards tied to earning forecasts and short‐term stock
return performance from investment recommendations
Focus on forecasting short‐term earnings and short‐term
stock prices.
Bought stock of flawed and unproven businesses because
of preferential allocation of IPO shares. These shares were
dumped to investors at attractive prices
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Fund Managers
Buy and sell securities to earn superior risk‐adjusted
returns
Paid as function of the size of asset under management and
relative performance of the fund vs. a bench mark.
Focus on attractive new securities which are often driven by
short‐term performance of the fund.
Relative performance evaluation often result in herd
behaviour.
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Auditors
Enhance credibility of financial information reported
by the company
Attest to its conference with Standards and GAAP
Rewarded for new client acquisition, client retention
and generating non‐audit fees
Unwillingness to confront the client to increase the
probability of retention and to attract non‐audit
income.
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Valuation challenges for dot.coms
Traditional methods of valuations are difficult to apply – EBITDA, P/E
ratio. No positive cash flow initially
New methods are not yet tested very well – Theoretical earnings per
share, comparable companies method of EPS, Inudtsry specific
methods
Dot. Com rely on future and future is uncertain
Evaluation of future earnings and valuation difficult
Business valuation of technology – Stages of marketing
Link between valuation and marketing
Ref: Savoie, Valuing dot.coms, The university of Texas, Dallas, school of Management
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Conclusions
Intermediaries are not perfect so markets are likely to be
imperfect either.
The dot com bubble is an extreme example but it happens
less dramatically but more frequently in individual stock.
Intermediaries can perform their functions if they are
insulated from market forces up to a point.
Reforms to make professional investors more responsive to
the markets.
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