Reading and Using Annual Reports: Financial Statement Analysis Activity Overview Purpose of the Activity The purpose of this activity is to help you synthesize many important aspects of accounting. Just as the title states, you will read and use financial information presented by a company in the form of an annual report. This activity helps you learn to gather information and become aware of the sources of financial information and then interpret, analyze, and use the information to evaluate the publicly traded company of your choice. You will also be given the opportunity to demonstrate your presentation skills as you communicate the facts you have uncovered in your a PowerPoint presentation. SCANS: ACC prescribes to the application and integration of skill requirements set forth in the U.S. Secretary of Labor's Commission on Achieving Necessary Skills (SCANS) as a measure of the effectiveness of teaching and learning. Of the list of 43 SCANS identified by the Commission, the following competencies are associated with this project. Exhibition of Responsibility Acquisition of information Use of information skills Application of data gathering skills Application of analytical skills Use of ratio analysis skills Development of business writing skills Use of presentation software Increased familiarity with industry analysis techniques Activity Summary This activity requires you to select the publicly traded company of your choice, and prepare a financial statement analysis consisting of four separate but integrated components. You will need to gather information and prepare the analysis of your findings from three different perspectives – that of a short-term creditor, a long-term creditor, and a potential investor. For the final report, you will be asked to assume the role of an employee of a fictitious company. Your findings in Parts A-C will then serve as the basis for Part D, an overall financial statement analysis that includes the three previous reports. Your findings will be presented in the form of both a written memo (3-5 page) and a brief PowerPoint presentation. Activity Outcome: Upon completion of this activity, you will be better prepared to use financial statements to identify strengths and weaknesses of a company. You will also become familiar with the tools of analysis that will allow you to conduct future analyses. Reading and Using Annual Reports: Financial Statement Analysis PART A: Liquidity Due Date: ______________________________ You are an analyst for a private company who has been assigned the task of preparing a liquidity analysis of a new customer. The analysis will be in the form of a Memo to the Files, which the head of your department will review. Instructions: 1. Obtain a copy of the annual report for your selected company. Read the financial statements, notes to the statements and Management Discussion & Analysis sections. Below are several recommended sites that should contain such data: Your company’s homepage. Usually the “investor relations” or “about the company” sections. Hoover’ Online www.hoovers.com Yahoo Financials http://finance.yahoo.com/ SEC Electronic Data Gathering and Retrieval http://www.sec.gov/edgar.shtml . 1. Outline a draft of your memo and include the following sections in the body of the memo: Introduction Ratio Analysis and Interpretation Recommendations 3. Calculate the ratios that indicate liquidity: the Current Ratio, Quick Ratio, Net Sales to Working Capital, Receivable Turnover Ratio and Inventory Turnover Ratio. Prepare the ratios for the two most recent years.* Note, you may use financial ratios that have been provided by a reputable financial Web site. 4. Analyze the trends over time (increasing, decreasing, fluctuating, etc.). Explain what the numbers might indicate based on the financial statements and your knowledge of accounting. 5. Prepare a typewritten memo reporting your findings, interpretations, and recommendations. (Two page MAXIMUM length plus an appendix containing ratio calculations). The following format is provided an example. MEMO TO: Credit Files FROM: Your Name DATE: Due Date of Assignment SUBJECT: Credit Analysis of "Your Company's Name" Introduction: Describe what you will and will not cover and why it is important to the reader. Ratio Analysis: In two-five paragraphs, describe the numbers and facts, and interpret them (i.e., their impact on the lending decision). Include also in your analysis management’s own view of its performance according to its Management Discussion and Analysis. Ratio calculations may be attached as an appendix. Recommendations: Explain why you should or should not grant credit. You must use a Web site that has at least two years of comparison data. Otherwise, you will need to find another company. . Reading and Using Annual Reports: Financial Statement Analysis PART B – Profitability Due Date ________________________ You have recently inherited a large sum of money. After enjoying a brief, but intense, spending spree, you plan to invest $5,000 to purchase the stock of a publicly traded company. You have decided to prepare a profitability analysis of your prospective purchase. Prepare your analysis in the form of a Memo to the Files. Instructions: 1. Use the same annual report data required in parts A and B above: financial statements, notes to the statements, and Management Discussion & Analysis sections. 2. Outline a draft of your memo and include the following sections in the body of the memo: Introduction Ratio Analysis and Interpretation Recommendations 3. Calculate the ratios that indicate profitability. Sample profitability ratios include Gross Margin, Before Tax Margin, Net Income, Return on Assets, Return on Equity, Earnings per Share, and Price-Earnings Ratio. Prepare the ratios for the two most recent years.* Note, you may use financial ratios that have been reported at a reputable Web site. Your responsibility is to represent the profitability category of ratios in your memo. If your particular company has other profitability ratios, choose the ratios that are available. Just be sure to interpret the ratios you describe. 4. Analyze the ratios in terms of the trend over time (increasing, decreasing, fluctuating, etc.) and then explain what the trends might indicate. Explain what the numbers might be based on the financial statements and your knowledge of accounting. 5. Prepare a MAXIMUM two-page typewritten memo, reporting your findings, interpretations and recommendations. Include also in your analysis management’s own view of its performance according to its Management Discussion and Analysis. The following format isprovided as a sample: MEMO TO: The Files FROM: Your Name DATE: Due Date of Assignment SUBJECT: Profitability Analysis of "Company Name" Introduction: Describe what you will and will not cover and why it is important to the reader. Ratio Analysis: (2-5 paragraphs) describe the numbers and facts, and interpret them (tell their impact on your investment decision). Ratio calculations may be attached as an appendix. Recommendations: Explain why you should or should not invest. . * You must use a Web site that has at least two years of comparison data. Otherwise, you will need to find another company. . Reading and Using Annual Reports: Financial Statement Analysis PART C – Solvency Due Date _____________________ Assume you are a financial analyst for a private banking group who has been assigned the task of preparing a long-term solvency analysis of your selected publicly traded company. Assume the company has applied for long-term financing. The analysis will be reported in the form of a Memo to the Files, which the head of your department will review. Instructions: 1. Use the same annual report data required in part A above, including financial statements, notes to the statements, and the Management Discussion & Analysis. 2. Outline a draft of your memo and include the following sections in the body of the memo: Introduction Ratio Analysis and Interpretation Recommendations 3. Calculate the ratios that indicate solvency. Suggested solvency ratios include the Debt Ratio, Total Liabilities to Net Worth Ratio, and Coverage Ratio (times interest earned). Prepare the ratios for the two most recent years.* Note, you may use financial ratios that have been reported at a reputable Web site. Your responsibility is to represent the solvency category of ratios in your memo. If your particular company has other solvency ratios, choose the ratios that are available. Just be sure to interpret the ratios you describe. 4. Analyze the ratios in terms of their trend over time (increasing, decreasing, fluctuating, etc.). Explain what the numbers indicate based on the financial statements and your knowledge of accounting. 5. Prepare a MAXIMUM two-page typewritten memo reporting your findings, interpretations and recommendations. Include also in your analysis management’s own view of its performance according to its Management Discussion and Analysis. The following format is provided as an example. MEMO TO: Bank Files FROM: Your Name DATE: Due Date of Assignment SUBJECT: Solvency Analysis of "Company's Name" Introduction: describe what you will and will not cover and why it is important to the reader. Ratio Analysis: Describe in two-five paragraphs the numbers and facts, and interpret them (tell their impact on the lending decision). Ratio calculations may be attached as an appendix. Recommendations: Explain why you should or should not grant credit. * You must use a Web site that has at least two years of comparison data. Otherwise, you will need to find another company. . Reading and Using Annual Reports: Financial Statement Analysis PART D – Complete Company Report Due Date ____________________ You are an employee of a successful accounting firm and have been asked to prepare a complete company analysis on a prospective new client for the firm. You should include relevant findings from the memos you completed in Parts A, B and C. However, you will also need to include additional research of the industry in which the company operates. Include also critical issues facing the company. in addition to preparing a written report, you will need to prepare a brief presentation of your recommendations. Instructions: 1. Obtain other news articles about the company. Obtain additional information about the company's industry. Hoovers Online (www.hoovers.com) is a useful site for company and industry data. Robert Morse & Associates and Valueline also prepare key ratios by industry (available at a local library). 2. Obtain additional business-press articles about the company. For example, Business Week, Barrons, Forbes, and Fortune are among the business magazines available online. In order to develop a balanced perspective of the company, it is important to seek the viewpoint of objective parties outside the company. 3. Draft the company report. Use the sample table of contents below for guidance: Sample Table of Contents Executive Summary: Summarize your results in two-three paragraphs. Company Background: Summarize the company’s business segments, products, services, and length of time in business, size, major competitors, etc., in two-three paragraphs. Industry Trends: 2-3 paragraphs explaining the nature and financial condition of the industry. Horizontal and Vertical Analysis: (2-3) paragraphs plus financial computations. These are comparisons across time and across components of the financial statement. Ask your professor for assistance in downloading the Excel spreadsheet for your company’s horizontal and vertical analyses. Financial Analysis: sections covering Liquidity, Solvency & Profitability. Your financial analysis MUST compare your company to its industry. Critical Issues: Identify and discuss two major issues facing the company based on article research: Competition, Regulation, Economy, Politics, Litigation, Public Concerns, etc. Summary and Conclusion: Take two-three paragraphs to wrap things up. Include your recommendations. Reference List: Use and cite at least five sources Appendix: Charts, graphs, ratio computations, horizontal and vertical analyses, etc. may be included in the appendix. 4. Prepare a brief (15-20 slides) PowerPoint presentation describing relevant facts about your company. Include a financial summary in your presentation.