This book provides a digestible step-by-step guide to reading corporate financial reports, drawing upon real-life case studies and examples of corporate collapses and accounting scandals, and applying practical tools to financial statement analysis. Appealing to a range of practitioners within corporate finance including investors, managers, and business analysts, this book is the first to specifically address the challenges facing those who are not professional accountants and auditors when examining corporate financial reports.
Corporate financial reports are used widely by managers, investors, creditors, and government agencies to examine company performance and evaluate potential risks. However, although seemingly an invaluable source of information for managerial decision-making, financial reports are often based on rough simplifications of a very complex reality. With no way of avoiding deliberate manipulations and fraudulent activity, these statements cannot be relied on completely when selecting stocks or evaluating credit risk, and therefore poor analysis can lead to potentially disastrous investment decisions.
The author suggests that in order to effectively interpret corporate financial reports, we must 'read between the lines' to accurately assess a company's economic performance and predict its long-term viability.
Author(s): Jacek Welc
Publisher: Palgrave Macmillan
Year: 2020
Language: English
Pages: 431
City: Cham
Preface
Contents
List of Charts
List of Examples
List of Tables
1 Most Common Distortions in a Financial Statement Analysis Caused by Objective Weaknesses of Accounting and Analytical Methods
1.1 Introduction
1.2 Undervaluation or Omission of Relevant Assets on Balance Sheet
1.2.1 L’Oréal SA
1.2.2 AkzoNobel
1.2.3 Hudson’s Bay Company
1.3 Undervaluation or Omission of Relevant Liabilities on Balance Sheet
1.3.1 Rental and Operating Lease Obligations
1.3.2 Contingent Liabilities of BP Plc
1.3.3 Contingent Liabilities of PG&E Corp
1.4 Inventory Write-Downs as an Imperfect Signal of Problems with Excess or Obsolete Inventories
1.5 Distortions Caused by a Leeway in a Financial Statement Presentation
1.5.1 Volkswagen and Daimler
1.5.2 Astaldi Group
1.6 Distortions of Turnover Ratios Caused by Seasonality, Growth and Tax-Related Factors
1.6.1 Distortions Caused by Seasonality of Sales
1.6.2 Distortions Caused by Growth Rates of Sales
1.6.3 Distortions Caused by Changing Sales Breakdown
Appendix
References
2 Other “Distortions” in a Financial Statement Analysis Caused by Objective Weaknesses of Accounting and Analytical Methods
2.1 Distortions Caused by Inventory Flow Methods
2.1.1 Incomparability of Results When Inventory Prices Change
2.1.2 Distortions of FIFO-Based Profits When Inventory Prices Change
2.1.3 Distortions of LIFO-Based Profits When Inventory Turnover Changes
2.1.4 Conclusions
2.1.5 Distortions Caused by Noncontrolling Interests
2.2 Distortions Caused by Changes in Accounting Principles, Changes in Accounting Estimates and Corrections of Accounting Errors
2.2.1 Incomparability of Results When Accounting Principles Are Changed
2.2.2 Incomparability of Results When Accounting Estimates Change
2.2.3 Incomparability of Results Caused by Accounting Errors
2.3 Distortions Caused by Non-Mandatory Early Adoption of New or Revised Accounting Standards
2.3.1 Boeing, General Dynamics, Lockheed Martin and Raytheon
2.3.2 Kinaxis Inc. and Tieto Oyj
Appendix
References
3 Deliberate Accounting Manipulations: Introduction and Revenue-Oriented Accounting Gimmicks
3.1 Quality of Earnings as One of the Major Problems of Contemporary Accounting
3.2 Links Between Earnings Manipulations and Balance Sheet Distortions
3.3 Overstatement of Profits by Overstatement of Revenues
3.3.1 Introduction
3.3.2 Overstatement of Profits by Premature Recognition of Revenues Which Should Be Deferred
3.3.3 Overstatement of Profits by Premature Recognition of Revenues Which Are Conditional on Future and Uncertain Events
3.3.4 Overstatement of Profits by Aggressive Usage of Percentage-of-Completion Method of Revenue Recognition
3.3.5 Overstatement of Profits by Artificial Sale-and-Buy-Back Transactions
Appendix
References
4 Deliberate Accounting Manipulations: Expense-Oriented Accounting Gimmicks and Intentional Profit Understatements
4.1 Overstatement of Profits by Understatement of Expenses
4.1.1 Overstatement of Profits by Understating Write-Downs of Inventories and Receivables
4.1.2 Overstatement of Profits by Capitalizing Excess Manufacturing Overheads in Carrying Amount of Inventory
4.1.3 Overstatement of Profits by Aggressive Capitalization of Costs in Carrying Amounts of Operating Fixed Assets
4.1.4 Overstatement of Profits by Artificial “Outsourcing” of R&D Projects
4.1.5 Overstatement of Profits by Delays in Depreciating Fixed Assets
4.1.6 Overstatement of Profits by Understating Provisions for Liabilities
4.2 Understatement of Profits by Overly Conservative Accounting
4.2.1 Motivations for Profit Understatements
4.2.2 Four Approaches to Accounting
4.2.3 Real-Life Examples of (More or Less Deliberate) Profit Understatements
4.2.3.1 Example of Pittards plc
4.2.3.2 Example of Mesa Air Group
4.2.3.3 Example of Takata Corp.
Appendix
References
5 Evaluation of Financial Statement Reliability and Comparability Based on Auditor’s Opinion, Narrative Disclosures and Cash Flow Data
5.1 Introduction
5.2 Auditor’s Opinion
5.2.1 L’Oreal
5.2.2 Agrokor Group
5.2.3 LumX Group Limited
5.2.4 CenturyLink Inc.
5.2.5 Hanergy Thin Film Power Group Limited
5.2.6 Conclusions
5.3 Narrative Information Disclosed in Financial Statements
5.3.1 OCZ Technology Group Inc.
5.3.2 Sino-Forest Corp.
5.3.3 AbbVie Inc.
5.3.4 Fresenius Group
5.3.5 Electronic Arts Inc. and Take-Two Interactive Software Inc.
5.4 Discrepancies Between Operating Profits and Operating Cash Flows
5.4.1 Toys “R” Us Inc.
5.4.2 21st Century Technology Plc
5.4.3 Pescanova Group
5.4.4 Carillion Plc
5.4.5 Cowell e Holdings Inc.
5.4.6 Conclusions
Appendix
References
6 Problems of Comparability and Reliability of Reported Cash Flows
6.1 Introduction
6.2 Unreliability of Reported Cash Flows When Cash Balances Themselves Are Falsified
6.2.1 China MediaExpress Holdings Inc.
6.2.2 Satyam Computer Services Limited
6.2.3 Patisserie Holdings Plc
6.2.4 Conclusions
6.3 Spurious Improvements in Operating Cash Flows of Shrinking Businesses
6.3.1 Admiral Boats S.A.
6.3.2 Claire’s Stores Inc.
6.3.3 Cowell e Holdings Inc.
6.3.4 Conclusions
6.4 Distortions of Reported Cash Flows Caused by Non-controlling Interests
6.4.1 Distorting Impact of Non-controlling Interests on Reported Cash Flows
6.4.2 Real-Life Example of Rallye SA
6.5 Distortions of Reported Cash Flows Caused by Capitalized Intangible Assets
6.6 Distortions of Reported Cash Flows Caused by off-Balance Sheet Financing Schemes
6.7 Distortions of Reported Cash Flows Caused by Customer Financing Schemes
6.8 Distortions of Reported Cash Flows Caused by Business Combinations
6.8.1 Distorting Impact of Business Combinations on Reported Cash Flows
6.8.2 Real-Life Example of Conviviality Plc
6.9 Example of Eroded Intercompany Comparability of Reported Cash Flows
Appendix
References
7 Evaluation of Financial Statement Reliability and Comparability Based on Quantitative Tools Other Than Cash Flows: Primary Warning Signals
7.1 Introduction
7.2 Signal No 1: Discrepancies Between Revenue Growth and Inventory Growth
7.2.1 Burberry Group Plc
7.2.2 Pittards Plc
7.2.3 Toshiba Corp
7.2.4 Conclusions
7.3 Signal No 2: Discrepancies Between Revenue Growth and Receivables Growth
7.3.1 Ingenta Plc
7.3.2 Aegan Marine Petroleum Network Inc
7.3.3 OCZ Technology Group Inc
7.3.4 Conclusions
7.4 Signal No 3: Discrepancies Between Growth Rates of Revenues and Unbilled Receivables from Long-Term Contracts
7.4.1 General Electric Co
7.4.2 Carillion Plc
7.4.3 Astaldi Group
7.4.4 Conclusions
7.5 Signal No 4: High or Fast Growing Share of Intangibles in Total Assets
7.5.1 GateHouse Media Inc
7.5.2 OCZ Technology Group Inc
7.5.3 Starbreeze AB
7.5.4 Conclusions
7.6 Signal No 5: Systematically Falling Turnover of Property, Plant and Equipment
7.6.1 Sino-Forest Corp
7.6.2 Icelandair Group
7.6.3 Jones Energy Inc
7.6.4 Conclusions
7.7 Signal No 6: Falling Ratio of Depreciation and Amortization to Carrying Amount of Operating Fixed Assets
7.7.1 Lufthansa Group
7.7.2 Netia S.A
7.7.3 Toshiba Corp
7.7.4 Conclusions
Appendix
References
8 Evaluation of Financial Statement Reliability and Comparability Based on Quantitative Tools Other Than Cash Flows: Additional Warning Signals
8.1 Signal No 7: Changing Growth Rates of Deferred Revenues
8.1.1 US Airways Group Inc.
8.1.2 GateHouse Media Inc.
8.1.3 Dart Group Plc
8.1.4 Conclusions
8.2 Signal No 8: Unusual Behavior of Provisions for Future Costs and Liabilities
8.2.1 OCZ Technology Group Inc.
8.2.2 Nortel Networks Corp.
8.2.3 Takata Corp
8.2.4 Conclusions
8.3 Signal No 9: Discrepancies Between Accounting Earnings and Taxable Income
8.3.1 GetBack S.A
8.3.2 General Electric Co.
8.3.3 Aventine Renewable Energy Holdings Inc.
8.4 Signal No 10: Related-Party Transactions
8.4.1 GetBack S.A.
8.4.2 Hanergy Thin Film Power Group Limited
8.4.3 Astaldi Group
8.5 Signal No 11: Suspected Behavior of Allowances for Impairments of Inventories and Receivables
8.5.1 OCZ Technology Group Inc.
8.5.2 EServGlobal Ltd.
8.5.3 Delta Apparel Inc.
8.6 Signal No 12: Suddenly Changing Breakdown of Inventories
8.6.1 Volkswagen Group
8.6.2 Nokia Corporation
8.6.3 Cowell e Holdings Inc.
8.7 Signal No 13: Other Significant and Unusual Trends
8.8 Importance of Investigating Combinations of Warnings Signals
8.9 When Detecting Accounting Manipulations May Be Difficult
Appendix
References
9 Techniques of Increasing Comparability and Reliability of Reported Accounting Numbers: Selected Simple Tools
9.1 Introduction
9.2 Adjustments for Differences in Inventory Accounting Methods
9.3 Adjustments for off-Balance Sheet Liabilities
9.3.1 Introduction
9.3.2 Example of Southern Cross Healthcare
9.4 Adjustments for Capitalized Development Costs and Other Intangible Assets
9.5 Adjustments for Differences in Depreciation Policies Applied to Property, Plant and Equipment
Appendix
References
10 Techniques of Increasing Comparability and Reliability of Reported Accounting Numbers: Some More Advanced Tools
10.1 Introduction
10.2 Adjustments for Non-controlling Interests
10.3 Adjustments for Long-Term Contracts Accounted for with the Use of the Percentage-of-Completion Method
10.3.1 Complexities of Accounting for Long-Term Contracts
10.3.2 Possible Profit Overstatements Caused by Unprofitable Long-Term Contracts
10.3.3 Adjusting Reported Earnings for Contract Assets and Liabilities
10.3.4 Real-Life Examples of Warnings Signals Generated by “Invoiced Earnings”
10.3.4.1 Astaldi Group
10.3.4.2 Carillion Plc
10.4 Increasing Comparability and Reliability of Financial Statement Numbers with the Use of Data on Current and Deferred Income Taxes
10.4.1 Accounting (Book) Earnings vs. Taxable Income
10.4.2 Increasing Financial Statement Comparability and Reliability with the Use of Income Tax Disclosures
Appendix
References
References
Index
