How to read a financial report - csinvesting

[Pages:192]How to Read a Financial Report

Wringing Vital Signs Out of the Numbers

Fifth Edition

John A. Tracy, Ph.D., CPA

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This book is printed on acid-free paper.

Copyright ? 1999 by John A. Tracy. All rights reserved.

Published by John Wiley & Sons, Inc. Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4744. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, (212) 850-6011, fax (212) 850-6008, E-Mail: PERMREQ@.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional person should be sought.

Library of Congress Cataloging-in-Publication Data:

Tracy, John A.

How to read a financial report : wringing vital signs out of the

numbers/John A. Tracy.--5th ed.

p. cm.

Includes index.

ISBN 0-471-32935-5 (cloth : alk. paper).--ISBN 0-471-32706-9

(paper : alk. paper)

1. Financial statements. I. Title.

HF5681.B2T733 1999

657'.3--dc21

98-49083

Printed in the United States of America. 10 9 8 7 6 5 4 3

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Preface to the Fifth Edition

When I started this book we had no grandchildren; today we have eight. Then (1979?1980) the Dow Jones Industrial Average hovered around 850. Today the Dow is over 8500, a multiple of 10 times in 20 years. During this period, millions of persons entered the stock market. Today a large part of retirement savings is invested in stocks. Stock values depend on information reported in financial statements, so knowing how to read a financial report is more important than ever.

This edition catches up with recent developments in financial statement accounting and financial reporting. All exhibits have been refreshed to make them easier to follow and more relevant. The exhibits in this edition are typeset from printouts from Microsoft Excel? work sheets I have prepared. To request a copy please contact me at my e-mail address: tracyj@colorado.edu.

In this edition I have added a brief introduction to management accounting (Chapter 23) that focuses on profit reporting to business managers. An internal profit report includes sensitive and confidential information that is not divulged in a company's external financial report to its outside investors and lenders. Business entrepreneurs in particular should find this chapter a very useful addition to the book.

Otherwise, the content and basic approach of the book remain the same. As they say: "If it ain't broke, don't fix it." The format and focus of the book have proved

Page v

Preface to the Fifth Edition

When I started this book we had no grandchildren; today we have eight. Then (1979?1980) the Dow Jones Industrial Average hovered around 850. Today the Dow is over 8500, a multiple of 10 times in 20 years. During this period, millions of persons entered the stock market. Today a large part of retirement savings is invested in stocks. Stock values depend on information reported in financial statements, so knowing how to read a financial report is more important than ever.

This edition catches up with recent developments in financial statement accounting and financial reporting. All exhibits have been refreshed to make them easier to follow and more relevant. The exhibits in this edition are typeset from printouts from Microsoft Excel? work sheets I have prepared. To request a copy please contact me at my e-mail address: tracyj@colorado.edu.

In this edition I have added a brief introduction to management accounting (Chapter 23) that focuses on profit reporting to business managers. An internal profit report includes sensitive and confidential information that is not divulged in a company's external financial report to its outside investors and lenders. Business entrepreneurs in particular should find this chapter a very useful addition to the book.

Otherwise, the content and basic approach of the book remain the same. As they say: "If it ain't broke, don't fix it." The format and focus of the book have proved

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very successful. Cash flow is underscored throughout the book; this is the hallmark of the book, and what distinguishes it from other books on analyzing financial statements.

Not many books like this make it to the fifth edition. It takes the joint effort of both the author and the publisher. I thank the many persons at John Wiley & Sons who have worked with me on the book over two decades. The comments and suggestions on my first draft for the book by Joe Ross, then national training director of Merrill Lynch, were extraordinarily helpful.

Again I express my deepest gratitude to the original editor of the book, Gordon Laing--for his guidance, encouragement, and friendship. Gordon gave shape to the book. His superb editing was a blessing that few authors enjoy. Gordon takes much pride in the success of the book--as well he should! Gordon, you old reprobate, I couldn't have done it without you.

JOHN A. TRACY BOULDER, COLORADO JANUARY 1999

Contents

1 Starting with Cash Flows

2 Introducing the Balance Sheet and Income Statement

3 Profit Isn't Everything

4 Sales Revenue and Accounts Receivable

5 Cost of Goods Sold Expense and Inventory

6 Inventory and Accounts Payable

7 Operating Expenses and Accounts Payable

8 Operating Expenses and Prepaid Expenses

9 Fixed Assets, Depreciation Expense, and Accumulated Depreciation

10 Accruing Unpaid Operating Expenses and Interest Expense

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1 7 15 21 27 33 37 41 45 53

11 Income Tax Expense and Income Tax Payable

12 Net Income and Retained Earnings; Earnings Per Share (EPS)

13 Cash Flow from Profit

14 Cash Flows from Investing and Financing Activities

15 Growth, Decline, and Cash Flow

16 Footnotes--The Fine Print in Financial Reports

17 The Cost of Credibility--Audits by CPAs

18 Accounting Methods and Quality of Earnings

19 Making and Changing the Rules

20 Cost of Goods Sold Conundrum

21 Depreciation Dilemmas

22 Ratios for Creditors and Investors

23 A Look Inside Management Accounting

24 A Few Parting Comments

Index

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59 63 67 73 77 87 95 109 117 127 139 147 161 171 181

1-- Starting with Cash Flows

Page 1

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