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Summary investment decisions IB year 2 Q1
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A summary about the subject investment decisions, taught at Avans international business, year 2, first quarter, all required materials included.
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Summary investment decisionsChapter 3:
Financial statements and ratio analysis
Financial statements
The guidelines companies use to prepare and maintain financial records are known
as generally accepted accounting principles (GAAP). The accounting profession’s
rule-setting body, the financial accounting standards board (FASB), authorizes
these accounting principles. The public company accounting oversight board
(PCAOB) is a not-for-profit corporation established by the Sarbanes-Oxley act of
2002 to protect the interests of investors and further the public interest in the
preparation of informative, fair, and independent audit reports.
The stockholders’ report summarizes and documents the firm’s financial activities
during the past year. It begins with a letter to the stockholders from the firm’s chief
executive officer or chairman of the board. The letter to stockholders is the primary
communication from management in the annual report. It describes the events that
managers believe had the greatest effect on the firm during the year. it also typically
discusses management philosophy, corporate governance issues, strategies, and
plans for the coming year.
The four key financial statements required for reporting to shareholders are:
1. Income statement
2. Balance sheet
3. Statement of stockholders’ equity
4. Statement of cashflows
The income statement
provides a financial summary
of the firm’s operating results
during a specified period,
usually one quarter or one
year. Most large companies
produce income statements at
least monthly, but they use
these statements internally and
do not publicly release them.
,The balance sheet
presents a
summary
statement of the
firm’s financial
position at a given
time. The
statement
balances the firm’s
assets against its
financing, which
can be either debt
or equity.
The current assets
and current
liabilities are short-
term assets and
liabilities, which
means that the firm
will convert them
into cash or pay
them within 1 year.
The balance sheet
classifies all other
assets and
liabilities, along
with stockholders’
equity, as long-
term, or fixed,
because they will likely remain on the company’s books for more than 1 year.
Accountants refer to an item on the balance sheet as being liquid if the item is easy
to convert into cash quickly without much loss in value. The balance sheet lists
assets from the most liquid down to the least liquid.
Similarly, the balance sheet lists the liabilities and equity accounts form short-term to
long-term.
The amount paid by the original purchasers of common stock appears in 2 separate
entries, common stock and paid-in capital in excess of par on common stock. The
common stock entry is the par value of common stock. Par value is an arbitrary
number assigned to shares of stock when they are first created. The par value is not
related to the price investors pay for the stock that a company issues. Paid-in capital
in excess of par (BOVEN PARI) represents the amount of proceeds in excess of the
par value received from the original sale of common stock. The sum of the common
stock and paid-in capital accounts divided by the number of shares outstanding
represents the original price per share received by the firm on a single issue of
common stock.
,The statement of retained earnings is an abbreviated form of the statement of
stockholders’ equity. Unlike the statement of stockholders’ equity, which shows all
equity account transactions that occurred during a given year, the statement of
retained earnings reconciles the net income earned during a given year, and any
cash dividends paid, with the change in retained earnings between the start and the
end of that year.
The statement of cash flows is a summary of the cash flows over the period. The
statement provides insight into the firm’s operating, investment, and financing cash
flows and reconciles them with changes in its cash and marketable securities during
the period.
The current rate (translation) method is a technique used by US-based companies
to translate their foreign-currency-denominated assets and liabilities into US dollars,
for consilidation with the parent company’s financial statements, using the year-end
(current) exchange rate.
, Financial ratios
Ratio analysis involves methods of calculating and interpreting financial ratios to
analyze and monitor the firm’s performance.
Ratio analysis of a firm’s financial statements is of interest to shareholders, creditors,
and the firm’s own management.
Ratio analysis is not merely the calculation of a given ratio. More important is the
interpretation of the ratio value.
Cross-sectional analysis involves the comparison of different firms’ financial rations
at the same point in time. Frequently, a firm will compare its ratio values with those of
a key competitor or with a group of competitors that it wishes to emulate. Nearly all
users of financial ratios use this type of cross-sectional analysis called
benchmarking.
Ratios may be above or below the industry norm for both positive and negative
reasons, and it is necessary to determine why a firm’s performance differs from that
of its industry peers. Thus, ratio analysis on its own is probably most useful in
highlighting areas for further investigation.
Time-series analysis evaluates performance over time. Comparison of current to
past performance, using ratios, enables analysts to assess the firm’s progress and to
spot trends. Any significant year-to-year changes may indicate a problem, especially
if the same trend is not an industry-wide phenomenon.
The most informative approach to ratio analysis combines cross-sectional and time-
series analyses. A combined view makes it possible to assess the trend in the
behaviour of the ratio in relation to the trend for the industry.
No single financial ratio can reveal much about a firm’s financial health, which has
many different facets. Consequently, financial experts typically analyse a firm using
many different ratios. Financial ratios fall into 5 general categories based upon the
specific attributes of performance they are designed to assess:
1. Liquidity
2. Activity
3. Debt
4. Profitability
5. Market ratios
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