Indian Institute of Management Bangalore
Financial Statement Analysis
PGP and PGSEM Elective Term 4, 2009
Course Outline
I LEARNING OBJECTIVES
1. To develop a framework for using financial statement information in a variety of business
analysis and valuation contexts.
2. To differentiate between good accounting and bad accounting.
3. To write an equity research report, credit evaluation report or internal management report
based on analysis of financial statements and other relevant reports.
4. To analyze business strategies to understand the value that they add.
5. To integrate accounting principles and finance concepts.
II COURSE CONTENTS
Session
1
Topic
Part I OVERVIEW OF FINANCIAL STATEMENTS
Introduction to Investing and Valuation
Investment Styles and Fundamental Analysis
The Role of Financial Reporting in Capital Markets
Stock Market Bubbles
The Professional Analyst and the Investor
Business Analysis
Valuation Technology
Read: Chapter 1 of SP.
Assignment: E1.5; E1.6; M1.1.
2
Introduction to the Financial Statements
The Financial Statements: Income Statement, Balance Sheet, Statement of
Cash Flows, etc.
Measurement in the Financial Statements
Comparisons using Financial Statements
Read: Chapter 2 of SP.
Assignment: E2.11; E2.12; M2.1.
3
How Financial Statements are Used in Valuation
Multiple Analysis
Asset-Based Valuation
Fundamental Analysis
The Architecture of Fundamental Analysis
Dividend Discount Model
Read: Chapter 3 of SP.
Assignment: E3.8; E3.13; E3.17; M3.1.
4
Cash Accounting, Accrual Accounting, and Discounted Cash Flow
Valuation
The Discounted Cash Flow Model
The Statement of Cash Flows
1
Cash Flow, Earnings, and Accrual Accounting
Read: Chapter 4 of SP.
Assignment: E4.8; E4.11; E4.14; M4.1.
TEST 1
5-6
7
8
Accrual Accounting and Valuation: Pricing Book Values
The Concept Behind the Price-to-Book Ratio
Prototype Valuations
A Model for Anchoring Value on Book Value
Read: Chapter 5 of SP.
Assignment: E5.3; E5.6; E5.14; E5.15; E5.16; E5.17; M5.2; M5.3.
Accrual Accounting and Valuation: Pricing Earnings
The Concept Behind the Price-to-Earnings Ratio
Prototype Valuation
A Model for Anchoring Value on Earnings
Read: Chapter 6 of SP.
Assignment: E6.1; E6.5; E6.8; E6.13; M6.4.
PART II THE ANALYSIS OF FINANCIAL STATEMENTS
Business Activities and Financial Statements
Business Activities and Reformulating Statements
Accruals
Read: Chapter 7 of SP.
Assignment: E7.1; E7.5; M7.1.
9
Analyzing the Statement of Shareholders’ Equity
Reformulating the Statement of Owners’ Equity
Clean Surplus and Dirty Surplus
Read: Chapter 8 of SP.
Assignment: E8.7; E8.12; E8.13; M8.2.
10
Analyzing the Balance Sheet and the Income Statement
Reformulation of the Balance Sheet
Reformulation of the Income Statement
Comparative Analysis
Read: Chapter 9 of SP.
Assignment: E9.8; E9.9; E9.10; M9.2.
11
Analyzing the Cash Flow Statement
Free Cash Flow
Reformulating Cash Flow Statements
Read: Chapter 10 of SP.
Assignment: E10.3; E10.8; E10.12; M10.1.
12
Analyzing Profitability
Effect of Leverage
Drivers of Profitability
Read: Chapter 11 of SP.
2
Assignment: E11.1; E11.4; E11.8; M11.2.
MID-TERM EXAMINATION
13
14
Analyzing Growth and Sustainable Earnings
What is Growth?
Analyzing Changes in Profitability and Sustainable Earnings
Analyzing Growth in Investment
Read: Chapter 12 of SP.
Assignment: E12.5; E12.6; E12.11; E12.13; E12.14; M12.2.
PART III FORECASTING AND VALUATION ANALYSIS
Valuation of Operations and Analysis of Price-to-Book Ratios
Forecasting and Valuation with Balance Sheets
Modifying Residual Earnings
The Cost of Capital in Valuation
Read: Chapter 13 of SP.
Assignment: E13.9; E13.12; E13.13; M13.2.
15
Simple Forecasting and Simple Valuation
Simple Forecasts and Simple Valuation
Simple Forecasts of Growth and Return on Net Operating Assets
The Applicability of Simple Valuations
Simple Valuation as an Analysis Tool
Read: Chapter 14 of SP.
Assignment: E14.7; E14.12; E14.14; M14.1.
16
Full-Information Forecasting and Valuation
Knowing the Business
Financial Statement Analysis: Focusing the Lens on the Business
Full-Information Forecasting and Pro Forma Analysis
Value Generated in Share Transactions
Read: Chapter 15 of SP.
Assignment: E15.41; E15.5; E15.8; E15.12; M15.1.
TEST 2
17
18
PART IV ACCOUNTING ANALYSIS AND VALUATION
Creating Accounting Value and Economic Value
Value Creation and the Creation of Residual Earnings
Accounting Methods, PB Ratios, PE Ratios, and Valuation
Hidden Reserves
Conservative and Liberal Accounting
Read: Chapter 16 of SP.
Assignment: E16.4; E16.5; E16.6; M16.1.
Analyzing the Quality of Accounting
Accounting Quality
Earnings Quality
Detecting Accounting Manipulation and Transaction Manipulation
3
Disclosure Quality
Read: Chapter 17 of SP.
Assignment: E17.7; E17.10; E17.15; M17.1.
19
20
PART V ANALYZING RISK
Analyzing Equity Risk and the Cost of Capital
Understanding Risk
Betas
Price Risk
Read: Chapter 18 of SP.
Assignment: E18.1; E18.4; E18.5.
Analyzing Credit Risk
Ratio Analysis for Credit Evaluations
Forecasting and Credit Analysis
Liquidity Planning and Financial Strategy
Read: Chapter 19 of SP.
Assignment: E19.1; E19.2; E19.3; M19.1.
END-TERM EXAMINATION
III EVALUATION AND SCHEDULE
Case presentation, 10 per cent, to be scheduled through the course.
Project, 10 per cent. Proposal due 5 p.m. Friday, July 3, 2009; report due Friday, August 21,
2009.
Test 1, 10 per cent. Chapters 1 to 4, multiple-choice questions and short problems, one hour,
Saturday, July 4, 2009 after classes for the day.
Mid-term examination, 20 per cent, Chapters 1 to 9, detailed problems, three hours, Sunday,
July 26, 2009.
Test 2, 10 per cent. Chapters 10 to 13, multiple-choice questions and short problems, one
hour, Saturday, August 8, 2009 after classes for the day.
End-term examination, 40 per cent, analysis of company financial statements, analyst reports
and other material, five hours, Sunday, August 30, 2009.
Tests and exams are open-book. The student may bring anything except laptop and mobile
phone.
IV READING MATERIAL
Prescribed Reading:
Stephen Penman. 2009. Financial Statement Analysis and Security Valuation. Fourth edition,
McGraw-Hill (SP for short).
In addition, selected articles will be distributed.
Additional Reading:
4
1. Krishna Palepu, Paul Healy and Victor Bernard. Business Analysis & Valuation Using
Financial Statements, Third Edition. Cincinnati, Ohio: South-Western College
Publishing, 2004.
2. Sidney Cottle, Roger F. Murray, and Frank E. Block. Graham and Dodd's Security
Analysis. Reprint by Tata McGraw-Hill, 2002. This is a FSA classic.
3. Financial Analysts’ Journal, Journal of Applied Corporate Finance.
Popular Reading:
1. Alex Berenson. The Number. New York: Random House, 2003.
2. Howard Schlitz. Financial Shenanigans. Second edition. Reprint by Tata McGraw-Hill,
2003.
V MARKING, COMPLAINTS AND REVIEW, AND GRADING
Answer-sheets will be usually marked within one week from the date of the test or
examination. Students will have the opportunity of inspecting their respective answer scripts
and the instructor's model answers at the instructor's office. Students must not remove
answer scripts and instructor's model answers.
Any complaint regarding marking should be given in writing a brief and precise note
immediately after inspecting the answer script. The instructor will examine the complaint and
revise the marks, if appropriate. The instructor is not able to discuss (in person, over the
phone or by e-mail) marking or grading matters.
On the basis of the student’s total marks in the course, there will be an overall grade and a
grade point average. The various components of evaluation will not be graded separately.
VI INSTRUCTOR
R. Narayanaswamy
Office:
A Block 2nd Floor Room # 205
3135
 narayan@iimb.ernet.in
Student meeting time: Wednesday and Thursday 2 to
5 p.m., and depending on availability at other times.
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