Introduction
When analyzing a company, investors spend most of their time working with the financial statements as presented in the company’s annual and quarterly reports. The financial statements are essential for what they reveal about the company’s operations and financial resources.
Investors must develop fluency in corporate accounting. Accounting is considered the “language of business.” Investors who thoroughly understand corporate accounting can understand a company’s financial profile and determine whether a company’s management is accurately reporting underlying economic reality.
Financial statement analysis is not merely an accounting exercise. For investors, the purpose is to determine whether reported numbers reflect economic reality. Revenue, earnings, assets, liabilities, and cash flow must be interpreted in context before they can be used in valuation.
A Brief Accounting Overview
Rulemaking Bodies
In the United States, the Financial Accounting Standards Board, or FASB, establishes U.S. Generally Accepted Accounting Principles, or GAAP. The FASB Accounting Standards Codification is the primary source of authoritative U.S. GAAP. Public companies must also comply with applicable SEC reporting rules and regulations.
Public companies generally file annual reports on Form 10-K, which include audited financial statements, and quarterly reports on Form 10-Q for the first three fiscal quarters, which include unaudited interim financial statements. These reports, along with other material, provide investors with the information necessary to conduct proper company analysis.
Investors who wish to analyze non-U.S. companies should also become familiar with accounting rules established by foreign standard-setting bodies. The most notable of these organizations is the International Accounting Standards Board, or IASB. The IASB establishes the International Financial Reporting Standards, or IFRS.
Recording Transactions
Companies initially record business activity in a transactions book known as a journal. The journal has two columns for numerical values. The column on the left is the debit column, and the column on the right is the credit column.
Debit entries increase assets and expenses and decrease income, liabilities, and owners’ equity. Credit entries increase income, liabilities, and owners’ equity and decrease assets and expenses.
The company records each transaction so every debit entry has a corresponding credit entry, and two or more accounts are affected for every business transaction. Throughout the journal, the total in the debit column must equal the total in the credit column. This system of debit and credit entries is known as the double-entry system.
For example, consider an apparel retailer that purchases 100 t-shirts at $10 each, for a total of $1,000, and pays cash. The journal entry would show an increase in inventory and a corresponding decrease in cash.
The company records every transaction in the journal over a period. The company then posts these transactions to a ledger, in which transactions are grouped by account. The company uses the account balances in the ledgers to prepare the financial statements.
Key Financial Statements
The Income Statement
A company’s income statement, also called the profit and loss statement or statement of operations, shows the company’s sales, expenses, and profit over a period, such as a quarter or year.
Companies use accrual accounting, meaning they recognize revenue when the revenue is earned. The period in which revenue is earned is not necessarily the same period in which cash is received. Likewise, companies recognize expenses in the same period as the corresponding revenue, which may not be the period in which cash is paid out. Because of the use of accrual accounting, a company’s net income will not equal its cash flow.
The typical income statement format will show:
- Sales;
- Direct costs of delivering goods or services, known as cost of sales or cost of goods sold;
- Gross profit, or sales minus direct costs;
- Operating expenses, known as selling, general, and administrative expenses;
- Operating income, or gross profit minus operating expenses;
- Interest expense; and
- Taxes.
A company may also have certain gains, losses, or expenses labeled nonoperating, nonrecurring, unusual, infrequent, one-time, restructuring-related, impairment-related, or otherwise outside normal operations.
The difference between revenue and expenses is the company’s net income. Net income is often called the company’s “bottom line” due to its position on the last line of the income statement.
The income statement format just described is referred to as a multi-step format because it presents gross profit as a subcategory.
The Balance Sheet
The balance sheet shows the ending balances of a company’s asset, liability, and equity accounts at a specific time. For example, the balance sheet may be as of calendar year-end, December 31, and will show the ending balances of those accounts as of that date.
The balance sheet must balance according to the accounting equation:
Assets = Liabilities + Shareholders’ Equity
Assets
The typical balance sheet begins with a presentation of a company’s assets. Assets are resources of the company that are expected to provide future economic benefits.
The balance sheet separates assets into current assets and noncurrent, or long-term, assets. Current assets are those assets whose economic benefits the company expects to realize within one year from the balance sheet date, or within the company’s operating cycle. Noncurrent assets are those assets with expected economic benefits exceeding one year.
The most common current assets are cash and equivalents, accounts receivable, inventory, and prepaid expenses.
The first item of monetary value on the balance sheet is cash and equivalents. This category includes cash balances at financial institutions and highly liquid, short-term financial securities. Because of the short time to maturity for such financial securities, the value of these securities should not deviate materially from their cash value due to interest rate fluctuations.
Often, a company will sell a good or service and, at the time of sale, receive from the customer a promise of future payment. When such a transaction occurs, the selling firm recognizes the sale and increases an asset account known as accounts receivable.
Accounts receivable must be recorded at net realizable value, meaning the company must estimate the amount of uncollectible receivables. The company establishes a contra-account to accounts receivable, known as allowance for bad debts, and adjusts this account accordingly in each accounting period. When a specific receivable is considered uncollectible and must be written off, the company debits the allowance account and credits the specific receivable. The allowance account, in other words, is a reserve for future uncollectible receivables.
Inventories are goods that a company holds to sell to customers as part of the company’s normal business operations. Companies often purchase the same inventory item at different prices. Thus, companies must assume, for accounting purposes, which items are sold.
Under current U.S. GAAP, companies can choose among three methods for allocating inventory costs to cost of goods sold:
- Weighted-average;
- First-in, first-out, or FIFO; and
- Last-in, first-out, or LIFO.
Under the weighted-average method, cost of goods sold for a period is the weighted average of the cost of goods available for sale, which includes beginning inventory plus inventory purchases, applied to the units sold during a period. The FIFO method assumes that the oldest units purchased are the first units sold. The LIFO method assumes that the most recently purchased units are the first units sold.
Under U.S. GAAP, inventory measurement depends on the inventory method used. Inventory measured using methods other than LIFO or the retail inventory method is generally measured at the lower of cost and net realizable value. Inventory measured using LIFO or the retail inventory method is generally measured at the lower of cost or market. If the required measurement amount is below the inventory’s carrying amount, the company must recognize a write-down. For some inventory-intensive companies, such as retailers, inventory write-downs may be an ongoing charge.
Long-term assets are those resources of the company expected to provide economic benefits beyond one period. Long-term assets can be tangible assets, such as property, plant, and equipment, or intangible assets, such as patents, trademarks, copyrights, or goodwill.
Accounting rules for long-term assets require companies to make determinations regarding capitalization, allocation, and impairment. Capitalization concerns which costs to include in the asset’s carrying value. Allocation concerns how to recognize the asset’s cost as an expense. Impairment concerns how and when to recognize deterioration in the asset’s fair value.
Companies generally carry tangible long-term assets at historical cost less accumulated depreciation and any recognized impairment. These assets are not ordinarily marked up to current market value under U.S. GAAP, although they may be written down if impaired.
The costs of certain tangible assets are periodically written down through a process known as depreciation. Limited-life intangible assets are also recorded at historical cost and written down through a process known as amortization.
For public companies, goodwill and many indefinite-lived intangible assets are not amortized but are tested for impairment at least annually and when events indicate possible impairment. Eligible private companies may elect accounting alternatives that allow goodwill to be amortized and tested for impairment upon triggering events. Investors should therefore understand whether they are analyzing public-company financial statements or private-company financial statements and adjust accordingly.
Impairment rules vary by asset type, but in general, if an asset’s carrying amount is no longer recoverable or exceeds its fair value under the applicable accounting model, the company may be required to recognize an impairment charge against earnings.
Liabilities
For the balance sheet to balance, the company must present assets with the corresponding claims against those assets. Liabilities, the financial or operational obligations that a company has with company outsiders, are one such claim. The other claim is owners’ equity.
Current liabilities are those obligations of the company that must be satisfied within one year or the company’s operating period, whichever is shorter. Consistent with the order-of-liquidity presentation of the balance sheet, the company’s current liabilities are presented before its noncurrent liabilities.
A company has two forms of current liabilities: operating liabilities and financing liabilities.
Current operating liabilities are the current obligations the company incurs as part of normal business operations. Examples of current operating liabilities are accounts payable and customer deposits.
Current financing liabilities are those current obligations related to the company’s borrowings. Companies must recognize in current liabilities borrowings with maturities of less than one year and the portion of longer-term borrowings due within one year from the balance sheet date.
Long-term liabilities include the noncurrent portion of debt, contingent liabilities, and pension obligations. Contingent liabilities are liabilities whose existence depends on the outcome of a future event.
Shareholders’ Equity
Shareholders’ equity refers to the residual claim on assets attributed to the company’s owners. Equity represents capital directly invested in the company by owners plus retained earnings. Certain gains, losses, and charges are recorded directly into owners’ equity.
Accounting for shareholders’ equity reflects the view of the firm as the sum of the capital employed. Lenders are considered outside providers of capital, while owners are considered inside providers of capital.
This view of the firm influences the recognition of income under both U.S. GAAP and IFRS. Income and expenses are generally recognized only when a transaction occurs with an outsider. The company would recognize no income or loss from transactions between the firm and its owners. For example, the company would not recognize dividends or share repurchases as transactions that affect income. In contrast, the company recognizes interest payments as expenses because they are transactions with outsiders.
The Cash Flow Statement
Because of timing differences between revenue and expense recognition and cash transfers, known as accruals, the income statement does not show the company’s cash receipts and cash disbursements. The cash flow statement, in contrast, shows the total cash receipts and disbursements for the company’s transactions over a period.
The cash flow statement shows the total change in the cash and equivalents amount on the balance sheet over a corresponding period.
Sections of the Cash Flow Statement
The cash flow statement is broken down into three sections:
- Cash flow from operating activities;
- Cash flow from investing activities; and
- Cash flow from financing activities.
Operating cash flow represents a company’s cash inflows and cash outflows resulting from transactions of the company’s normal business operations. The operating cash flow section is the first section presented in the cash flow statement.
Operating cash flow is the most important source of cash flow. A company producing insufficient operating cash flow will be unable to invest in growth, service debt, or pay dividends to shareholders.
Common sources of operating cash flow are cash from sales and collection of accounts receivable. Common uses of operating cash flow are cash payments for inventory, cash payments for operating expenses, and reductions in payables.
Cash flow from investing activities represents cash inflows and outflows arising from the purchase or sale of long-term assets. Examples of sources of investing cash flow are the sale of equipment and real estate. Examples of uses of investing cash flow include the purchase of equipment, real estate, and intangible assets.
The direct purchase of assets in the investing section is known as capital expenditures. These activities are presented separately from cash used for acquisitions, which are the outlays used to acquire companies.
Cash flow from financing activities represents cash inflows and outflows relating to a company obtaining and paying capital. Essentially, this section of the cash flow statement shows any cash transactions with the company’s owners and creditors.
Examples of sources of financing cash flow include the cash proceeds from the issuance of equity and cash proceeds from the issuance of debt. Examples of uses of financing cash flow include cash payments used to repurchase stock, the payment of cash dividends, and the repayment of long-term debt.
Direct and Indirect Methods
The two cash flow statement formats are the direct method and the indirect method.
Under the direct method, the operating section of the cash flow statement is broken down such that each income statement category is adjusted for its related accruals. Because of the increased detail, the direct method offers financial statement users a more in-depth presentation of the company’s cash sources and uses. The direct method cash flow presentation is often considered the cash-basis income statement.
U.S. GAAP requires companies electing to use the direct method to, at a minimum, present cash sources and uses in the following categories:
- Cash collected from customers;
- Interest and dividends received;
- Other operating cash receipts;
- Cash paid to employees and suppliers;
- Interest paid;
- Income taxes; and
- Other cash payments.
The indirect method presents operating cash flow indirectly by reconciling net income to operating cash flow. The presentation of the indirect method begins by adding back noncash expenses, such as depreciation, amortization, and employee stock-option expense.
The statement then shows the cash impact of changes in current assets and current liabilities:
- Increases in current assets represent uses of cash and are subtracted from net income;
- Decreases in current assets are sources of cash and are added to net income;
- Increases in current liabilities are a source of cash and are added to net income; and
- Decreases in current liabilities are a use of cash and are subtracted from net income.
U.S. GAAP requires companies to use the indirect method, regardless of the use of the direct method. Thus, most U.S. public companies present their cash flow statement using only the indirect method.
Adjustments to Financial Statements
Investors must adjust a company’s financial statements for two primary reasons:
- To better reflect the firm’s underlying economics; and
- To facilitate better comparison of companies using different accounting estimates or reporting under different accounting regimes.
Investors use adjusted financial statements to improve the usefulness of financial ratios and company analysis.
Investors must determine which financial statement items warrant adjustment. This is a subjective undertaking. Although there is no single accepted approach to making such adjustments, most investors follow a similar framework.
Normalizing Operating Income
Investors are more concerned with the company’s ability to generate sustainable earnings than they are with reported profits. To develop estimates of sustainable earnings, investors must segregate operating earnings from income items that are nonoperating or nonrecurring.
Investors generally follow a two-part approach for handling nonoperating and nonrecurring items:
- Identify items within operating earnings that are outside of a company’s recurring business operations; and
- Determine which of these nonrecurring items should be provisioned for or eliminated and adjust income accordingly.
Through this process, investors will not naively ignore these items. Rather, investors will develop an adjusted income statement better suited for valuation and credit analysis.
Investors should perform this analysis for several years of financial data. For noncyclical firms, three to five years may suffice. For cyclical firms, investors should look at the company’s financial performance going back at least one full business cycle.
Investors must first identify those items least likely to persist. Not all nonrecurring items are separately disclosed on the income statement. Investors must carefully read the footnotes and the management’s discussion and analysis, or MD&A, section of the annual reports to identify such items.
These items are often described by management as nonrecurring, unusual, infrequent, one-time, restructuring-related, impairment-related, or otherwise outside normal operations. Investors should be aware that U.S. GAAP no longer uses “extraordinary items” as a formal income statement classification, although unusual or infrequent items may still require separate presentation or disclosure.
In general, investors should ask the following question: Does the item have any explanatory value for future earnings and cash flows?
If the answer is yes, the item should be provisioned for when calculating normalized earnings. If the answer is no, the item should be eliminated from normalized earnings.
Adjusting the Balance Sheet
Investors should make certain adjustments to the balance sheet to:
- Recognize obligations or assets that are not included on the balance sheet; and
- Reflect assets at estimated current market values.
The resulting adjusted balance sheet is referred to as a current cost balance sheet and will better reflect the net resources available to the company’s credit and equity investors.
Investors should identify assets that are unnecessary to the firm’s core operations. Once identified, these assets should occupy a separate section within the current cost balance sheet.
By segregating assets that do not contribute to operating earnings, investors can analyze business operations against corresponding assets. This adjustment also allows investors to identify assets that the firm can sell without impeding operating earnings.
Adjusting the Cash Flow Statement
The cash flow statement reports cash flow in the following categories:
- Cash flow from operations, or CFO;
- Cash flow from investing activities, or CFI; and
- Cash flow from financing activities, or CFF.
From an investor’s standpoint, however, not all items are appropriately classified. Thus, investors must adjust the cash flow statement to improve its usefulness. Like the other financial statements, investors should make these adjustments to several years of statements and look at trends in the adjusted numbers.
Adjusting the cash flow statement involves several steps:
- Reclassifying certain items from or into CFO;
- Identifying non-sustainable sources of operating cash flow;
- Separating CFO into sustainable and unsustainable components; and
- Calculating free cash flow, defined as adjusted CFO minus capital expenditures.
Financial Ratios
Financial ratios are the foundation of fundamental analysis. Ratios allow investors to view certain financial figures in relation to other financial figures. Ratios are important because few financial statement items have meaning in isolation.
By placing financial statement items within a deeper analytical context, investors can make more informed decisions about the company’s financial position and operating performance.
Investors rely on three categories of ratios:
- Operating activity ratios;
- Credit ratios; and
- Profitability ratios.
Operating Activity Ratios
Operating ratios help investors determine how efficiently a company is employing its assets. Some common operating ratios include inventory turnover, receivables turnover, payables turnover, working capital turnover, fixed assets turnover, and total asset turnover.
Inventory Turnover
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
This ratio shows investors how many times, on average, inventory is sold and replaced during an accounting period. A higher-than-average ratio, as compared against industry norms, could indicate efficient inventory management. Alternatively, a high ratio could indicate that the company is carrying insufficient quantities of inventory, which could impair future sales.
Investors should pay attention to the trend in the ratio. A significant decrease in inventory turnover suggests inventory is slow to sell.
Receivables Turnover
Receivables Turnover = Net Credit Sales ÷ Average Accounts Receivable
This ratio helps investors assess the quality and liquidity of a firm’s trade receivables. The ratio indicates the number of times the firm’s outstanding trade receivables have been collected during the accounting period.
A comparatively high turnover ratio could indicate collection efficiency, or it could mean the firm is too conservative in granting credit terms, potentially losing sales. The turnover ratio indicates the age of the receivables, so a comparatively low turnover ratio could be a sign of poor earnings quality, as the collection of receivables is doubtful.
Payables Turnover
Payables Turnover = Inventory Purchases ÷ Average Trade Payables
This ratio measures the average number of times a company pays its suppliers in a period. A comparatively high ratio may indicate the company is taking advantage of supplier early-pay discounts. However, a comparatively high ratio could also indicate inefficient cash management, as the company is not fully utilizing supplier credit terms.
Investors should give attention to an abnormally low payables turnover ratio, as this could indicate the company is struggling to pay its bills.
Working Capital Turnover
Working Capital Turnover = Revenue ÷ Average Working Capital
Working capital is the difference between a company’s current assets and current liabilities. This ratio indicates the amount of revenue a company generates per dollar of working capital.
The higher the ratio, the more efficient the company is in managing its working capital. To improve the usefulness of this ratio, investors should exclude nonoperating assets and liabilities from the calculation of working capital.
Fixed Assets Turnover
Fixed Assets Turnover = Revenue ÷ Average Net Fixed Assets
This ratio measures the sales the company generates per dollar of fixed assets. Generally, a higher ratio indicates more efficient use of fixed assets in generating revenue.
Investors, however, should be aware of two issues with this ratio. First, newer and less-depreciated assets will lead to a lower ratio than older, more-depreciated assets. Second, investment patterns are usually unequal, which can create volatility in the trend.
Total Asset Turnover
Total Asset Turnover = Revenue ÷ Average Total Assets
This ratio measures the sales the company generates per dollar of total assets. Thus, this ratio is sensitive to both the level of current assets and the level of long-term, or fixed, assets.
Credit Ratios
Credit ratios help investors determine if a company can meet its current and long-term debt obligations. Credit ratios are further classified into liquidity ratios and solvency ratios.
Liquidity Ratios
Liquidity refers to a company’s ability to pay short-term credit obligations. Common liquidity ratios include the current ratio, quick ratio, cash ratio, and defensive interval ratio.
Current Ratio
Current Ratio = Current Assets ÷ Current Liabilities
The current ratio indicates the current assets a company has available to cover each dollar of current liabilities.
Investors should be aware of the inclusion of inventory and prepaid expenses in current assets. For an ongoing enterprise, inventory should not be considered a liquid asset, since the company must maintain a minimum level of inventory to operate. Also, inventory is unlikely to be sold quickly without substantial impairment. Prepaid expenses have no liquidation value but are considered an asset only in the sense that they preserve the outlay of funds.
Quick Ratio
Quick Ratio = (Cash + Marketable Securities + Receivables) ÷ Current Liabilities
The quick ratio excludes inventory and prepaid expenses from current assets and is thus a more conservative measure of liquidity than the current ratio.
Cash Ratio
Cash Ratio = (Cash + Marketable Securities) ÷ Current Liabilities
By using the company’s most liquid assets, the cash ratio is the most conservative measure of liquidity.
Defensive Interval Ratio
Defensive Interval Ratio = (Cash + Marketable Securities + Receivables) ÷ Daily Cash Expenditures
This ratio indicates the amount of time that a company can fund its expenditures with existing resources. A similar concept known as the burn rate is used in the analysis of start-up and distressed firms.
Solvency Ratios
Solvency refers to a company’s ability to service long-term debt obligations. Common solvency ratios include debt-to-assets, debt-to-capital, debt-to-equity, financial leverage ratio, interest coverage, and fixed charge coverage.
Debt-to-Assets
Debt-to-Assets = Total Debt ÷ Total Assets
This ratio indicates the proportion of total assets financed with debt. The higher this ratio, the more debt a company has relative to total assets.
Debt-to-Capital
Debt-to-Capital = Total Debt ÷ (Total Debt + Shareholders’ Equity)
This ratio indicates the amount of debt a company has per dollar of total capital. The greater the ratio, the more leveraged the company’s capital structure.
Debt-to-Equity
Debt-to-Equity = Total Debt ÷ Shareholders’ Equity
This ratio indicates the amount of debt a company has per dollar of equity. The greater the ratio, the more leveraged the company’s capital structure.
Financial Leverage Ratio
Financial Leverage Ratio = Average Total Assets ÷ Average Total Equity
This ratio measures the assets the firm owns for each dollar of equity capital. The higher the ratio, the more the company uses debt to finance assets.
Interest Coverage
Interest Coverage = Earnings Before Interest and Taxes, or EBIT ÷ Interest Expense
This ratio indicates the amount of pretax, pre-interest operating earnings available for each dollar of interest expense. The ratio is also referred to as the times interest earned ratio and can be interpreted as the number of times that operating earnings can cover interest expense.
A higher ratio indicates a more conservatively financed company.
Fixed Charge Coverage Ratio
Fixed Charge Coverage Ratio = (EBIT + Fixed Charges) ÷ Total Fixed Charges
This ratio is a more conservative measure of a firm’s solvency in that it indicates the earnings available to cover all contractually obligated financing payments. In particular, this measure includes rent payments as a financing cost. A higher ratio indicates a more conservative use of fixed charges in the company’s financial structure.
Profitability Ratios
Profitability ratios assist investors in analyzing two aspects of profitability. The first is the amount of profit in relation to sales. The second is profit in relation to the assets and capital that support the firm’s operations.
Profit is more meaningful to investors when analyzed in relation to the resources employed in generating that profit. Common profitability ratios include gross margin, operating margin, pretax margin, net profit margin, return on assets, return on total capital, and return on common equity.
Gross Profit Margin
Gross Profit Margin = Gross Profit ÷ Revenue
Gross profit is defined as revenue minus cost of goods sold. This measure indicates the amount of each revenue dollar that is available to pay the firm’s operating expenses.
Operating Margin
Operating Margin = Operating Income ÷ Revenue
Operating income is the earnings from the company’s core operations, excluding the effects of investments, financing costs, and taxes. This measure indicates the amount of revenue available after the firm pays cost of goods and operating expenses. Operating margin reflects the firm’s cost structure and pricing strategy.
Pretax Margin
Pretax Margin = Earnings Before Taxes, or EBT ÷ Revenue
The pretax margin measures the amount of each sales dollar subject to taxation. This measure includes the effects of interest expense.
Net Profit Margin
Net Profit Margin = Net Income After Tax ÷ Revenue
This ratio indicates the amount of each revenue dollar that is available after all expenses, including interest and taxes, have been paid. This ratio is most useful to investors when it excludes nonrecurring items.
Return on Assets
Return on Assets = Operating Income, or EBIT ÷ Average Total Assets
This ratio measures the amount of income the company generates per dollar of assets. By using EBIT in the numerator, the calculation eliminates the impact of leverage, since a company’s assets are financed with both equity and debt. Using EBIT in the numerator also allows investors to compare this measure among firms with different capital structures.
Return on Total Capital
Return on Total Capital = EBIT ÷ (Total Debt + Shareholders’ Equity)
This ratio measures the profits a company earns relative to all the firm’s capital employed in its operations. The measure is interpreted as the amount of operating income generated per dollar of total capital.
Return on Common Equity
Return on Common Equity = (Net Income – Preferred Dividends) ÷ Average Common Equity
This ratio measures income relative to the company’s common equity. This measure is impacted by both the company’s operating income and its use of financial leverage.
A useful tool for further analysis of return on equity, or ROE, is the DuPont formula, so named because it was created at E. I. du Pont de Nemours and Company.
The DuPont formula states ROE as follows:
ROE = Return on Assets × Financial Leverage
ROE = (Net Income ÷ Average Total Assets) × (Average Total Assets ÷ Average Shareholders’ Equity)
This formula states ROE as a product of:
- The firm’s ability to earn returns on assets; and
- The firm’s use of financial leverage.
Investors can see that a company has several levers it can pull to increase returns on assets and equity. Namely, the company can improve ROE by improving its return on assets or by increasing its leverage.
Conclusion
Corporate accounting is considered the language of business. As such, investors cannot understand a company’s operating performance or financial profile without thoroughly analyzing the company’s financial statements.
Financial statement analysis is one of the key skills for successful investing. Successful investors understand the limitations of accounting standards and the discretion that management has in recognizing certain items. Investors, therefore, know to make necessary adjustments to the company’s financial statements to formulate an accurate description of the company’s operations and financial position.
Investors’ efforts in this field, however, can be well rewarded.
Sources
Revsine, Lawrence, Daniel W. Collins, W. Bruce Johnson, H. Fred Mittelstaedt, and Leonard C. Soffer. Financial Reporting & Analysis, 6th ed. New York: McGraw-Hill, 2015.
Robinson, Thomas R., Elaine Henry, Wendy L. Pirie, and Michael A. Broihahn. International Financial Statement Analysis, 3rd ed. Hoboken: Wiley, 2015.
White, Gerald I., Ashwinpaul C. Sondhi, and Dov Fried. The Analysis and Use of Financial Statements, 3rd ed. Hoboken: Wiley, 2003.
