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Accounting IP / 17312053

FINANCIAL STATEMENT ANALYSIS

WEEKLY ASSIGNMENT

Chapter 3

2. How do business analysis and financial statement analysis affect each other?
Answer:
Business analysis and financial statement analysis work hand in hand to help us
understand the target firm's potential. Business analysis will highlight issues we need to study
further in the financial statement analysis stage. Likewise, financial statement analysis
identifies concerns that require more detailed business analysis. This is the reason for the
two-way arrow between business analysis and financial statement analysis in this figure:
3. Why do we need to understand the economic structure of the industry?
Answer:
Due to understanding the economic structure of the industry, it will determine the
returns, profitability, and cash flow of target firm. Then, because economic structure of the
industry is part of external analysis, the more intense the competition, the lower the expected
industry return, and the lower value of a given firm in the industry. If an industry has high
returns, it is likely to attract the investments from both new and existing firms, creating more
competition and eventually lowering the industry return.
Competitive Strategy (1980) by Michael Porter presents a systematic approach to
studying the economic structure of an industry by analyzing five basic competitive forces that
affect industry returns. In addition to helping us understand the industry economic structure,
Porters framework provides a complete and organized structure for becoming knowledgeable
about the industry.
Other than that, by considering the existing competitive rivalry and how it might
change due to the actions of buyers, potential entrants, and suppliers, as well as the effects of
substitute products, this framework helps us think about the firm's ability to generate cash
flow in the future. Thus, it is a link between our analysis and the valuation models we will
study later.

4. In our external analysis, we study our individual competitors. What should we know learn
about the firm’s competitor?
Answer:
By understanding the firm’s competitor, it will help us determine reasonable estimates
of growth, margins, and capital requirements. For instance, when we evaluate historical
financial ratios as benchmarks of firm performance, we will use the business analysis
especially on external analysis to assess how these ratios may change in the future. The
business analysis will help us consider whether the firm can maintain profitability, become
more profitable, or become less profitable. The business analysis should help us determine a
range of reasonable assumptions for our valuation model. Other than that, several things that
we should learn about the firm’s competitor are about :
a) How does this competitor approach the marketplace?
b) What are the unique characteristics of its product or service?
c) What is its competitive advantage?
 d) How does its pricing compare with the target company?
e) What is its apparent marketing strategy?
f) How do customers view the product or service?
g) Is the competitor well positioned for future trends in the industry?
h) Is this competitor profitable? Is it likely to invest more in the business if the
competitive situation heats up?
i) How does the competitor make or buy its product? Is the way it makes or buys its
product a competitive advantage?
j) How is the product distributed? Does the distribution method provide a
competitive advantage?
k) Is the business management a strength or weakness?

Chapter 4

1. Describe the relationship between the income statement and the balance sheet.
Answer:
The Balance Sheet
The balance sheet also called a statement of financial position, because the balance
sheet describes the position of assets and liabilities of a company. Basically, the balance sheet
communicates what the entity owns in terms of assets, what it owes in terms of liabilities, and
the difference between those two which represents what the owners of the company are
entitled to. The owner’s portion is called equity. The balance sheet can be expressed as the
fundamental accounting equation:
Assets = Liabilities + Equity
When we look at the common structured Assets in the balance are in the left position
while the liabilities are on the right side. Assets in the left position contain current assets and
fixed assets of a company, while liabilities in the right position contain the debt and capital of
a company. In the balance sheet recording between assets and liabilities the balance must be
balanced, in terms of income must be in accordance with expenses, this is the reason why the
balance sheet is called a balance sheet.

The Income Statement

 The income statement communicates the inflows and outflows of assets, where
inflows are the revenues generated and outflows are the expenses. An excess of inflows over
outflows is called net income, and an excess of outflows over inflows is called a net loss. The
income statement can be expressed as an equation:
Revenue – Expenses = Net Income (Loss)
Revenues are calculated according to the type of business the company is running.
After income for a period has been identified, then the accountant will calculate the expenses
incurred in a period after the expense is known, then the next step is to look for the difference
between the balance in income and the balance at the expense. The result is called 'net profit'
if revenue exceeds costs, and is called 'net loss' if costs exceed revenue.

From the explanation of the income statement and balance sheet above it can be
concluded that the income statement and balance sheet have a very important relationship.
The relationship between the income statement and balance sheet, which is the income and
expenses presented in the income statement, results in changes in assets and liabilities in the
balance sheet. Other than those, the connection between the balance sheet and the income
statement results from:
The use of double-entry accounting or bookkeeping, and
The accounting equation Assets = Liabilities + Owner's Equity

Basically, the income statement components have the following effects on the owner's equity:
Revenues and gains cause owner's (or stockholders') equity to increase
Expenses and losses cause the owner's (or stockholders') equity to decrease

To explain more, the income statement and balance sheet of a company are linked
through the net income for a period and the subsequent increase, or decrease, in equity that
results. The income that an entity earns over a period of time is transcribed to the equity
portion of the balance sheet. The income represents an increase in the owners’ claim against
the assets: Income is NOT a cash asset. It is through the income and equity accounts that the
balance sheet and income statement reflect the total financial picture of the entity.
2. Describe the relationship between cash flow statement and balance sheet
Answer:
The Balance Sheet
In a short explanation that the Balance Sheet or we can also be called Statement of
Financial Position is shows the firm's net worth at a certain point in time that includes the
company’s assets and liabilities or equity. Balance sheet items are separated into two sides
that have to balance since every asset has to be purchased with a liability, like a bank loan, or
owners' equity, such as a portion of the retained earnings. Moreover, the balance sheet is an
indicator of net worth while the income statement or statement of profit and loss is an
indicator of profitability.

The Cash Flow Statement

The cash flow statement shows the amount of cash and cash equivalents entering and
leaving a company. This statement uses data from both the income statement and balance
sheet, making it the last financial statement to be developed. This statement tracks how cash
is coming into the firm and how it is being spent in the areas of day-to-day operations,
financing, and investments. To explain more, the operations part lists how much cash inflows
and outflows have been generated by the business product or services. The investing part is
related to equipment, buildings or short-term assets. The financing part includes debts, loans,
and dividends. In addition, Statement of Cash Flows is primarily linked to balance sheet as it
explains the effects of change in cash and cash equivalents balance at the beginning and end
of the reporting period in terms of the cash flow impact of changes in the components of
balance sheet including assets, liabilities and equity reserves.

Hence, from the information above the relationship between cash flow statement and
balance sheet are:
 Changes in various line items in the balance sheet roll forward into the cash flow
line items listed on the statement of cash flows. For example, an increase in the
outstanding amount of a loan appears in both the liabilities section of the balance
sheet (as an ongoing balance) and in the cash flow from financing activities
section of the statement of cash flows (in the amount of the incremental change).
 The ending cash balance in the balance sheet also appears in the statement of cash
flows.
Problems

2. Pepsi Co reported two earning per share amount for the year ended December 30,
2000: $. 1,51 and $. 1,48. Which of these amounts is basic earnings per share and which
is diluted earnings per share?
Answer:
The Basic earnings per share is $. 1,51, and the diluted earnings per share is $. 1,48.
Because basically the basic earnings per share per share is higher than the diluted
earnings per share.