ANALYSIS OF FINANCIAL STATEMENTS Syllabus and Course Outline

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1 Syllabus and Course Outline UCLA EXTENSION BUSINESS AND MANAGEMENT COURSE TITLE: COURSE NUMBER: Analysis of Financial Statements X Reg#V6148 QUARTER: Spring 2010 INSTRUCTOR: MEETING TIMES: Charles E. P. Wood President, C. E. Peterson & Company PO Box 50001, Pasadena Phone: (626) cepwood@ucla.edu cepw@cepeterson.com Thursdays 6:30PM to 9:30PM LOCATION: Figueroa Courtyard Rm 102 OFFICE HOURS: By appointment. Course Description: This course is intended for financial and credit analysts, CPA or CFA candidates, investors, business managers, and individuals who are involved in equipment or real estate financing or leasing, or trade credit analysis. The course focuses on the mechanics of financial statement analysis including balance sheet and income statement analysis, ratio analysis, cash flow analysis, common size analysis, and trend analysis. Students are expected to analyze and evaluate free cash flow generation, profitability, operating efficiency, and the impact of leverage on business risk and return on equity. Prerequisite: X 1A and X 1B Principles of Accounting, or consent of instructor. Purpose and Scope: I have organized this course into two components. Prior to the midterm, the course will focus on gaining a broad understanding of how to perform financial statement analysis, i.e., crunch numbers, read financial statements, and crunch more numbers). Just before the midterm, we will focus on the thinking so we may effectively communicate the conclusions of our analyses [a nal y sis noun: 1. the separation of something into its constituents in order to find out what it contains, to examine individual parts, or to study the structure of the whole; 2. the examination of something in detail in order to understand it better or draw conclusions from it]. Beginning with the midterm, the course segues to the practical execution of the skills, most importantly thinking, learned in the first half of the course as we move into the case analysis phase. The course will be participative and focus on thinking, understanding, analyzing, and presenting findings and conclusions based on developing analytical skills for use in a multitude of corporate, banking and investment settings [think ing adjective capable of using the mind to Spring /9/10 3:52 PM AFS_432.3_Syllabus_ doc

2 reason or reflect. Noun: 1. use of the mind to form thoughts, 2. opinions or conclusions arrived at]. Although the course will touch on the selling of concepts, objectivity and intellectual integrity will be stressed and challenged during peer discussions. In addition, the course will highlight the need for continued collaboration amongst participants to ensure (and reinforce the need for) relevance to the ROW (1 st acronym, Rest Of the World contrasted with Real World). Typical Class Schedule: There is no such thing as a typical class schedule. The real value of education is in understanding that one s flexibility and ability to react to change caused by both endogenous and exogenous events is tantamount to strict consistency. As your instructor was once admonished, consistency is the hobgoblin of small minds. REQUIRED READINGS Financial Statement Analysis: A Practitioner s Guide, 3 rd Ed., University Ed., by Martin S. Fridson, CFA and Fernando Alvarez, Wiley, 2002 X432.3 Analysis of Financial Statements Course Reader, edited by Charles E. P. Wood, UCLA Academic Publishing Services, 2009 RECOMMENDED READINGS AND OTHER RESOURCES Periodicals: The New York Times, Business Section (online: Wall Street Journal, (online: Barron s, Dow Jones & Company, weekly The Economist, weekly Books: The Interpretation of Financial Statements: The Classic 1937 Edition by Benjamin Graham and Spencer B. Meredith, Harper Business 1998 (Harper & Row 1934). Security Analysis: The Classic rd Edition by Benjamin Graham and David Dodd, McGraw-Hill Irrational Exuberance, Robert J. Schiller, Princeton University Press 2000 (Paperback, also) The Roaring Nineties, Joseph E. Stiglitz, WW Norton, 2003 The Great Crash, John Kenneth Galbraith, initially published 1954, available in paperback A Short History of Financial Euphoria, John Kenneth Galbraith, 1990, available in paperback Elements of Style, White and Strunk, first published who knows when, available in paperback Websites: Financial Accounting Standards Board ( National Bureau of Economic Research ( Economy.com ( The Federal Reserve Board Statistics ( Federal Reserve Bank of St. Louis: Economic Research ( Standard and Poors (www2.standardandpoors.com) New York Stock Exchange ( National Association of Securities Dealers ( Securities Exchange Commission ( SEC Edgar Database of Financial Filings ( Spring 2010 Page 2 of 8

3 Text, Course Reader, Recommended Readings and Other Resources, etc. Participation in this course assumes basic accounting knowledge and some modicum of securities and capital markets understanding. The required text provides an effective overview of issues critical to effective financial statement analysis. The reader contains Harvard Business School (HBS) notes on various aspects of financial statement analysis along with HBS/Stanford cases that will be the impetus for analytical thinking and classroom discussion. The recommended readings and other resources are intended to provide additional insight, knowledge, data, food for thought, and fodder for classroom mastication. Participation We are each expected to be at every class. We are each expected to participate constructively. Since participation (defined as meaningful attendance) will comprise up to 15% of the course grade (more for those of us too shy to actively participate, less for those of us who like to hear themselves talk), being there/here is important. The instructor has a fragile ego so absence will be taken as a personal affront. Quizzes and Exams Pop quizzes will be reserved for those of us who behave like we are still in junior high (middle school for those under age 35). The take-home midterm will be our first introduction to case analysis. The final exam will be geared toward the overall objective of this course: to assist each student in understanding the broad concepts of financial statement analysis. As such, each student will be given the same company to analyze. Students will be expected to present a summary of their analysis during the final class. Problem Sets (busywork) expected to be completed prior to Class We are each old enough to know that homework is really only busywork designed to keep us honest. As such, busywork will consist of two separate and distinct components: a) a ratio problem set (full guidance and numbers provided) and a cash flow analysis. Problem sets will not be graded but rather guide the instructor s focus in the ensuing class sessions. Case Analysis and Discussion Each of the three cases included in the second half of the course are key to developing real world analytical skills. Analyses should be both qualitative and quantitative in nature. Since this course is, by definition, quantitative, the artful (and most successful) students will include clear and concise quantitative analysis in preparation for each case discussion. Grading Grading, by its very nature is frequently believed to be arbitrary and capricious. However, the instructor has endeavored to divine a grading structure that permits both the instructor and the student maximum flexibility. The final grade (100 max, zero min) is composed of the abovementioned components. The approximate point allocations follow on the next page: Midterm 30 Take-home Final 40 Problem Sets 20 Participation up to 15 Total 105 Spring 2010 Page 3 of 8

4 One constant in life is that if you, as a lender, investor, stock or bond research analyst, or investment manager, pay attention to the task at hand, you will do just fine. Assuming for the moment that the class is balanced, attends and participates regularly, a student who gets a total of points will receive an A points will receive a B points will receive a C points will receive a D Below 65 points will fail. Just like the global investment markets: the market s the market, all prices grades are final. Final thoughts. The instructor is really big on language and communication skills. There are no degrees of uniqueness. Unique is unique. We often try to do something, to is not and. You can t have a one without a two, or an A without a B. Hyperbole is just that, hyperbole. Puffery is best practiced by the Magic Dragon and Peter Paul & Mary. State facts; avoid superlatives. Questions? Call or , but be patient, the instructor has a day job, also. The Required Disclosures usually found in very small print: PLEASE NOTE: ALL COURSE GRADES ARE FINAL. Incompletes: The interim grade Incomplete may be assigned when a student s work is of passing quality, but a small portion of the course requirements is incomplete for good cause (e.g., illness or other serious problem). It is the student s responsibility to discuss with the instructor the possibility of receiving an I grade as opposed to a non-passing grade. The student is entitled to replace this grade by a passing grade and to receive unit credit provided they complete the remaining coursework satisfactorily, under the supervision of and in a time frame determined by the instructor in charge, but in no case later than the end of the next academic quarter. At that time, the Registrar will cause all remaining Incompletes to lapse to the grade F. Note: Receiving an I does not entitle a student to retake all or any part of the course at a later date. If you have any questions regarding the instructor s grading policy, please raise any such questions immediately. Spring 2010 Page 4 of 8

5 SESSION DETAIL 1 April 1 Reading between the lines introducing financial statement analysis a. First, a look back at economic history b s financial collapse cheap, easy credit; deregulation; the new paradigm isn t so new, after all. c. Financial Analysis? What it is, what it isn t. d. Back to the Fundamentals didn t my high school coach say that a lot? a. Text: Chapter 1 b. HBS: i. A Conceptual Framework for Financial Reporting ii. Introduction to Financial Ratios and Financial Statement Analysis 2 April 8 The Balance Sheet & Income Statement Since this course is not an accounting course, our discussion of financial statements will be relatively brief but extraordinarily critical to financial statement analysis. a. The basic balance sheet i. a measure at a specific point in time, a snapshot. ii. Assets = Liabilities + Shareholders Equity iii. Key to liquidity and credit quality (risk) assessment iv. Intangibles? Goodwill? v. Reserves? b. The income statement i. Reports financial transactions during a period certain ii. Revenue/Sales what comes in the door iii. Cost of Goods Sold (COGS), Operating Expenses what goes out the door iv. Quality of earnings GAAP interpretation c. The statement of cash flows merely a brief intro a. Text: Chapters 2 & 3 b. HBS: i. Financial Reporting Fundamentals ii. The Balance Sheet iii. The Income Statement iv. Financial Statement Analysis 3 April 15 Statement of Cash Flows a. To some the single most important financial schedule i. Cash is king certainly obvious after the past 18 months ii. Allows the analyst to deduce the fundamental strength of a company, financial trends, and tie the income statement to the balance sheet Spring 2010 Page 5 of 8

6 b. Three fundamental sources or uses of cash - i. Operating cash flow ii. Cash used/generated through investing activities iii. Cash used/generated through financing activities c. Trends visible through analysis of the cash flow statement - i. Growth ii. Leveraging or de-leveraging iii. Potential wasting away of productive assets iv. Changes in corporate strategy v. Underlying trends in the business d. Two methods for presenting cash flow information - i. Direct ii. Indirect a. Text: Chapter 4 b. HBS: i. The Statement of Cash Flows ii. Statements of Cash Flows: Three Examples 4 April 22 Profit a. Review of Ratio Problem Set b. Profit, a must have What is it? Do all companies measure profit in the same way? c. Our first look at Quality of Earnings i. Aren t all earnings equal? ii. Mustn t earnings comply with GAAP? iii. What red flags am I looking for? iv. What is management s control and influence over reported earnings? Required Reading a. Text: Chapter 5 b. HBS: Diversity in Accounting Principles: A Problem, a Strategic Imperative, or a Strategic Opportunity? Problem Set #1 Due: Ratio Problem Set 5 April 29 Revenue & Expense Recognition Guest Lecturer a. Review Cash Flow Problem Set b. Are you suggesting that $1 of earnings here isn t as good as $1 of earnings there? c. Why do I begin my review and analysis with the Notes to Financial Statements? d. How may balance sheet accounting affect quality of earnings? e. How does management impact quality of earnings? a. Text: Chapters 6 & 7 b. HBS: Quality of Earnings Problem Set #2 Due: Cash Flow Problem Set - Statements of Cash Flow: Three Examples Alpha & Beta Spring 2010 Page 6 of 8

7 6 May 6 Quality of Earnings; EBIT, EBITDA, and Free Cash Flow a. Revisit quality of earnings analysis. b. Begin fixed charge coverage analysis i. Define fixed charges ii. Explain concept of coverage of fixed charges iii. What should cover fixed charges? a. Text: Chapter 8 b. HBS: iii. Calculating Free Cash Flows iv. Quality of Earnings Analysis 7 May 13 MIDTERM DUE: FIRST INVESTMENTS a. Fundamental approach to case analysis. b. Application of the DuPont Model to evaluate trends in ROE. c. Separating critical data from number noise. HBS First Investments Incorporated; Accounting Fraud at Worldcom. 8 May 20 Disclosures & Audits; M&A Accounting a. Revisit quality of earnings as it relates to financial statement disclosure. b. The meaning of the audit opinion. c. The impact or mergers & acquisitions on the financial statements Required Reading Text: Chapters 9 & 10 9 TBA Forecasting & Projecting Financial Statements a. Discuss Costco (A) b. Discuss various forecasting methods. c. Forecasting vs. budgeting vs. projecting a. Text: Chapter 12 b. HBS: Costco Wholesale Corp. (A) Case Analysis #1 Due: Costco Wholesale Corp. (A) 10 June 3 Credit Analysis a. Liquidity. b. Interest and coverage of fixed charges. c. Leverage measures. d. Goodwill and other intangible assets. a. Text: Chapter 13 b. HBS: Bond Ratings Spring 2010 Page 7 of 8

8 11 June 10 Equity Analysis a. Discuss Costco (B) b. Review time value of money. c. Understand key issues from an equity investor s perspective. a. Text: Chapter 14 b. HBS: Costco Wholesale Corp. (B) Case Analysis #2 Due: Costco Wholesale Corp. (B) 12 June 17 BNSF Analysis Due; Course Wrap-up Spring 2010 Page 8 of 8