Module 1

Framework for Analysis and Valuation

DISCUSSION QUESIONS
Q1!1" Or#ani$ations undertake %lannin# a&ti'ities t(at s(a%e t(ree ma)or
a&ti'ities* finan&in#+ in'estin#+ and o%eratin#" Finan&in# is t(e
means a &om%any uses to %ay for resour&es" In'estin# refers to
t(e ,uyin# and sellin# of resour&es ne&essary to &arry out t(e
or#ani$ation-s %lans" O%eratin# a&ti'ities are t(e a&tual &arryin#
out of t(ese %lans" .lannin# is t(e #lue t(at &onne&ts t(ese
a&ti'ities+ in&ludin# t(e or#ani$ation-s ideas+ #oals and strate#ies"
Finan&ial a&&ountin# information %ro'ides 'alua,le in%ut into t(e
%lannin# %ro&ess+ and+ su,se/uently+ re%orts on t(e results of
%lans so t(at &orre&ti'e a&tion &an ,e taken+ if ne&essary"
Q1!0" An or#ani$ation-s finan&in# a&ti'ities 1lia,ilities and e/uity 2
sour&es of funds3 %ay for in'estin# a&ti'ities 1assets 2 uses of
funds3" An or#ani$ation-s assets &annot ,e more or less t(an its
lia,ilities and e/uity &om,ined" (is means* assets 2 lia,ilities 4
e/uity" (is relation is &alled t(e a&&ountin# e/uation 1sometimes
&alled t(e balance sheet equation3+ and it a%%lies to all
or#ani$ations at all times"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-1
Q1!5" (e four main finan&ial statements are* in&ome statement+ ,alan&e
s(eet+ statement of sto&k(olders- e/uity+ and statement of &as(
flows" (e in&ome statement %ro'ides information a,out t(e
&om%any-s re'enues+ e6%enses and %rofita,ility o'er a %eriod of
time" (e ,alan&e s(eet lists t(e &om%any-s assets 1w(at it owns3+
lia,ilities 1w(at it owes3+ and sto&k(olders- e/uity 1t(e residual
&laims of its owners3 as of a %oint in time" (e statement of
sto&k(olders- e/uity re%orts on t(e &(an#es to ea&( sto&k(olders-
e/uity a&&ount durin# t(e %eriod" (e statement of &as( flows
identifies t(e sour&es 1inflows3 and uses 1outflows3 of &as(+ t(at
is+ w(ere t(e &om%any #ot its &as( from and w(at it did wit( it"
o#et(er+ t(e four statements %ro'ide a &om%lete %i&ture of t(e
finan&ial &ondition of t(e &om%any"
Q1!7" (e ,alan&e s(eet %ro'ides information t(at (el%s users
understand a &om%any-s resour&es 1assets3 and &laims to t(ose
resour&es 1lia,ilities and sto&k(olders- e/uity3 as of a #i'en point
in time"
Q1!8" (e in&ome statement &o'ers a period o time" An in&ome
statement re%orts w(et(er t(e ,usiness (as earned a net in&ome
1also &alled %rofit or earnin#s3 or in&urred a net loss" Im%ortantly+
t(e in&ome statement lists t(e ty%es and amounts of re'enues and
e6%enses makin# u% net in&ome or net loss"
Q1!9" (e statement of &as( flows re%orts on t(e &as( inflows and
outflows relatin# to a &om%any-s o%eratin#+ in'estin#+ and
finan&in# a&ti'ities o'er a period o time" (e sum of t(ese t(ree
a&ti'ities yields t(e net &(an#e in &as( for t(e %eriod" (is
statement is a useful &om%lement to t(e in&ome statement+ w(i&(
re%orts on re'enues and e6%enses+ ,ut w(i&( &on'eys relati'ely
little information a,out &as( flows"
Q1!:" ;etained earnin#s 1re%orted on t(e ,alan&e s(eet3 is in&reased
ea&( %eriod ,y any net in&ome earned durin# t(e %eriod 1as
re%orted in t(e in&ome statement3 and de&reased ea&( %eriod ,y
t(e %ayment of di'idends 1as re%orted in t(e statement of &as(
flows and t(e statement of sto&k(olders- e/uity3" ransa&tions
refle&ted on t(e statement of &as( flows link t(e %re'ious %eriod-s
,alan&e s(eet to t(e &urrent %eriod-s ,alan&e s(eet" (e endin#
&as( ,alan&e a%%ears on ,ot( t(e ,alan&e s(eet and t(e
statement of &as( flows"
Cambridge Business Publishers, 2013
1-2 !inancial Statement "nal#sis $ %aluation, 3rd &dition
Q1!<" E6ternal users and t(eir uses of a&&ountin# information in&lude*
1a3 lenders for measurin# t(e risk and return of loans= 1,3
s(are(olders for assessin# t(e return and risk in a&/uirin# s(ares=
and 1&3 analysts for assessin# in'estment %otential" Ot(er users
are auditors+ &onsultants+ offi&ers+ dire&tors for o'erseein#
mana#ement+ em%loyees for )ud#in# em%loyment o%%ortunities+
re#ulators+ unions+ su%%liers+ and a%%raisers"
Q1!>" Fore&astin# is a met(od of formally e6%ressin# our e6%e&tations
of a &om%any?s future %ayoffs" @(en fore&astin# &om%any
%ayoffs+ we need to &onsider t(e effe&ts of t(eir ,usiness
en'ironment on t(e &om%any?s a,ility to a&(ie'e t(ose future
%ayoffs" Com%etiti'e for&es as well as o%%ortunities and t(reats
will im%a&t w(at t(e &om%any &an %ay in t(e future" (is in turn
affe&ts w(at %ayoffs are e6%e&ted" A ,etter understandin# of
,usiness en'ironment and a&&ountin# information leads to more
a&&urate fore&asts of t(e future and more relia,le 'aluation
estimates"
Q1!1A"
A
.ro&ter B Cam,le-s inde%endent auditor is Deloitte B ou&(e DD."
(e auditor e6%ressly states t(at Eour res%onsi,ility is to e6%ress
an o%inion on t(ese finan&ial statements ,ased on our audits"F
(e auditor also states t(at Et(ese finan&ial statements are t(e
res%onsi,ility of t(e &om%any-s mana#ement"F (us+ t(e auditor
does not assume res%onsi,ility for t(e finan&ial statements"
Q1!11"
G
@(ile firms a&knowled#e t(e in&reasin# need for more &om%lete
dis&losure of finan&ial and nonfinan&ial information+ t(ey (a'e
resisted t(ese demands to %rote&t t(eir &om%etiti'e %osition"
Cor%orate e6e&uti'es must wei#( t(e ,enefits t(ey re&ei'e from
t(e finan&ial markets as a result of more trans%arent and re'ealin#
finan&ial re%ortin# a#ainst t(e &osts of di'ul#in# %ro%rietary
information to &om%etitors and ot(ers"
Q1!10"
G
Cenerally A&&e%ted A&&ountin# .rin&i%les 1CAA.3 are t(e 'arious
met(ods+ rules+ %ra&ti&es+ and ot(er %ro&edures t(at (a'e e'ol'ed
o'er time in res%onse to t(e need to re#ulate t(e %re%aration of
finan&ial statements" (ey are %rimarily set ,y t(e Finan&ial
A&&ountin# Standards Goard 1FASG3+ a %ri'ate se&tor entity wit(
re%resentati'es from &om%anies t(at issue finan&ial statements+
a&&ountin# firms t(at audit t(ose statements+ and users of
finan&ial information" Ot(er ,odies t(at &ontri,ute to CAA. are t(e
AIC.A+ t(e EIF+ and t(e SEC"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-3
Q1!15"
G
Cor%orate #o'ernan&e is t(e system of %oli&ies+ %ro&edures and
me&(anisms t(at %rote&t t(e interests of stake(olders in t(e
,usiness" (ese stake(olders in&lude in'estors+ &reditors+
re#ulatory ,odies+ and em%loyees+ to name a few" Sound
&or%orate #o'ernan&e in'ol'es t(e maintenan&e of an effe&ti'e
internal auditin# fun&tion+ an inde%endent and effe&ti'e e6ternal
auditin# fun&tion+ an informed and im%artial ,oard of dire&tors+
#o'ernmental o'ersi#(t 1su&( as from t(e SEC3+ and t(e o'ersi#(t
of t(e &ourts"
Q1!17"
G
(e auditor-s %rimary fun&tion is to e6%ress an o%inion as to
w(et(er t(e finan&ial statements fairly %resent t(e finan&ial
&ondition of t(e &om%any and are free from material
misstatements" Auditors do not %re%are t(e finan&ial statements=
t(ey only audit t(em and issue t(eir o%inion on t(em" (e
auditors %ro'ide no #uarantees a,out t(e finan&ial statements or
a,out t(e &om%any-s &ontinued %erforman&e"
Q1!18" Finan&ial a&&ountin# information is fre/uently used in order to
e'aluate mana#ement %erforman&e" (e return on e/uity 1;OE3
and return on assets 1;OA3 %ro'ide useful measures of finan&ial
%erforman&e as t(ey &om,ine elements from ,ot( t(e in&ome
statement and t(e ,alan&e s(eet" Finan&ial a&&ountin# information
is also fre/uently used to monitor &om%lian&e wit( e6ternal
&ontra&t terms" Ganks often set limits on su&( items as t(e
amount of total lia,ilities in relation to sto&k(olders- e/uity or t(e
amount of di'idends t(at a &om%any may %ay" Audited finan&ial
statements %ro'ide information t(at &an ,e used to monitor
&om%lian&e wit( t(ese limits 1often &alled co'enants3" ;e#ulators
and ta6in# aut(orities also utili$e finan&ial information to monitor
items of interest"
Q1!19" Mana#ers are 'itally &on&erned a,out dis&losin# %ro%rietary
information t(at mi#(t ,enefit t(e &om%any-s &om%etitors" Of most
&on&ern+ is t(e E&ostF of losin# some &om%etiti'e ad'anta#e"
(ere (as traditionally ,een tension ,etween &om%anies and t(e
finan&ial %rofessionals 1es%e&ially in'estment analysts3 w(o %ress
firms for more and more finan&ial and nonfinan&ial information"
Cambridge Business Publishers, 2013
1-( !inancial Statement "nal#sis $ %aluation, 3rd &dition
Q1!1:" Net in&ome is an im%ortant measure of finan&ial %erforman&e" It
indi&ates t(at t(e market 'alues t(e &om%any-s %rodu&ts or
ser'i&es+ t(at is+ it is willin# to %ay a %ri&e for t(e %rodu&ts or
ser'i&es enou#( to &o'er t(e &osts to ,rin# t(em to market and to
%ro'ide t(e &om%any-s in'estors wit( a %rofit" Net in&ome does
not tell t(e w(ole story+ (owe'er" A &om%any &an always in&rease
its net in&ome wit( additional in'estment in somet(in# as sim%le
as a ,ank sa'in#s a&&ount" A more meanin#ful measure of
finan&ial %erforman&e &omes from measurin# t(e le'el of net
in&ome relati'e to t(e in'estment made" One in'estment measure
is t(e ,alan&e of sto&k(olders- e/uity+ and t(e &om%arison of net
in&ome to a'era#e sto&k(olders- e/uity 1;OE3 is a fundamental
measure of finan&ial %erforman&e"
Q1!1<" Gorrowed money must ,e re%aid+ ,ot( t(e %rin&i%al amount
,orrowed+ as well as interest on t(e ,orrowed funds" (ese
%ayments (a'e &ontra&tual due dates" If %ayments are not %rom%t+
&reditors (a'e %owerful le#al remedies+ in&ludin# for&in# t(e
&om%any into ,ankru%t&y" Conse/uently+ w(en &om%arin# two
&om%anies wit( t(e same return on e/uity+ t(e one usin# less de,t
would #enerally ,e 'iewed as a safer 1less risky3 in'estment"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-)
MINI EHE;CISES
M1!1> 11A minutes3
1I millions3
Assets 2 Dia,ilities 4 E/uity
I5<+8>> I5A+<55 I:+:99
Dell re&ei'es more of its finan&in# from nonowners 1I5A+<55 million3 t(an
from owners 1I:+:99 million3" Its owner finan&in# &om%rises 0A"1J of its
total finan&in# 1I:+:99 millionK I5<+8>> million3" (us+ nonowners finan&e
:>">J of Dell-s total assets"
M1!0A 11A minutes3
1I millions3
Assets 2 Dia,ilities 4 E/uity
I1:+<7> I1A+88: I:+0>0
Gest Guy re&ei'es more of its finan&in# from nonowners 1I1A+88: million3
t(an from owners 1I:+0>0 million3" Its owner finan&in# &om%rises 7A">J of
its total finan&in# 1I:+0>0 millionK I1:+<7> million3"
Cambridge Business Publishers, 2013
1-* !inancial Statement "nal#sis $ %aluation, 3rd &dition
M1!01 118 minutes3
1I millions3
Assets 2 Dia,ilities 4 E/uity
Lewlett!.a&kard I107+8A5 I<5+:00 1a3 I7A+:<1
Ceneral Mills I1<+9:7 1,3 I10+A90 I9+910
ar#et 1&3 I75+:A8 I0<+01< I18+7<:
(e %er&ent of owner finan&in# for ea&( &om%any follows*
Lewlett!.a&kard""""""""""""""""""""" 50"<J 1I7A+:<1 million K I107+8A5 million3
Ceneral Mills""""""""""""""""""""""""""" 58"7J 1I9+910 million K I1<+9:7 million3
ar#et""""""""""""""""""""""""""""""""""""""" 58"7J 1I18+7<: million K I75+:A8 million3
Ceneral Mills and ar#et are more owner finan&ed+ w(ile Lewlett!.a&kard is
more nonowner finan&ed+ ,ut all are finan&ed wit( rou#(ly t(e same le'el
of de,t and e/uity" All t(ree en)oy relati'ely sta,le &as( flows and &an+
t(erefore+ utili$e a #reater %ro%ortion of de,t 's" e/uity" As t(e un&ertainty
of &as( flows in&reases+ &om%anies #enerally su,stitute e/uity for de,t in
order to redu&e t(e ma#nitude of &ontra&tual %ayment o,li#ations"
M1!00
A
118 minutes3
In its O&to,er 0A1A annual re%ort+ Star,u&ks re%orts t(e followin# fi#ures
1in I millions3*
Assets 2 Dia,ilities 4 E/uity
I 9+5<8"> 2 I 0+:A5"9 4 I 5+9<0"5
As s(own+ t(e a&&ountin# e/uation (olds for Star,u&ks" Also+ we &an see
t(at Star,u&ks- nonowner finan&in# is 70"5J 1I0+:A5"9 K I9+5<8">3 of its total
finan&in#"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-+
M1!05
A
10A minutes3
Du.ont
Statement of ;ein'ested Earnin#s
For Mear Ended De&em,er 51+ 0A1A
Ge#innin# rein'ested earnin#s+ De&em,er 51+ 0AA>"""""""""""""""""""""" I 1A+:1A
Net in&ome for 0A1A""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 5+A51
Common sto&k di'idends"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 11+8AA3
.referred sto&k di'idends""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 11A3
reasury sto&k retirementN"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 10A13
Endin# rein'ested earnin#s+ De&em,er 51+ 0A1A"""""""""""""""""""""""""""" I 10+A5A
N reasury Sto&k re%resents t(e &om%any-s re%ur&(ase of Common Sto&k" (e effe&t is to
de&rease sto&k(olders- e/uity+ w(i&( is t(e o%%osite effe&t from t(e issuan&e of sto&k"
Durin# 0A1A+ Du.ont retired reasury Sto&k and will not reissue t(ese s(ares a#ain" (is
transa&tion redu&ed t(e &om%any-s retained earnin#s ,ut did not affe&t net in&ome for t(e
year"
M1!07 10A minutes3
a" GS and SCF d" GS and SE #" SCF and SE
," IS e" SCF (" SCF and SE
&" GS f" GS and SE i" IS+ SE+ and SCF
Cambridge Business Publishers, 2013
1-, !inancial Statement "nal#sis $ %aluation, 3rd &dition
M1!08 11A minutes3
(ere are many stake(olders im%a&ted ,y t(is ,usiness de&ision+ in&ludin#
t(e followin# 1alon# wit( a des&ri%tion of (ow3*
Mou as a Mana#erOyour re%utation+ self!esteem+ and %otentially your
li'eli(ood &ould ,e ne#ati'ely im%a&ted"
Creditors and Gond(oldersO&redit de&isions ,ased on ina&&urate
information &ould o&&ur"
S(are(oldersO,uyin# or sellin# s(ares ,ased on ina&&urate
information &ould o&&ur"
Mana#ement and ot(er Em%loyees of your &om%anyOre%er&ussions of
your de&ision e6tend to all ot(er em%loyees" Also+ a de&ision to re&ord
t(ese re'enues su##ests an en'ironment &ondonin# dis(onesty"
Indeed+ your de&isions &an affe&t many more %arties t(an you mi#(t
initially reali$e" (e s(ort!term ,enefit of meetin# @all Street-s e6%e&tations
&ould (a'e serious lon#!term ramifi&ations"
M1!09
G
11A minutes3
Internal &ontrols are desi#ned for t(e followin# %ur%oses*
Monitorin# an or#ani$ation-s a&ti'ities to %romote effi&ien&y and to
%re'ent wron#ful use of its resour&es
Ensurin# t(e 'alidity and &redi,ility of e6ternal a&&ountin# re%orts
.romotin# effe&ti'e o%erations
Ensurin# relia,le internal re%ortin#
Con#ress (as a s%e&ial interest in internal &ontrols and re%orts a,out
t(em" S%e&ifi&ally+ t(e a,sen&e or failure of internal &ontrols &an ad'ersely
affe&t t(e effe&ti'eness of domesti& and #lo,al finan&ial markets" Enron
%ro'ided Con#ress wit( a &ase in %oint"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1--
EHE;CISES
E1!0: 118 minutes3
a" ar#et (as a %ro%rietary &redit &ard 1t(e ar#et Card3" Customers- un%aid
&redit &ard ,alan&es at t(e end of t(e re%ortin# %eriod are similar to
a&&ounts re&ei'a,le"
," ar#et-s in'entories &onsist of t(e %rodu&t lines it &arries* &lot(in#+
ele&troni&s+ (ome furnis(in#s+ food %rodu&ts+ and so fort("

&" ar#et-s ..E assets &onsist of land+ ,uildin#s+ store im%ro'ements su&(
as li#(tin#+ floorin#+ LVAC+ store s(el'in#+ s(o%%in# &arria#es+ and &as(
re#isters"
d" Alt(ou#( ar#et sells some of its mer&(andise 'ia its @e,site+ t(e
ma)ority of its sales a&ti'ity is &ondu&ted in its retail lo&ations" (ese
stores re%resent a su,stantial and ne&essary &a%ital in'estment for its
,usiness model"
E1!0< 10A minutes3
1I millions3
a" Usin# t(e a&&ountin# e/uation*
Assets 1I95+1<93 2 Dia,ilities 1I15+:893 4 E/uity 1P3
.hus/ I7>+75A 2 E/uity
Li#(!te&( &om%anies must &ontend wit( a su,stantial amount of risk
relatin# to &(an#in# te&(nolo#y" Future &as( flows are+ t(erefore+ not as
&ertain and &annot su%%ort (i#( le'els of de,t" (us+ t(e &om%any uses
e/uity finan&in#= :<"0J in t(e &ase of Intel"
Cambridge Business Publishers, 2013
1-10 !inancial Statement "nal#sis $ %aluation, 3rd &dition
E1!0< 1&on&luded3
," Usin# t(e a&&ountin# e/uation at t(e beginning of t(e year*
Assets 1I9+87>3 2 Dia,ilities 1P3 4 E/uity 1I1+8793
.hus/ Beginning Dia,ilities 2 I8+AA5
Usin# t(e a&&ountin# e/uation at t(e end of t(e year*
Assets 1I9+87> 4 I773 2 Dia,ilities 1I8+AA5 ! I973 4 E/uity 1P3
.hus/ &nding E/uity 2 I1+987
"lternati'e approach to sol'ing part 0b1/
Assets1I773 2 Dia,ilities1I!973 4 E/uity1P3
w(ere EF refers to E&(an#e in"F
.hus/ &nding E/uity 2 I77 ! I!97 2 I1A< and
Endin# e/uity 2 I1+879 4 I1A< 2 I1+987
&" ;etained Earnin#s is t(e ,alan&e s(eet a&&ount t(at %ro'ides t(e link
,etween t(e ,alan&e s(eet and t(e in&ome statement" Ea&( a&&ountin#
%eriod+ ;etained Earnin#s is u%dated ,y t(e net in&ome 1loss3 re%orted
for t(at %eriod 1and is redu&ed ,y any di'idends t(at are %aid to
s(are(olders3" (e ,alan&e s(eet and t(e in&ome statement are+
t(erefore+ linked ,y t(is ,alan&e s(eet a&&ount"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-11
E1!0> 118 minutes3
E6ternal &onstituents use a&&ountin# information from finan&ial statements
to answer /uestions su&( as t(e followin#*
1" S(are(olders 1in'estors3+ ask /uestions su&( as*
a" Are t(e &om%any-s resour&es ade/uate to &arry out strate#i& %lansP
," Are t(e &om%any-s de,ts a%%ro%riate in amount #i'en t(e &om%any-s
e6istin# assets and %lans for #rowt(P
&" @(at is t(e &urrent le'el of in&ome 1and w(at are its &om%onents3P
d" Is t(e &urrent sto&k %ri&e indi&ati'e of t(e &om%any-s %rofita,ility and
le'el of de,tP
0" Creditors+ ask /uestions su&( as*
a" Does t(e ,usiness (a'e t(e a,ility to re%ay its de,ts as t(ey &ome
dueP
," Can t(e ,usiness take on additional de,tP
&" Are &urrent assets suffi&ient to &o'er &urrent lia,ilitiesP
5" Em%loyees+ ask /uestions su&( as*
a" Is t(e ,usiness finan&ially sta,leP
," Can t(e ,usiness afford to %ay (i#(er salariesP
&" @(at are #rowt( %ros%e&ts for t(e or#ani$ationP
d" @ill t(e &om%any ,e a,le to %ay my %ension w(en I retireP
E1!5A 11A minutes3
Com%utation of di'idends
Ge#innin# retained earnin#s+ 0A1A""""""""""""""""""""""""""""""""""""""""""""""""" I 15+18:
4 Net in&ome"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 0+0A5
Q Cas( di'idends""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 1P3
2 Endin# retained earnin#s+ 0A1A"""""""""""""""""""""""""""""""""""""""""""""""""""""" I 17+50>
(us+ di'idends were I1+A51 million for 0A1A" (e &om%any %aid out
di'idends e/ual to 79"<J of 0A1A net in&ome 1I1+A51 K I0+0A53"
Cambridge Business Publishers, 2013
1-12 !inancial Statement "nal#sis $ %aluation, 3rd &dition
E1!51 10A minutes3
a" Col#ate!.almoli'e was %rofita,le durin# 0A1A as witnessed ,y its
%ositi'e net %rofit mar#in of 17J" Lowe'er+ t(e %rofit mar#in is lower
t(an in 0AA>"
," Col#ate!.almoli'e-s %rodu&ti'ity measure 1asset turno'er3 de&reased
sli#(tly from 1"8 in 0AA> to 1"7 in 0A1A" (is indi&ates t(at o%eratin#
assets are #eneratin# a sli#(tly lower le'el of sales t(an in t(e %rior
year" (is is a ne#ati'e de'elo%ment"

&" ;OA 2 .rofit mar#in asset turno'er" 0A1A ;OA 2 17J 1"7 2 1>"9J"
0AA> ;OA 2 18J 1"8 2 00"8J" (e de&rease in ;OA durin# 0A1A
results from a de&rease in ,ot( %rofita,ility and %rodu&ti'ity"
E1!50 118 minutes3
;eturn on assets 1;OA3 2 Net in&ome K A'era#e assets
2 I915 K 1I9+8:> 4 I:+7903K0R
2 <":J
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-13
E1!55 10A minutes3
a" Creditors are an im%ortant #rou% of e6ternal stake(olders" (ey are
%rimarily interested in t(e a,ility of t(e &om%any to #enerate suffi&ient
&as( flow in order to re%ay t(e amounts owed" Sto&k(olders are anot(er
si#nifi&ant stake(older in t(e &om%any" (ey are %rimarily interested in
t(e &om%any-s a,ility to effe&ti'ely raise &a%ital and to in'est t(at &a%ital
in %ro)e&ts wit( a rate of return in e6&ess of t(e &ost of t(e &a%ital
raised+ t(at is+ to in&rease t(e 'alue of t(e firm" ;e#ulators su&( as t(e
SEC and t(e ta6 aut(orities+ in&ludin# t(e I;S and state and lo&al ta6
offi&ials+ are im%ortant &onstituents t(at are interested in knowin#
w(et(er t(e &om%any is &om%lyin# wit( all a%%li&a,le laws and
re#ulations"
," Cenerally A&&e%ted A&&ountin# .rin&i%les 1CAA.3 are t(e 'arious
met(ods+ rules+ %ra&ti&es+ and ot(er %ro&edures t(at (a'e e'ol'ed o'er
time in res%onse to t(e need to re#ulate t(e %re%aration of finan&ial
statements" (ey are %rimarily set ,y t(e Finan&ial A&&ountin#
Standards Goard 1FASG3+ a %ri'ate se&tor entity wit( re%resentati'es
from &om%anies t(at issue finan&ial statements+ a&&ountin# firms t(at
audit t(ose statements+ and users of finan&ial information" Ot(er ,odies
t(at &ontri,ute to CAA. are t(e AIC.A+ t(e EIF+ and t(e SEC"
&" Finan&ial information %ro'ides users wit( information t(at is useful in
assessin# t(e finan&ial %erforman&e of &om%anies and+ t(erefore+ in
settin# sto&k and ,ond %ri&es" o t(e e6tent t(at t(ese %ri&es are
a&&urate+ t(e &osts of t(e funds t(at &om%anies raise will a&&urately
refle&t t(eir relati'e effi&ien&y and risk of o%erations" Com%anies t(at
&an utili$e &a%ital more effe&ti'ely will ,e a,le to o,tain t(at &a%ital at a
reasona,le &ost and so&iety-s finan&ial resour&es will ,e effe&ti'ely
allo&ated"
d" First+ t(e %re%aration of finan&ial statements in'ol'es an understandin#
of &om%le6 a&&ountin# rules and si#nifi&ant assum%tions and
&onsidera,le estimation" Se&ond+ CAA. allows for differin# a&&ountin#
treatments for t(e same transa&tion" And t(ird+ auditors are at a relati'e
information disad'anta#e 'is!S!'is &om%any a&&ountants" As t(e &a%ital
markets %la&e in&reasin# %ressures on &om%anies to %erform+
a&&ountants are often %la&ed in a diffi&ult et(i&al %osition to use t(e
fle6i,ility #i'en to t(em under CAA. in order to ,ias t(e finan&ial results
or to use t(eir inside information to t(eir ad'anta#e"
Cambridge Business Publishers, 2013
1-1( !inancial Statement "nal#sis $ %aluation, 3rd &dition
E1!57 10A minutes3
a" ;OE 2 Net in&ome K A'era#e sto&k(olders- e/uity
2 I>78"9 million K T1I5+A89"> million 4 I5+9<0"5 million3K0R 2 0<"1J
," (e re%ur&(ase of &ommon sto&k redu&es t(e denominator 1a'era#e
sto&k(olders- e/uity3" (e outflow of &as( for t(e re%ur&(ase+ (owe'er+
redu&es net in&ome ,y t(e return on t(e &as( t(at is for#one" Cenerally+
t(e redu&tion in t(e denominator is #reater t(an t(at for t(e numerator+
and &onse/uently ;OE in&reases" (at is one of t(e reasons &ited for
s(are re%ur&(ases"
&" Com%anies usually re%ur&(ase t(eir own sto&k w(en t(ey feel t(at it is
under'alued ,y t(e market" (e re%ur&(ase is a way to send a si#nal to
t(e market to t(at effe&t" Com%any mana#ement is+ in essen&e+ ,a&kin#
u% its assertions t(at t(e sto&k is under'alued wit( a tan#i,le
in'estment of t(e &om%any-s funds" Com%anies also re%ur&(ase t(eir
own sto&k to (a'e s(ares a'aila,le to #i'e to e6e&uti'es and ot(er
em%loyees as &om%ensation"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-1)
.;OGDEMS
.1!58 17A minutes3
a"
0A11 ;OE 2 I15+5<1 K T1I98+0<8 4 I:A+79<3K0R 2 1>":J
0A1A ;OE 2 I17+5:A K T1I:A+79< 4 I9<+8703K0R 2 0A":J
@al!Mart-s ;OE de&reased from 0A1A to 0A11+ and is sli#(tly ,elow t(e
median ;OE of 0AJ for ot(er &om%anies in t(e Dow Uones a'era#e"
,"
0A11 ;OA 2 I15+5<1 K T1I195+70> 4 I1:A+7A:3K0R 2 <"AJ
0A1A ;OA 2 I17+5:A K T1I1:A+7A: 4 I1<A+9953K0R 2 <"0J
@al!Mart-s ;OA de&reased from 0A1A to 0A11 ,ut is a,o'e t(e median
for ot(er Dow Uones &om%anies"
&" @al!Mart does not sell %rodu&ts wit( a (i#( le'el of te&(nolo#y and
s%e&iali$ation+ and it+ t(erefore+ is not %rote&ted ,y %atents or ot(er
le#al ,arriers to entry" It does+ (owe'er+ (a'e &onsidera,le market %ower
o'er su%%liers as a result of its &onsidera,le si$e+ w(i&( may result in
%rodu&t &ost sa'in#s" @al!Mart is also a,le to use its &onsidera,le
ad'ertisin# ,ud#et to its ad'anta#e"

Cambridge Business Publishers, 2013
1-1* !inancial Statement "nal#sis $ %aluation, 3rd &dition
.1!59 15A minutes3
a"
Ceneral Mills+ In&"
In&ome Statement 1I millions3
For Mear Ended May 0>+ 0A11
;e'enue""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I17+<<A"0
Cost of #oods sold"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" <+>09":
Cross %rofit"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 8+>85"8
otal e6%enses""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 7+188"0
Net in&ome""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I 1+:><"5
Ceneral Mills+ In&"
Galan&e S(eet 1I millions3
May 0>+ 0A11
Cas(""""""""""""""""""""""""""""""""""" I 91>"9 otal lia,ilities""""""""""""""""""""""""" I10+A90"5
Non&as( assets""""""""""""""""" 1<+A87"> Sto&k(olders- e/uity"""""""""""""" 9+910"0
otal assets"""""""""""""""""""""""" I1<+9:7"8 otal lia,ilities and e/uity"""""" I1<+9:7"8
Ceneral Mills+ In&"
Statement of Cas( Flows 1I millions3
For Mear Ended May 0>+ 0A11
Cas( from o%eratin# a&ti'ities I 1+809"<
Cas( from in'estin# a&ti'ities 1:18"13
Cas( from finan&in# a&ti'ities 1<98 "53
Net &(an#e in &as( 185"93
Cas(+ ,e#innin# year 9:5 "0
Cas(+ endin# year I 91> "9
," A ne#ati'e amount for &as( from in'estin# a&ti'ities refle&ts furt(er
in'estment ,y t(e &om%any in its lon#!term assets+ w(i&( is #enerally a
%ositi'e si#n of mana#ement-s &ommitment to future ,usiness su&&ess"
A ne#ati'e amount for &as( from finan&in# a&ti'ities refle&ts t(e
redu&tion of lon#!term de,t+ w(i&( is often a %ositi'e si#n of t(e
&om%any-s a,ility to retire de,t o,li#ations"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-1+
.1!59 1&on&luded3
&" .rofit mar#in 2 I1+:><"5 K I17+<<A"0 2 10"A>J
urno'er of total assets 2 I17+<<A"0 K I1<+9:7"8 2 A"<A
;eturn on assets 2 I1+:><"5 K I1<+9:7"8 2 >"9J 110"A>J V A"<A3
;eturn on e/uity 2 I1+:><"5 K I9+910"0 2 0:"0J
.1!5: 15A minutes3
a"
A,er&rom,ie B Fit&(
In&ome Statement 1I millions3
For Mear Ended Uanuary 0>+ 0A11
;e'enue"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I5+79>
Cost of #oods sold"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 1+08:
Cross %rofit"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 0+010
E6%enses"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 0+A90
Net in&ome""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I 18A
A,er&rom,ie B Fit&(
Galan&e S(eet 1I millions3
Uanuary 0>+ 0A11
Cas(""""""""""""""""""""""""""""""""""" I <09 otal lia,ilities"""""""""""""""""""""""""""I 1+A8:
Non&as( assets"""""""""""""""" 0+100 Sto&k(olders- e/uity"""""""""""""""" 1+<>1
otal assets""""""""""""""""""""""" I0+>7< otal lia,ilities and e/uity""""""" I0+>7<
Cambridge Business Publishers, 2013
1-1, !inancial Statement "nal#sis $ %aluation, 3rd &dition
.1!5: 1&on&luded3
A,er&rom,ie B Fit&(
Statement of Cas( Flows 1I millions3
For Mear Ended Uanuary 0>+ 0A11
Cas( from o%eratin# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" I 5>0
Cas( from in'estin# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" 1>53
Cas( from finan&in# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" 11753
Net &(an#e in &as("""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 189
Cas(+ ,e#innin# year"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 9:A
Cas(+ endin# year""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I <09
," A ne#ati'e amount for &as( from in'estin# a&ti'ities refle&ts furt(er
in'estment ,y t(e &om%any in its lon#!term assets+ w(i&( is #enerally a
%ositi'e si#n of mana#ement &ommitment to future ,usiness su&&ess"
A ne#ati'e amount for &as( from finan&in# a&ti'ities refle&ts t(e
redu&tion of lon#!term de,t+ w(i&( is often a %ositi'e si#n of t(e
&om%any-s a,ility to retire de,t o,li#ations"
&" .rofit mar#in 2 I18A K I5+79> 2 7"50J
Asset turno'er 2 I5+79> K I0+>7< 2 1"1<
;eturn on assets2 I18A K I0+>7< 2 8"A>J 17"50J V 1"1<3
;eturn on e/uity 2 I18A K I1+<>1 2 :">5J
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-1-
.1!5< 15A minutes3
a"
Cis&o Systems+ In&"
In&ome Statement 1I millions3
For Mear Ended Uuly 51+ 0A1A
Sales""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I7A+A7A
Cost of #oods sold"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 17+5>:
Cross %rofit"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 08+975
E6%enses"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 1:+<:9
Net in&ome""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I :+:9:
Cis&o Systems+ In&"
Galan&e S(eet 1I millions3
Uuly 51+ 0A1A
Cas("""""""""""""""""""""""""""""""""" I 7+8<1 otal lia,ilities""""""""""""""""""""""""""""""I59+<78
Non&as( assets""""""""""""""" :9+87> Sto&k(olders- e/uity"""""""""""""""""""" 77+0<8
otal assets"""""""""""""""""""""" I<1+15A otal lia,ilities and e/uity"""""""""""I<1+15A
Cis&o Systems+ In&"
Statement of Cas( Flows 1I millions3
For Mear Ended Uuly 51+ 0A1A
Cas( from o%eratin# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" I1A+1:5
Cas( used in in'estin# a&ti'ities""""""""""""""""""""""""""""""""""""""""" 111+>513
Cas( from finan&in# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" 901
Net &(an#e in &as("""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 11+15:3
Cas(+ ,e#innin# year"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 8+:1<
Cas(+ endin# year""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I 7+8<1
," A ne#ati'e amount for &as( from in'estin# a&ti'ities refle&ts furt(er
in'estment ,y t(e &om%any in its lon#!term assets+ w(i&( is #enerally a
%ositi'e si#n of mana#ement &ommitment to future ,usiness su&&ess"
Cambridge Business Publishers, 2013
1-20 !inancial Statement "nal#sis $ %aluation, 3rd &dition
.1!5< 1&on&luded3
&" .rofit mar#in 2 I:+:9: K I7A+A7A 2 1>"7J
urno'er of total assets 2 I7A+A7A K I<1+15A 2 A"7>
;eturn on assets2 I:+:9: K I<1+15A 2 >"8:J 11>"7J V A"7>3
;eturn on e/uity 2 I:+:9: K I77+0<8 2 1:"8J
.1!5> 118 minutes3
Cro&ker Cor%oration
Statement of Sto&k(olders- E/uity
For Mear Ended De&em,er 51+ 0A11
Contri,uted
Ca%ital
;etained
Earnin#s
Sto&k(olders-
E/uity
De&em,er 51+ 0A1A"""""""""""""""""""""""""""""" I :A+AAA I 5A+AAA I1AA+AAA
Issuan&e of &ommon sto&k"""""""""""""""" 5A+AAA 5A+AAA
Net in&ome""""""""""""""""""""""""""""""""""""""""""" 8A+AAA 8A+AAA
Cas( di'idends"""""""""""""""""""""""""""""""""""" WWWWWWW 108+AAA3 108+AAA3
De&em,er 51+ 0A11""""""""""""""""""""""""""""""" I1AA+AAA I 88+AAA I188+AAA
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-21
.1!7A 118 minutes3
Ca%+ In&"
Statement of Sto&k(olders- E/uity
For Mear Ended Uanuary 0>+ 0A11
Common
Sto&k
and
A.IC
reasury
Sto&k
;etained
Earnin#s
A&&um" Ot(
Com%" In&
Sto&k(olders-
E/uity
Uanuary 5A+ 0A1A""""""""""""""""""""""""""""""""""""""""""""" I0+>>A I1>+A9>3 I1A+<18 I188 I7+<>1
Sale of sto&k""""""""""""""""""""""""""""""""""""""""""""""""""" 7 7
.ur&(ase of sto&k"""""""""""""""""""""""""""""""""""""""""" 11+:>:3 11+:>:3
Net in&ome"""""""""""""""""""""""""""""""""""""""""""""""""""""" 1+0A7 1+0A7
Ot(er &om%" in&ome""""""""""""""""""""""""""""""""""""""" 5A 5A
Cas( di'idends""""""""""""""""""""""""""""""""""""""""""""""" 10803 10803
Uanuary 0>+ 0A11""""""""""""""""""""""""""""""""""""""""""""" I0+>>7 I11A+<993 I11+:9: I1<8 I7+A<A
.1!71 15A minutes3
1I millions3
a"
;OA ;OE
0AA> 1A"1J
I1+<<7KT1I1>+0A>4I1<+A<>3K0R
5:">J
I1+<<7KT1I8+9>A4I7+0913K0R
0A1A >"7J
I1+<75KT1I1>+<974I1>+0A>3K0R
51"AJ
I1+<75KT1I9+0A04I8+9>A3K0R
Cambridge Business Publishers, 2013
1-22 !inancial Statement "nal#sis $ %aluation, 3rd &dition
.1!71 1&on&luded3
.rofit Mar#in
1.M3
Asset urno'er
1A3
0AA> >">J
1I1+<<7KI1>+1183
1"A0
I1>+118KT1I1>+0A>4I1<+A<>3K0R
0A1A >"5J
1I1+<75KI1>+:793
1"A1
I1>+:79KT1I1>+<974I1>+0A>3K0R
Xim,erly!Clark-s ;OA and ;OE ,ot( de&lined from 0AA> to 0A1A"
(e de&line in ;OA is a result of a de&line in %rofit mar#in 1from >">J to
>"5J3 as well as a sli#(t de&line in asset turno'er 1from 1"A0 to 1"A13" (e
%rofit mar#in de&line was t(e more si#nifi&ant &ause"
," (e re%ur&(ase of &ommon sto&k redu&es ,ot( t(e numerator 1net
in&ome3 and denominator 1sto&k(olders- e/uity3 of t(e return on e/uity
&al&ulation" ;e%ur&(ases redu&e net in&ome ,y t(e for#one %rofit on
t(e &as( t(at is used to ,uy t(e sto&k on t(e o%en market" Xim,erly!
Clark-s re%ur&(ase of &ommon sto&k redu&ed sto&k(olders- e/uity ,y
I7": ,illion+ t(us de&reasin# t(e denominator ,y t(at amount" Cenerally+
t(e denominator effe&t dominates* its redu&tion is #reater t(an t(e
redu&tion of t(e numerator" (erefore+ it is reasona,le to %redi&t t(at t(e
re%ur&(ase would in&rease ;OE"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-23
.1!70 15A minutes3
;OA ;OE
0A1A :"0J
I771KT1I9+8:>4I8+9913K0R
51":J
I771KT1I1+8:04I1+01A3K0R
0A11 <":J
I915KT1I:+7904I9+8:>3K0R
57"1J
I915KT1I0+A014I1+8:03K0R
.rofit Mar#in
1.M3
Asset urno'er
1A3
0A1A 8"1J
1I771KI<+90:3
1"71
I<+90:KT1I9+8:>4I8+9913K0R
0A11 9"5J
1I915KI>+:AA3
1"5<
I>+:AAKT1I:+7904I9+8:>3K0R
Got( ;OA and ;OE in&reased from 0A1A to 0A11" (e in&rease in ;OA is
dri'en %rimarily ,y t(e in&rease in %rofit mar#in 1from 8"1J to 9"5J3 as
asset turno'er de&lined sli#(tly durin# t(e year 1from 1"71 to 1"5<3"
Cambridge Business Publishers, 2013
1-2( !inancial Statement "nal#sis $ %aluation, 3rd &dition
.1!75 10A minutes3
a" ;eturn on e/uity is net in&ome di'ided ,y a'era#e total sto&k(olders-
e/uity"
Nokia-s ;OE* Y1+<8A K T1Y19+051 4 Y17+:7>3K0R 2 11">J"
," @e know t(at sales minus e6%enses e/uals net in&ome" Usin# Nokia-s
num,ers we o,tain*
Y70+779 ! E6%enses 2 Y1+<8A E6%enses 2 Y7A+8>9"
&" Com%anies re%ur&(ase t(eir own sto&k for a num,er of reasons" First+
mana#ers may ,elie'e t(at t(e &om%any-s sto&k is under'alued ,y t(e
market" (e re%ur&(ase is a way to si#nal t(e market to t(at effe&t"
Essentially+ &om%any mana#ement is ,a&kin# u% its assertions t(at t(e
sto&k is under'alued wit( a tan#i,le in'estment of t(e &om%any-s funds"
Se&ond+ firms often use treasury s(ares to (onor e6e&uti'e and ot(er
em%loyees- sto&k o%tion e6er&ises" (ird+ sto&k ,uy,a&ks return &as( to
in'estors w(o may %refer &a%ital #ains 1from a ,uy,a&k3 to ordinary
di'idends+ for ta6 reasons"
.1!77 10A minutes3
a" ;OA 2 Net in&ome K A'era#e assets
UH 0A11 ;OA 2 I1+575 K T1I:+>:0 4 I:+7973 K 0R 2 1:"7J
ANF 0A11 ;OA 2 I18A K T1I0+>7< 4 I0+<003 K0R 2 8"0J
,"
UH ANF
.rofit Mar#in I1+575KI01+>70 2 9"1J I18AKI5+79> 2 7"5J
Asset urno'er I01+>70KT1I:+>:04I:+7973K0R
2 0"<7
I5+79>KT1I0+>7<4
I0+<003K0 2 1"0A
;OA 9"1J V 0"<7 2 1:"5JN 7"5J V 1"0A 2 8"0J
N ;oundin# differen&e
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-2)
.1!77 1&on&luded3
&" UH is out%erformin# ANF in 0A11" ANF-s re%utation as a (i#(!end
retailer would lead us to e6%e&t (i#(er %rofit mar#ins" Gut+ t(is is not t(e
&ase as UH-s %rofit mar#in is o'er 7AJ (i#(er t(an ANF-s" UH-s real
&om%etiti'e ad'anta#e+ (owe'er+ is in its asset turno'er of nearly 56+
nearly 0"76 (i#(er t(an ANF-s 1"0A" In 0A11+ UH is out%erformin# ANF on
,ot( dimensions+ resultin# in a ;OA of 1:"7J+ o'er 56 (i#(er t(an ANF-s
;OA of 8"0J"
.1!78 15A minutes3
a"
0A1A 0AA>
;OA I7+>79"5KT1I51+>:8"04I5A+007">3K0R
2 18">J
I7+881"AKT1I5A+007">4I0<"791"83K0R
2 18"8J
.rofit Mar#in I7+>79"5KI07+A:7"9
2 0A"8J
I7+881"AKI00+:77":
2 0A"AJ
Asset urno'er I07+A:7"9KT1I51+>:8"04I5A+007">3K0R
2 A"::
I00+:77":KT1I5A+007">4I0<+791"83K0R
2 A":<
," M&Donald-s ;OA in&reased from 0AA> to 0A1A+ due to an in&rease in
%rofita,ility 1from 0A to 0A"8J3 as its asset turno'er de&reased sli#(tly
1from A":< to A"::3 durin# t(is %eriod"
Cambridge Business Publishers, 2013
1-2* !inancial Statement "nal#sis $ %aluation, 3rd &dition
.1!79 15A minutes3
a"
.rofit Mar#in Asset urno'er ;OA
0AA< I5+79AKI08+09>
2 15":J
I08+09>KT1I08+:>54I07+9>73K0R
2 1"AA
15":J 1"AA
2 15":J
0AA> I5+1>5KI05+105
2 15"<J
I05+105KT1I0:+08A4I08+:>53K0R
2 A"<:
15"<J A"<:
2 10"AJ
0A1A I7+A<8KI09+990
2 18"5J
I09+990KT1I5A+1894I0:+08A3K0R
2 A">5
18"5J A">5
2 17"0J
5M-s ;OA di%%ed durin# t(e re&ession of 0AA<!0AA>+ ,ut re,ounded in
0A1A"
," (e %rimary dri'er of t(e ;OA di% in 0AA> was a de&rease in asset
turno'er" (at year+ %rofit mar#in stayed a,out t(e same* 15":J to
15"<J" (is flu&tuation in asset turno'er is attri,uta,le to t(e 0AA<KA>
re&ession" (en+ in 0A1A as t(e e&onomy im%ro'ed ,ot( turno'er and
%rofit mar#in stren#t(ened" Alt(ou#( some assets are more 'aria,le in
nature 1i"e"+ re&ei'a,les and in'entories3+ 5M is &a%ital intensi'e and
&annot redu&ed its lon#!term assets in t(e s(ort run" As a result+ asset
turno'er de&lines as sales de&line durin# a re&ession and in&reases as
sales im%ro'e durin# t(e re&o'ery"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-2+
.1!7:
A
108 minutes3
a" (e auditors address t(eir re%ort to t(e &om%any-s ,oard of
dire&tors and t(e s(are(olders of A%%le In&" (is is an im%ortant %oint"
Auditors work for t(e ,enefit of t(e s(are(olders and re%ort dire&tly to
t(e ,oard of dire&tors+ t(e ele&ted re%resentati'es of t(e s(are(olders
w(ose )o, it is to %rote&t s(are(older interests" It would not ,e
a%%ro%riate for t(e e6ternal auditors to re%ort dire&tly to mana#ement
,e&ause t(e auditors are e6aminin# mana#ement-s a&ti'ities as
des&ri,ed in t(e &om%any-s finan&ial statements" ;e%ortin# to t(e ,oard
%reser'es t(e auditor-s inde%enden&e"
," (e audit %ro&ess &onsists of two &om%onents" First t(e auditors
assess t(e &om%any-s system of internal &ontrols to ensure t(e
information in t(e finan&ial statements was #at(ered+ re&orded+
a##re#ated in a&&ordan&e wit( CAA." (is in'ol'es an assessment of
t(e &om%any-s a&&ountin# %oli&ies to#et(er wit( t(e assum%tions used
and estimates made in t(e %re%aration of t(e finan&ial statements"
Se&ond+ t(e auditors e6amine+ on a test ,asis+ e'iden&e su%%ortin# t(e
amounts and dis&losures in t(e statements" (e key word is test"
Auditors do not e6amine ea&( transa&tion" (ey take a sam%le from t(e
transa&tions" If t(at sam%le does not un&o'er any irre#ularities+ t(ey #o
no furt(er" If it does+ t(ey e6%and t(e sam%le until t(ey are &onfident
t(at t(e amounts %resented in t(e statements fairly %resent t(e
&om%any-s %erforman&e and &ondition in a&&ordan&e wit( CAA."
&" (e nature of t(e inde%endent auditors- o%inion is t(at t(e
finan&ial statements E%resent fairly+ in all material res%e&ts+ t(e finan&ial
&ondition of t(e &om%any"F Ge&ause t(is is standard audit!re%ort
lan#ua#e+ any de'iations s(ould raise a fla#" E.resent fairlyF does not
mean a,solute assuran&e t(at t(e finan&ials are error!free" It means t(at
a reasona,le %erson would &on&lude t(at t(e finan&ial statements
reasona,ly des&ri,e t(e finan&ial &ondition of t(e &om%any"
d" X.MC also rendered an o%inion on t(e &om%any-s system of
internal &ontrols" Internal &ontrols are desi#ned to insure t(e inte#rity of
t(e finan&ial re%ortin# system and t(e %reser'ation of t(e &om%any-s
assets" A well!fun&tionin# internal &ontrol system is a &riti&al
&om%onent of t(e &om%any-s o'erall &or%orate #o'ernan&e system"
Cambridge Business Publishers, 2013
1-2, !inancial Statement "nal#sis $ %aluation, 3rd &dition
.1!7< 10A minutes3
a" Ste'e Uo,s made assertions t(at t(e Sar,anes!O6ley A&t re/uires
all CEOs and CFOs to make" In %arti&ular+ Uo,s &ertified t(at*
Le (as read t(e finan&ial re%orts"
(e finan&ial re%orts do not &ontain any si#nifi&ant 1material3
misstatement or omit to state a si#nifi&ant fa&t t(at s(ould (a'e ,een
in&luded" (e finan&ial re%orts are+ t(erefore+ &om%lete"
(e finan&ial re%orts fairly %resent t(e finan&ial &ondition of t(e
&om%any"
(e &om%any maintains a system of internal &ontrols and t(ose
&ontrols are fun&tionin# &orre&tly"
," Con#ress %assed t(e Sar,anes!O6ley A&t followin# a s%ate of
&or%orate a&&ountin# s&andals in t(e early 0AAAs" (e im%etus for t(e
le#islation was t(e ,elief t(at some CEOs and CFOs no lon#er assumed
res%onsi,ility for t(e finan&ial re%ortin# of t(eir &om%anies" Gy re/uirin#
t(ese (i#(!rankin# e6e&uti'es to %ersonally &ertify to t(e items
referen&ed in %art a a,o'e+ Con#ress wanted to en&oura#e &loser
s&rutiny of t(e finan&ial re%ortin# %ro&ess at t(e (i#(est le'els of t(e
&om%any"
&" (e Sar,anes!O6ley A&t %res&ri,es si#nifi&ant %enalties for falsely
&ertifyin# to t(e &om%leteness and &orre&tness of t(e finan&ial re%orts"
CEOs and CFOs fa&e fines of u% to I8 million and %rison terms of u% to
0A years" Additionally+ s(ould t(e &om%any later restate its finan&ial
statements as a result of wron#ful false re%ortin#+ t(e CEOs and CFOs
may ,e re/uired to forfeit any %rofits earned as a result of t(at re%ortin#"
(is forfeiture (as ,een la,eled Edis#or#ementF in t(e finan&ial %ress"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-2-
.1!7> 15A minutes3
Followin# is t(e statement of Cor%orate Co'ernan&e from CE-s @e,site*
1" ;ole of Goard and Mana#ement
CE-s ,usiness is &ondu&ted ,y its em%loyees+ mana#ers and offi&ers+ under t(e
dire&tion of t(e &(ief e6e&uti'e offi&er 1CEO3 and t(e o'ersi#(t of t(e ,oard+ to
en(an&e t(e lon#!term 'alue of t(e Com%any for its s(areowners" (e ,oard of
dire&tors is ele&ted ,y t(e s(areowners to o'ersee mana#ement and to assure t(at
t(e lon#!term interests of t(e s(areowners are ,ein# ser'ed" Got( t(e ,oard of
dire&tors and mana#ement re&o#ni$e t(at t(e lon#!term interests of s(areowners are
ad'an&ed ,y res%onsi,ly addressin# t(e &on&erns of ot(er stake(olders and
interested %arties in&ludin# em%loyees+ re&ruits+ &ustomers+ su%%liers+ CE
&ommunities+ #o'ernment offi&ials and t(e %u,li& at lar#e"
0" Fun&tions of Goard
(e ,oard of dire&tors (as ei#(t s&(eduled meetin#s a year at w(i&( it re'iews and
dis&usses t(e %erforman&e of t(e Com%any+ its %lans and %ros%e&ts+ as well as
immediate issues fa&in# t(e Com%any" Dire&tors are e6%e&ted to attend all s&(eduled
,oard and &ommittee meetin#s" In addition to its #eneral o'ersi#(t of mana#ement+
t(e ,oard also %erforms a num,er of s%e&ifi& fun&tions+ in&ludin#*
a" sele&tin#+ e'aluatin# and &om%ensatin# t(e CEO and o'erseein# CEO su&&ession
%lannin#=
," %ro'idin# &ounsel and o'ersi#(t on t(e sele&tion+ e'aluation+ de'elo%ment and
&om%ensation of senior mana#ement=
&" re'iewin#+ monitorin# and+ w(ere a%%ro%riate+ a%%ro'in# fundamental finan&ial
and ,usiness strate#ies and ma)or &or%orate a&tions=
d" assessin# ma)or risks fa&in# t(e Com%any O and re'iewin# o%tions for t(eir
miti#ation= and
e" ensurin# %ro&esses are in %la&e for maintainin# t(e inte#rity of t(e Com%any ! t(e
inte#rity of t(e finan&ial statements+ t(e inte#rity of &om%lian&e wit( law and
et(i&s+ t(e inte#rity of relations(i%s wit( &ustomers and su%%liers+ and t(e
inte#rity of relations(i%s wit( ot(er stake(olders"
5" Qualifi&ations
Dire&tors s(ould %ossess t(e (i#(est %ersonal and %rofessional et(i&s+ inte#rity and
'alues+ and ,e &ommitted to re%resentin# t(e lon#!term interests of t(e s(areowners"
(ey must also (a'e an in/uisiti'e and o,)e&ti'e %ers%e&ti'e+ %ra&ti&al wisdom and
mature )ud#ment" @e endea'or to (a'e a ,oard re%resentin# di'erse e6%erien&e at
%oli&y!makin# le'els in ,usiness+ #o'ernment+ edu&ation and te&(nolo#y+ and in
areas t(at are rele'ant to t(e Com%any-s #lo,al a&ti'ities"
Dire&tors must ,e willin# to de'ote suffi&ient time to &arryin# out t(eir duties and
res%onsi,ilities effe&ti'ely+ and s(ould ,e &ommitted to ser'e on t(e ,oard for an
e6tended %eriod of time" Dire&tors s(ould offer t(eir resi#nation in t(e e'ent of any
si#nifi&ant &(an#e in t(eir %ersonal &ir&umstan&es+ in&ludin# a &(an#e in t(eir
%rin&i%al )o, res%onsi,ilities"
Dire&tors w(o also ser'e as CEOs of %u,li&ly!traded &om%anies or in e/ui'alent
%ositions s(ould not ser'e on more t(an two ,oards of %u,li& &om%anies in addition
to t(e CE ,oard+ and ot(er dire&tors s(ould not ser'e on more t(an four ot(er ,oards
Cambridge Business Publishers, 2013
1-30 !inancial Statement "nal#sis $ %aluation, 3rd &dition
of %u,li& &om%anies in addition to t(e CE ,oard" Current %ositions in e6&ess of t(ese
limits may ,e maintained unless t(e ,oard determines t(at doin# so would im%air t(e
dire&tor-s ser'i&e on t(e CE ,oard"
(e ,oard does not ,elie'e t(at ar,itrary term limits on dire&tors- ser'i&e are
a%%ro%riate+ nor does it ,elie'e t(at dire&tors s(ould e6%e&t to ,e renominated
annually until t(ey rea&( t(e mandatory retirement a#e" (e ,oard self!e'aluation
%ro&ess des&ri,ed ,elow will ,e an im%ortant determinant for ,oard tenure" Dire&tors
will not ,e nominated for ele&tion to t(e ,oard after t(eir :5rd ,irt(day+ alt(ou#( t(e
full ,oard may nominate &andidates o'er :5 in s%e&ial &ir&umstan&es"
7" Inde%enden&e of Dire&tors
A ma)ority of t(e dire&tors will ,e inde%endent dire&tors+ as inde%enden&e is
determined ,y t(e ,oard+ ,ased on t(e #uidelines set fort( ,elow"
All future non!em%loyee dire&tors will ,e inde%endent" CE seeks to (a'e a
minimum of ten inde%endent dire&tors at all times+ as inde%enden&e is determined ,y
t(e ,oard ,ased on t(e #uidelines set fort( ,elow+ and it is t(e ,oard-s #oal t(at at
least two!t(irds of t(e dire&tors will ,e inde%endent" Dire&tors w(o do not satisfy
CE-s inde%enden&e #uidelines also make 'alua,le &ontri,utions to t(e ,oard and to
t(e Com%any ,y reason of t(eir e6%erien&e and wisdom"
For a dire&tor to ,e &onsidered inde%endent+ t(e ,oard must determine t(at t(e
dire&tor does not (a'e any dire&t or indire&t material relations(i% wit( CE" (e ,oard
(as esta,lis(ed #uidelines to assist it in determinin# dire&tor inde%enden&e+ w(i&(
&onform to or are more e6a&tin# t(an t(e inde%enden&e re/uirements in t(e New Mork
Sto&k E6&(an#e listin# re/uirements 1NMSE rules3" In addition to a%%lyin# t(ese
#uidelines+ t(e ,oard will &onsider all rele'ant fa&ts and &ir&umstan&es in makin# an
inde%enden&e determination"
(e ,oard will make and %u,li&ly dis&lose its inde%enden&e determination for
ea&( dire&tor w(en t(e dire&tor is first ele&ted to t(e ,oard and annually t(ereafter for
all nominees for ele&tion as dire&tors" If t(e ,oard determines t(at a dire&tor w(o
satisfies t(e NMSE rules is inde%endent e'en t(ou#( (e or s(e does not satisfy all of
CE-s inde%enden&e #uidelines+ t(is determination will ,e dis&losed and e6%lained in
t(e ne6t %ro6y statement"
In a&&ordan&e wit( NMSE rules+ inde%enden&e determinations under t(e
#uidelines in se&tion 1a3 ,elow will ,e ,ased u%on a dire&tor-s relations(i%s wit( CE
durin# t(e 59 mont(s %re&edin# t(e determination" Similarly+ inde%enden&e
determinations under t(e #uidelines in se&tion 1,3 ,elow will ,e ,ased u%on t(e
e6tent of &ommer&ial relations(i%s durin# t(e t(ree &om%leted fis&al years %re&edin#
t(e determination"
a" (e &ornerstone of CE-s #o'ernan&e stru&ture is its relian&e on an
inde%endent and /ualified Goard of Dire&tors" Inde%enden&e means t(at
insiders are not in'ol'ed in o'ersi#(t of t(e &om%any-s mana#ers" (is
(el%s a'oid %otential &onfli&ts of interest" ELi#(ly /ualifiedF dire&tors
ensure t(at t(ose res%onsi,le for o'ersi#(t (a'e t(e knowled#e to
%erform t(eir duties and t(e &on'i&tion to ask %ro,in# /uestions"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-31
.1!7> 1&on&luded3
," Co'ernan&e stru&tures ser'e s(are(olders 1and indire&tly+ %u,li&
interest3" (e s(are(olders of CE (o%e to ensure t(at t(e &om%any-s
%oli&ies are ad(ered to and t(at t(e interests of s(are(olders are #i'en
%aramount &onsideration in t(e mana#ement of t(e ,usiness"
Cambridge Business Publishers, 2013
1-32 !inancial Statement "nal#sis $ %aluation, 3rd &dition
IF;S A..DICAIONS
I1!8A 10A minutes3
1&urren&y in millions3 Assets 2 Dia,ilities 4 E/uity
OMV Crou% Y 01+718 Y 11+5<A 1a3 Y 1A+A58
Eri&sson SEX 09>+<A> 1,3 SEX
10<+:<0
SEX 171+A0:
GAE Systems 1&3 Z08+7A: Z0A+9<A Z7+:0:
(e %er&ent of owner finan&in# for ea&( &om%any follows* 1all &urren&y in
millions3
OMV Crou%""""""""""""""""""""""""""""" 79">J 1Y 1A+A58 K Y 01+7183
Eri&sson"""""""""""""""""""""""""""""""""" 80"5J 1SEX 171+A0: K SEX 09>+<A>3
GAE Systems"""""""""""""""""""""""""" 1<"9J 1Z7+:0: K Z08+7A:3
Got( Eri&sson and OMV Crou% (a'e a,out (alf of t(eir finan&in# from
owners" GAE Systems is more nonowner!finan&ed" Li#(!te&( &om%anies+
su&( as Eri&sson+ fa&e more un&ertain &as( flows t(an do &a%ital intensi'e
&om%anies su&( as GAE Systems" Ge&ause nonowner finan&in# is riskier+
&om%anies like Eri&sson 1t(at fa&e #reater un&ertainty3 tend to utili$e more
e/uity in t(eir &a%ital stru&ture" OMV #rou% is a mature &as(!#eneratin#
&om%any and+ as su&(+ (as re%aid its de,t+ w(i&( is now relati'ely t(e
same le'el as t(e &om%any-s e/uity"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-33
I1!81 108 minutes3
a" 0AA< ;OE 2 I7+007 K T1I19+A9A 4 I17+>183K0R 2 0:"5J
0AA> ;OE 2 I:+7>A K T1I0A+<014I19+A9A3K0R 2 7A"9J
Astra[ene&a-s ;OE (as in&reased from 0AA< to 0AA>+ and is well a,o'e
t(e median ;OE of 1:J for &om%anies in t(e Dow Uones a'era#e" (e
&om%any is e6&eedin#ly %rofita,le in 0AA>"
," 0AA< ;OA 2 I 7+007 K T1I79+>8A4I7:+><<3K0R 2 <">J
0AA> ;OA 2 I:+7>A K T1I87+>0A 4 I79+>8A3K0R 2 17":J
Astra[ene&a-s ;OA in&reased from 0AA< to 0AA> and it too is well a,o'e
t(e median for Dow Uones &om%anies 1on a'era#e3 for ,ot( years" On
t(is dimension+ t(e &om%any is 'ery %rofita,le"
&" Astra[ene&a sells %rodu&ts t(at (a'e a (i#( le'el of te&(nolo#y and
s%e&iali$ation" Some or t(e &om%any-s &om%ounds are %atented"
Com%anies t(at are a,le to a&(ie'e a &om%etiti'e ad'anta#e wit( uni/ue
%rodu&ts and ser'i&es ty%i&ally en)oy a,o'e!le'el %rofita,ility and
returns on e/uity" Furt(er+ to t(e e6tent t(at t(e &om%any is a,le to
de'elo% &ustomer!s%e&ifi& %rodu&ts and ser'i&es+ &om%etiti'e t(reats
lessen and+ t(us+ furt(er in&rease its %rofita,ility"
Cambridge Business Publishers, 2013
1-3( !inancial Statement "nal#sis $ %aluation, 3rd &dition
I1!80 108 minutes3
a" 0AA< ;OA 2 Z0+15A K T1Z5A+197 4 Z07+<A:3K0R 2 :":8J
0AA> ;OA 2 Z0+199 K T1Z79+A85 4 Z5A+1973K0R 2 8"9<J
," 0AA< .rofit Mar#in 2 Z0+15A K Z7:+0>< 2 7"8AJ
0AA> .rofit Mar#in 2 Z0+199 K Z87+50: 2 7"AAJ
0AA< Asset urno'er 2 Z7:+0>< K T1Z5A+197 4 Z07+<A:3K0R 2 1":0
0AA> Asset urno'er 2 Z87+50: K T1Z79+A85 4 Z5A+1973K0R 2 1"75
&" O'er t(is %eriod+ es&o-s ;OA de&reased from :":8J to 8"9<J" (is
de&rease is due to two fa&tors* i3 %rofita,ility de&reased from 7"8AJ to
7"AAJ and ii3 asset turno'er de&reased from 1": to 1"7" @e would
&on&lude t(at t(e &om%any is less %rofita,le on e'ery sale and (as
redu&ed asset effi&ien&y durin# 0AA> &om%ared to 0AA<" (is
&orres%onds to a %eriod of #eneral weakenin# in t(e #lo,al e&onomy"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-3)
DISCUSSION .OINS
D1!85 15A minutes3
Finan&in# &an &ome from a num,er of sour&es+ in&ludin# o%eratin#
&reditors+ ,orrowed funds+ and t(e sale of sto&k" Ea&( (as its stren#t(s
and weaknesses"
1" O%eratin# &reditors Q o%eratin# &reditors are mer&(andise and ser'i&e
su%%liers+ in&ludin# em%loyees" Cenerally+ t(ese lia,ilities are non!
interest ,earin#" As a result+ &om%anies ty%i&ally use t(is sour&e of
&redit to t(e fullest e6tent %ossi,le+ often stret&(in# %ayment times"
Lowe'er+ a,use of o%eratin# &reditors (as a si#nifi&ant downside" (e
&om%any may ,e una,le to su%%ly its o%eratin# needs and t(e dama#e
to em%loyee morale mi#(t (a'e si#nifi&ant re%er&ussions" O%eratin#
&redit must+ t(erefore+ ,e used wit( &are"

0" Gorrowed funds Q ,orrowed money ty%i&ally &arries an interest rate"
Ge&ause interest e6%ense is dedu&ti,le for ta6 %ur%oses+ ,orrowed
funds redu&e in&ome ta6 e6%ense" (e ta6es sa'ed are &alled t(e Eta6
s(ield"F (e dedu&ti,ility of interest redu&es t(e effe&ti'e &ost of
,orrowin#" (e downside of de,t is t(at t(e &om%any must make
%rin&i%al and interest %ayments as s&(eduled" Failure to make %ayments
on time &an result in se'ere &onse/uen&es Q &reditors (a'e si#nifi&ant
le#al remedies+ in&ludin# for&in# t(e &om%any into ,ankru%t&y and
re/uirin# its li/uidation" (e lower &ost of de,t must ,e ,alan&ed
a#ainst t(e fi6ed %ayment o,li#ations"

5" Sale of sto&k Q &om%anies &an sell 'arious &lasses of sto&k to in'estors"
Some &lasses of sto&k (a'e mandatory di'idend %ayments" On ot(er
&lasses of sto&k+ di'idends are not a le#al re/uirement until de&lared ,y
t(e ,oard of dire&tors" Conse/uently+ unlike de,t %ayments+ some
di'idends &an ,e &urtailed in ,usiness downturns" (e downside of
sto&k issuan&e is its &ost" Ge&ause e/uity is t(e most e6%ensi'e sour&e
of &a%ital+ &om%anies use it s%arin#ly"
Cambridge Business Publishers, 2013
1-3* !inancial Statement "nal#sis $ %aluation, 3rd &dition
D1!87 15A minutes3
Ea&( of t(e t(ree %rimary finan&ial statements %ro'ides a different
%ers%e&ti'e on t(e &om%any-s finan&ial %erforman&e and &ondition"
1" In&ome statement" (e in&ome statement %ro'ides information on t(e
&om%any-s sales+ e6%enses+ and net in&ome or loss" .rofita,ility
indi&ates t(at t(e &om%any-s #oods or ser'i&es are 'alued ,y t(e
market+ t(at is+ &ustomers are willin# to %ay a %ri&e t(at is suffi&ient to
&o'er t(e &osts of %ro'idin# t(ose #oods andKor ser'i&es to#et(er wit(
an ade/uate return on in'ested &a%ital" Furt(er+ t(e in&ome statement is
%re%ared on an a&&rual ,asis+ w(ere re'enues are re&o#ni$ed w(en
EearnedF and e6%enses w(en Ein&urred"F A&&ountants do not wait for
&as( to ,e re&ei'ed or %aid to re&ord re'enues and e6%enses"
Conse/uently+ mana#ement is a,le to &ommuni&ate some of its %ri'ate
information a,out e6%e&ted &as( inflows or outflows t(rou#( its
re&ordin# of re'enues and e6%enses" .resuma,ly t(is information is
'alua,le to finan&ial statement readers ,e&ause t(e in&ome statement
%ro'ides information a,out t(e e&onomi& %rofit of t(e &om%any"
0" Galan&e s(eet" (e ,alan&e s(eet re%orts t(e resour&es a'aila,le to t(e
&om%any and (ow t(e &om%any o,tained t(ose resour&es 1t(e sour&es3"
(e ,alan&e s(eet also re'eals asset &ate#ories 1%ro'idin# insi#(t into
mana#ement-s in'estment %(iloso%(y3 and t(e manner in w(i&(
mana#ement (as finan&ed its o%erations 1t(e relati'e use of de,t 'ersus
e/uity3" Effi&ient mana#ement of t(e ,alan&e s(eet is &riti&al to finan&ial
%erforman&e and &areful analysis of t(e ,alan&e s(eet &an %ro'ide &lues
into t(e effe&ti'eness of t(e &om%any-s mana#ement team and t(e
'ia,ility of t(e &om%any wit(in t(e &onte6t of its industry"
5" Statement of &as( flows" Cas( is im%ortant to a &om%any-s
&ontinued o%erations" De,ts must ,e %aid in &as( and em%loyees
ty%i&ally only a&&e%t &as( in %ayment of t(eir ser'i&es" Com%anies must
#enerate %ositi'e &as( flow o'er t(e lon# run in order to sur'i'e" (e
in&ome statement+ %re%ared on an a&&rual ,asis+ does not dire&tly
%ro'ide information a,out &as( flows" Gut t(e statement of &as( flows
does+ and+ for t(at reason+ it is a &riti&al finan&ial statement" (e
statement of &as( flows tells us t(e sour&es of &as( and (ow &as( (as
,een used" In %arti&ular+ t(e statement re%orts o%eratin#+ in'estin# and
finan&in# &as( flows" From t(e statement we &an infer w(et(er t(e
&om%any-s sour&es of &as( are lon#!term or transitory" (is is im%ortant
to fore&astin# future &as( flows" In addition+ t(e uses of &as( %ro'ide
insi#(t into mana#ement-s in'estment %(iloso%(y+ w(i&( &an ,e a
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-3+
'alua,le in%ut into our e'aluation of mana#ement and 'aluation of t(e
&om%any"
Cambridge Business Publishers, 2013
1-3, !inancial Statement "nal#sis $ %aluation, 3rd &dition
D1!88 15A minutes3
.ransparenc# is t(e de#ree to w(i&( t(e finan&ial statements a&&urately
and &om%letely %ortray t(e finan&ial &ondition of t(e &om%any and t(e
results of its o%eratin# a&ti'ities" rans%arent finan&ial statements are
timely and %ro'ide all t(e information re/uired to effe&ti'ely e'aluate t(e
finan&ial %erforman&e of t(e &om%any" A&&ura&y+ timeliness+ and
&om%leteness are im%ortant to finan&ial statement readers w(o seek
finan&ial information t(at is rele'ant and relia,le" rans%aren&y ,e&ame a
&entral issue in finan&ial re%ortin# followin# t(e a&&ountin# s&andals of t(e
early 0AAAs+ w(en analysts ,elie'ed too many finan&ial statements la&ked
trans%aren&y"
Galan&in# &om%anies- desire to issue trans%arent finan&ial statements is
t(eir need to %rote&t %ro%rietary information" Markets are 'ery &om%etiti'e+
and t(e information dis&losed to in'estors and &reditors is also dis&losed
to t(e &om%any-s &om%etitors" Most &riti&al is information relatin# to t(e
&om%any-s strate#i& dire&tion" E'en (istori&al information+ (owe'er+
%ro'ides insi#(t into t(e relati'e %rofita,ility of t(e &om%any-s o%eratin#
units t(at &an ,e effe&ti'ely utili$ed ,y future &om%etitors"
(ere (as traditionally ,een tension ,etween &om%anies and t(e finan&ial
%rofessionals 1es%e&ially in'estment analysts3 w(o %ress firms for more
and more finan&ial and nonfinan&ial information"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-3-
D1!89 15A minutes3
A&&ountin# measures ot(er t(an net in&ome (a'e ,e&ome &ommon%la&e in
&or%orate %ress releases" Gy t(eir use+ &om%anies seek to redefine t(e
,en&(mark t(e market uses to e'aluate t(e &om%anies- %erforman&e"
(ese non!CAA. in&ome metri&s often &reate a lower ,ar t(at &om%anies
&an more easily rea&(" Gy toutin# non!CAA. %erforman&e measures+
&om%anies (o%e to im%ro'e t(e market-s assessment of %erforman&e"
(e SEC will not a&&e%t non!CAA. finan&ial statements for /uarterly and
annual finan&ial re%ortin#" In fa&t+ auditors must &ite CAA. e6&e%tions in
t(eir audit o%inion+ w(i&( &reates a si#nifi&ant red fla#" Com%anies are
allowed to use non!CAA. measures in %ress releases+ %ro'ided t(at t(ey
also re&on&ile t(e non!CAA. num,ers to CAA. num,ers in t(e same %ress
release"
It is a &riminal offense to issue false or misleadin# finan&ial statements for
t(e %ur%ose of influen&in# se&urity %ri&es" Also+ most &om%anies (a'e
de'elo%ed and %u,lis(ed to em%loyees+ &odes of &ondu&t t(at %ro(i,it t(e
falsifi&ation of finan&ial re%ortin# for t(e %ur%ose of )o, retention+
%romotion+ or &om%ensation" Offi&ially+ senior mana#ement ,elie'es t(at
false finan&ial re%orts %ose si#nifi&ant et(i&al issues t(at must ,e &learly
&ommuni&ated to all em%loyees" Nonet(eless+ we &ontinue to witness
&or%orate e6e&uti'es doin# a E%er% walkF on national V as t(ey are
es&orted to )ail ,y federal aut(orities"
Condonin# e6&e%tions to finan&ial re%ortin# im%li&itly &ondones t(eft in all
of its forms+ and t(e &or%orate &ulture /ui&kly deteriorates" .ro%er
&or%orate #o'ernan&e re/uires t(e &ommuni&ation of &lear #uidelines
a,out w(at information may ,e &ommuni&ated in %ress releases and (ow
internal %erforman&e measures are to ,e &onstru&ted" (ese must ,e
enfor&ed to t(e letter"
Guffett is ri#(tly &on&erned wit( t(e use of non!CAA. measures of
%erforman&e" On&e t(e door is o%ened to im%ro%er re%ortin#+ it ,e&omes
in&reasin#ly diffi&ult to &onsistently measure %erforman&e"
Cambridge Business Publishers, 2013
1-(0 !inancial Statement "nal#sis $ %aluation, 3rd &dition
D1!8:
G
15A minutes3
(e SEC (as 'oi&ed its &on&ern o'er t(e %er&ei'ed la&k of inde%enden&e of
auditors+ and Con#ress (as %assed le#islation to define t(e a&ti'ities t(at
auditors may and may not %erform for t(eir &lients" (e issue of
inde%enden&e first arose w(en auditors fa&ed no &ontrols" In res%onse to
de&linin# audit fees+ %u,li& a&&ountin# firms sou#(t to ,olster t(eir in&ome
wit( mana#ement &onsultin# en#a#ements+ su&( as software de'elo%ment+
MBA assistan&e+ internal audit outsour&in#+ su%%ly &(ain mana#ement+ and
a (ost of ot(er ser'i&es"
As mana#ement &onsultin# re'enues and %rofits #rew dis%ro%ortionately
&om%ared to traditional audit re'enues and %rofit+ t(e SEC ,e&ame
&on&erned t(at auditors mi#(t ,e unduly influen&ed to issue ,iased audit
re%orts rat(er t(an risk losin# lu&rati'e mana#ement &onsultin# fees from
t(e same &lient" In res%onse+ t(e SEC &om%elled %u,li& a&&ountin# firms to
di'est t(eir mana#ement &onsultin# su,sidiaries" Furt(er+ firms were
limited as t(e ty%es of non!audit en#a#ements t(ey &ould %erform for
&lients"
Auditors are an im%ortant &om%onent of t(e &or%orate #o'ernan&e system+
and t(eir effe&ti'eness is lessened if t(eir inde%enden&e is &om%romised"
(e ,oard of dire&tors 1s%e&ifi&ally+ t(e audit &ommittee3 must &ontinually
e'aluate t(e inde%enden&e of t(e &om%any-s auditors"
Cambridge Business Publishers, 2013
Solutions Manual, Module 1 1-(1