Jiambalvo Chapter 14

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Analyzing Financial Statements: A Managerial Perspective
Home and G arden Warehouse (HGW) is a large home i m p r o v e m e n t r e t a i l e r, m u c h l i k e H o m e D e p o t o r L o w e ’s . A number of managers are interested in its financial situation. For example, Barbara Wilson, president of HGW, wants to know whether the company has been able to obtain planned discounts from suppliers and reduce selling and operating expenses. Bob Watson, a manager at John Deere, which is one of HGW’s suppliers, is also interested in HGW’s financial situation. Deere is considering linking its information system to the electronic checkout systems at the more than 200 HGW locations so it can track sales and efficiently schedule production of products it markets exclusively to HGW. Before making this investment, Bob wants to be confident that HGW is profitable and financially stable. Unless HGW is going to be around for the foreseeable future, Deere’s investment won’t be worthwhile. Finally, Thomas Nandier, the CEO of HGW, is preparing for a meeting with shareholders and financial analysts, and he wants to be ready for questions they may ask about the company’s performance. Thus, he too is interested in HGW’s financial situation. In each of these situations, the managers will analyze the financial statements of HGW to address their concerns. This chapter discusses how to perform this analysis.

1. Explain why managers analyze financial statements. 2. Perform horizontal and vertical analyses of the balance sheet and the income statement. 3. Discuss earnings management and the importance of comparing net income to cash flow from operations. 4. Understand how MD&A, credit reports, and news articles can be used to gain insight into a company’s current and future financial performance. 5. Calculate and interpret profitability ratios. 6. Calculate and interpret turnover ratios. 7. Calculate and interpret debt-related ratios.

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536 Chapter 14 Analyzing Financial Statements: A Managerial Perspective LEARNING OBJECTIVE 1 Explain why managers analyze financial statements.

WHY MANAGERS ANALYZE FINANCIAL STATEMENTS
Managers analyze financial statements for a variety of reasons including (1) to control operations; (2) to assess the financial stability of vendors, customers, and other business partners; and (3) to assess how their companies appear to investors and creditors. In this section, we discuss each of these motivations for analyzing financial statements.

Control of Operations
Managers frequently set goals and develop financial plans related to various aspects of their businesses. To gain insight into whether their goals have been achieved or the plans have been implemented successfully, managers analyze financial statements. In part, this is how they control operations. Managers expect that successful implementation of their plans will be reflected in subsequent financial information. If the financial information is inconsistent with successful implementation, managers launch an investigation to determine why this is the case. If the information is consistent with successful implementation, then managers assume that their plans are working and direct their attention to other pressing issues. For example, consider the case of City Appliances. During 2013, the company had cost of goods sold of $80,000,000 and inventory at the end of 2013 of $20,000,000. Thus, inventory turnover (the ratio of cost of goods sold to ending inventory) was 4. Senior management of City Appliances knows that the industry average is closer to 6 and concludes that the company has too much invested in inventory given its sales levels. In light of this, the company develops plans to better monitor inventory and sales data and gets commitments from suppliers to provide merchandise on a timely basis. This should allow City Appliances to reduce the amount of inventory it keeps on hand. Has the...
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