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Investing Decisions, Pro Forma Statement

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Discussion Questions

C13 - Financial Analysis: The Big Picture

1. "Income statement provides investors with past financial data and information and therefore cannot be relied on to make future investing decisions." Do you agree? Explain.

2. What is pro forma income statement and in your opinion has this practice put too much "spin" on operating results of a company? Explain.

3. Perform a research (using internet etc) on a company that makes a restatement of improper revenue recognition. State the reason of such revenue restatement and the impact of such on its stock price shortly before and after such announce of restatement/restatement.

4. Wall Street financial analysts have put a substantial amount of weight on a company's stock price performance as whether it meets or does not meet its income or earnings per share estimates. Have you experience that impact of failure to make the Wall Street expectation in your company or know of someone who did? Explain.

5. Why is it essential to apply more than one financial statement analysis ratio when analyzing a company? You can use the four types of financial ratios as a basis for your discussion.

6. What are examples of irregular items? How does a change in accounting principles affect the financial statements? Who in the organization is responsible for the application of a change in an accounting principle? Why?

7. What is horizontal analysis? What is the value in using horizontal analysis? Why would a company use this analysis? What does this analysis tell you?

8.What are the three most common types of ratios? Why are they important? Which ratios would you use to determine the long-term viability of an organization? Why?

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Solution Preview

Financial Analysis: The Big Picture

Answer one:

I do not agree, recent past financial data and information can be used to develop a trend on how a firm has been performing in the recent past which may reflect a trend that the firm may face in the near future. Such recent past information is very important as it helps managers be able to estimate possible income projections in the near future within a very small margin error and therefore help in the planning process of a firm's financial needs (Financial Modeling Guide, 2010). In this sense therefore, past financial information can be modeled to predict future financial needs and therefore may help in making investing decisions.

Answer two:

Pro forma income statement is that income statement showing a firm's forecasted income statement based on specific conditions (Weygandt, Kimmel, & Kieso, 2010). In essence therefore it shows the impact that certain financial activities may have on a firm's future income. For instance if a firm plans to acquire another, a pro forma income statement provides future projected income estimates of the firm based on the acquisition decisions.

Yes, this practice puts too much "spin" on the operating results of a company since companies and definitely individuals within a company have the ability to a "spin" on the forecasted figure whether negative or positive. In most instance though companies may use a positive "spin" as such projections puts the company in good light and gives it's a favorable stance in obtaining capital financing.

Answer three:

An example of a company which made a restatement of improper revenue recognition is Bristol-Myers Squibb. The restatement of improper revenue recognition was due the company increasing its sales to the wholesalers beyond the existing demand for their products. This company provided incentives to wholesalers through discounts to purchase more drugs from the company that was actually required in the market, resulting to the wholesalers building up inventories. When the wholesalers stopped purchasing due t the massive inventories they had, BristolMyers Squibb dropped drastically. The company therefore had to restate previous two years' financial result as most its products had not been sold, and this impacted more than $2 billion in revenue (Collingwood, Sherman, & Young, 2003). Before the restatement of the revenue, the share price was flourishing at $57 but with the announcement of the restatement the share price plummeted by 46% $30.75 within a month of the announcement (Rezaee & Riley, 2010).

Answer four:

Yes I know of a company which failed to experience the failure to make the Wall Street expectation; Cisco Systems. The Wall Street ...

Solution Summary

The investing decisions and pro forma statements are examined.