Nalyzing Financial Statements of Actual U.S. Companies

The objective of this project is to give experience in analyzing the financial statements and other financial information of actual companies. It also provides an opportunity to work on your analytical, writing, presentation and interpersonal skills and to gain experience working with current financial statements of publicly traded companies.

Select an industry (preferably: airline, aviation, manufacturing, or transportation) to analyze for this project. While there are many places to look on the Internet for lists of business sectors, industries and companies, the Yahoo website html).

The critical information that you will need is largely contained in the financial statements (Item 8), the notes to the financial statements (Item 8), the MD&A (Item 7 & 7A), and the description of the business (Item 1) and risk factors (Item 1A). Thus, you may want to avoid downloading (or printing) entire 10K reports or entire annual reports for the companies since some 10-Ks exceed 100 pages. In order to examine growth trends, you may want to find a summary table of selected financial results that most firms provide in their annual reports or on their web site.

Written project report:
First, provide an overview of the industry chosen by including things such as the economic health of the industry, growth (or shrinkage) in the industry and challenges that the industry may be required to deal with in the next 3-5 years (e.g., foreign competitors, increased regulation, shrinking customer base, etc.). A key aspect of understanding an industry is identifying the strategies firms use to compete in that industry. The two main strategies are cost leadership and product differentiation. As discussed in class, these strategies result in different ratios. Some of this type of information will be discussed in the description of the business (Item 1 and 1A) and MD&A (Item 7 & 7A) section of the companies annual reports or 10-Ks.

Second, identify the companies that you have chosen to analyze in the industry and provide a brief description of the most important operating activities for each company. Also indicate the amount of total sales and total assets for the most recent five fiscal years and determine whether the firm has been growing or shrinking its revenues, assets and earnings over the past five years. (This information should be shown in a tabular or spreadsheet format; graphs are also useful in identifying trends.)

Third, examine the first note to the financial statements for each firm to determine the significant accounting policies (methods) that it uses. Firms identify and discuss these under the Critical Accounting Estimates in the MD&A. Choose 2-3 policies that would likely be important in the industry that you are analyzing (there is no need to examine all accounting policies). If one of the main activities for the industry chosen involves selling products, you should include inventory method as one of your choices of significant accounting policies. After choosing which accounting policies to examine, compare and contrast these policies for all the firms in the group. Also, examine the appropriate footnotes to determine whether your firms have operating leases (off-balance sheet financing), under-funded pension plans or any contingent liabilities, including environmental liabilities (sometimes discussed under legal matters, if at all) and provide a brief discussion of how these items are likely to affect the financial condition of the company, future profitability and risk of the firm.

Fourth, examine and comment on the profitability, liquidity, and solvency for each firm for the past five fiscal years using the financial ratios listed below and discussed in Financial & Managerial Accounting for MBAs, 4e, Easton & Halsey. For profitability, focus on return on net operating assets (RNOA) and return on equity (ROE). RNOA should be disaggregated into net operating profit margin (NOPM) and net operating asset turnover (NOAT). Examine separately the two main components of profitability: gross profit margin (GPM) and operating expense margin (OEM). Examine separately the following three measures of operating efficiency that impact NOAT: accounts receivable turnover (ART), inventory turnover (INVT) and long-term operating asset turnover (LTOAT). With respect to liquidity, focus on current ratio and quick ratio. For solvency, focus on times interest earned ratio and debt-to-equity ratio (liabilities-to-equity ratio). All of these ratios are discussed in Module 4 or Appendix 4B of the textbook and expanded on in later parts of the book. Any other ratios or measures of profitability or financial position may be used if they help define the industry you have chosen to analyze.

The actual presentation of the ratios should be efficiently presented in a table or spreadsheet format; it is not necessary to show all the numbers used in computing the ratios in the main report, but please include the details of such calculations in the appendix. Then, when discussing the ratios and trends, etc., you can simply refer to the table or spreadsheet. Also, in computing the ratios, carry all calculations out to two decimal places.

Last, when you are finished with this analysis, assume that you have $20,000 to invest and that it must be invested in one of the firms included in your analysis. Decide which firm you would invest in and then support your choice based on the results of the entire analysis that your group performed.

The written project report should be typed, double spaced and should not exceed 8 pages in length (not counting any appendices that you may wish to include). Please note: Do not include actual annual reports or 10K reports with your paper.
Added on 04.03.2015 17:45
Appendix (FYI)

Net Operating Assets Operating Assets  Operating Liabilities

Operating Assets Total Assets  Cash  ST Investments  LT Investments

Operating Liabilities Total Liabilities  ST Debt  LT Debt

Long-term Operating Assets Long-term Assets  LT Investments

Long-term Assets Total Assets  Current Assets

NOPAT Operating Income  Income Taxes adjusted for Tax Shield

Income Taxes adjusted for Tax Shield Income Taxes + tax shield

Tax Shield (interest expense, net) * (tax rate)

Tax Rate Use the effective tax rate which is income tax expense divided by income before taxes. If, however, your company has a year with a tax benefit (i.e. where tax benefits exceed expenses), use the average effective tax rate from the other years. Calculating the tax rate with the effective tax rate can be slightly off because it can be affected by certain non-operating items. The problem with using the statutory rate of 37% like the book is that some companies have a much lower effective tax rate because of tax breaks.

Note: Mergent (and some companies) net interest income and interest expense. Mergent does this by taking interest income  interest expense. If you get a positive value, interest income exceeds interest expense. This means your taxes are actually higher because of your non-operating investments, so you have to subtract this amount times the tax rate from taxes (you can think of this as a negative tax shield). If you have a negative amount from Mergent, interest expense exceeds interest income. To get the tax shield you multiply this times the tax rate. See page 4-6 in the book for additional explanation