Financial Reporting, Financial Statement Analysis and Valuation, 8th Edition

Book Preface

The process of financial reporting, financial statement analysis, and valuation is intended to help investors and analysts to deeply understand a firm’s profitability and risk and to use that information to forecast future profitability and risk, and ultimately value the firm, enabling intelligent investment decisions. This process is central to the role of accounting, financial reporting, capital markets, investments, portfolio management, and corporate management in the world economy. When conducted with care and integrity, thorough and thoughtful financial statement analysis and valuation are fascinating and rewarding activities that can create tremendous value for society. However, as the recent financial crises in our capital markets reveal, when financial statement analysis and valuation is conducted carelessly and without integrity, it can create enormous loss of value in the capital markets and trigger deep recession in even the most powerful economies in the world. The stakes are high.

In addition, the game is changing. The world is shifting toward a new approach to financial reporting, and expectations for high quality and high integrity financial analysis and valuation are increasing among investors and securities regulators. Many of the world’s most powerful economies, including the European Union, Canada, and Japan, have shifted to International Financial Reporting Standards (IFRS). The U.S. Securities and Exchange Commission (SEC) accepts financial statement filings based on IFRS from non-U.S. registrants, and is considering whether to converge financial reporting from U.S. Generally Accepted Accounting Principles (GAAP) to IFRS for U.S. registrants. Given the pace and breadth of financial reform legislation, it is clear that it is no longer ‘‘business as usual’’ on Wall Street and around the world for financial statement analysis and valuation.

Given the profound importance of financial reporting, financial statement analysis, and valuation, and given our rapidly changing world in accounting and the capital markets, this textbook provides you with a principled and disciplined approach to analysis and valuation. This textbook demonstrates and explains a thoughtful and thorough sixstep framework you should use for financial statement analysis and valuation. You should begin an effective analysis of a set of financial statements with an evaluation of (1) the economic characteristics and current conditions of the industries in which a firm competes and (2) the particular strategies the firm executes to compete in each of these industries. Your analysis process should then move to (3) assessing how well the firm’s financial statements reflect the economic effects of the firm’s strategic decisions and actions. Your assessment requires an understanding of the accounting principles and methods used to create the financial statements, the relevant and reliable information that the financial statements provide, and the appropriate adjustments that you should make to improve the quality of that information. In this text we help you embrace financial reporting and financial statement analysis based on U.S. GAAP and IFRS. Next, you should (4) assess the profitability and risk of the firm using financial statement ratios and other analytical tools, and then (5) forecast the firm’s future profitability and risk, incorporating information about expected changes in the economics of the industry and the firm’s strategies. Finally, you can (6) value the firm using various valuation methods, making an investment decision by comparing likely ranges of the value of the share to the share price observed in the capital market. This six-step process forms the conceptual and pedagogical framework for this book, and it is a principled and disciplined approach you can use for intelligent analysis and valuation decisions.