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Financial Analysis A Business Decision Guide #362624

Course Overview

Credit

Amount

CPA

Course Author: Steven M. Bragg, CPA Field of Study (CPA): Finance

Course Description

Course publication/revision date: This course was updated on 10/5/2023.

Nearly every business decision calls for a clear understanding of the underlying numbers. A manager needs this information to understand how well a business unit is performing, whether a new venture can achieve a reasonable profit, how much debt to take on, and so forth. Financial Analysis can assist with these decisions by focusing on the key indicators in a business that will drive its future performance. It does so by describing how to extract meaningful information from financial statements. It also delves into a number of analyses that are linked to specific business decisions, such as price optimization, constraint management, and credit granting. Another area addressed is financing, where the course covers financial leverage, capital structure, and foreign exchange risk. Other topics include financial forecasting, discounted cash flow analysis, and the valuation of acquisitions. In short, Financial Analysis is the essential desk reference for anyone who wants to make better-informed decisions.

Table of Contents

Chapter 1 - Overview of Financial Analysis1

The Purpose of Financial Analysis	1
Key Financial Analysis Concepts	2
Judgment in Financial Analysis	3
Precision of Financial Analysis	4
Death by a Thousand Cuts	4
Monitoring Analysis	5
Role of the Financial Analyst	6
A Conservative Bias	6

Chapter 2 - The Financial Statements9

The Income Statement	9
Income Statement Overview	9
The Single-Step Income Statement	12
The Multi-Step Income Statement	12
The Contribution Margin Income Statement	13
The Multi-Period Income Statement	14
The Balance Sheet	15
Overview of the Balance Sheet	16
The Common Size Balance Sheet	19
The Comparative Balance Sheet	20
The Statement of Cash Flows	21
Overview of the Statement of Cash Flows	21
The Direct Method	22
The Indirect Method	24
The Statement of Retained Earnings	25
Overview of the Statement of Retained Earnings	25
Financial Statement Disclosures	26

Chapter 3 - Accounting Issues Impacting the Financials35

The Basis of Accounting	35
Accrual Basis of Accounting	35
Cash Basis of Accounting	36
Modified Cash Basis of Accounting	36
Effect of the Fiscal Year	37
Recordation of Revenue at Gross or Net	37
Bill and Hold Revenue	38
Negative Cash	39
Inventory Costing Methods	39
Depreciation Methods	40
Current Value Accounting	42
Illusory Profits	42
Financial Statement Reporting Issues	43
Headline Earnings	43
Pro Forma Earnings	43
Window Dressing	44
Auditor Certification	44

Chapter 4 - Interpretation of Financial Statements47

Interpretation of Financial Statements	47
Horizontal Analysis	48
Vertical Analysis	50
Cash Coverage Ratio	51
Current Ratio	52
Quick Ratio	53
Liquidity Index	54
Accounts Payable Turnover Ratio	55
Accounts Receivable Turnover Ratio	56
Inventory Turnover Ratio	57
Fixed Asset Turnover Ratio	57
Sales to Working Capital Ratio	58
Debt to Equity Ratio	59
Fixed Charge Coverage	60
Breakeven Point	60
Gross Profit Ratio	61
Net Profit Ratio	62
Return on Net Assets	62
EBITDA	63
NOPAT	64
Limitations of Ratio Analysis	64

Chapter 5 - Cost-Volume-Profit Analysis68

Contribution Margin	68
Breakeven Point	69
Margin of Safety	72
Cost-Volume-Profit Analysis	73
Sales Mix	75

Chapter 6 - Pricing Decisions78

Psychological Pricing	78
Cost Plus Pricing	79
Dynamic Pricing	80
Freemium Pricing	81
High-Low Pricing	82
Premium Pricing	83
Time and Materials Pricing	84
Value Based Pricing	86
Other Pricing Strategies	87
When to Review Pricing	88
Price Elasticity of Demand	89
Cross Price Elasticity of Demand	90
Non-Price Determinants of Demand	91

Chapter 7 - Cost Object Analysis94

Factors in Cost Object Analysis	94
The Assignability of Costs	95
The Customer Cost Object	96
Customer Acquisition Costs	97
Customer Lifetime Value	98
The Employee Cost Object	99
The Product Cost Object	100
The Product Line Cost Object	101
The Sales Channel Cost Object	103
Cost Object Termination Issues	103
Which Cost Objects to Track	104

Chapter 8 - Constraint Analysis106

Overview of Constraint Analysis	107
The Cost of the Bottleneck	108
Local Optimization	109
Constraint Analysis Financial Terminology	110
Constraint Analysis from a Financial Perspective	111
The Constraint Analysis Model	111
The Decision to Sell at a Lower Price	113
The Decision to Outsource Production	114
The Capital Investment Decision	115
The Decision to Cancel a Product	117

Chapter 9 - Credit Decisions120

The Credit Rating	120
Internal Credit Rating Systems	120
Third Party Credit Ratings	123
Evaluating Credit Scores	124
Use of Credit Ratings	124
Credit Rating Errors	125
Indicators of Future Payment Delinquency	125
Ongoing Credit Monitoring Actions	126
Requests for Credit Increases	129
The Riskiest Customers	129
The Demanding Customer	130
Effects of Industry Credit Practices	131

Chapter 10 - Financing Choices134

Overview of Debt Funding	134
The Line of Credit	135
The Borrowing Base	135
Early Payment Discounting	137
Invoice Discounting	138
Factoring	138
Inventory Financing	139
Purchase Order Financing	139
Leases	139
The Long-Term Loan	140
Bonds	141
Agency Financing	142
Deleveraging	142
Overview of Equity Funding	143
Restricted Stock	144
Unrestricted Stock	144
Warrants	144
Angel Investors and Venture Capital	145
Crowdfunding	146
Private Investment in Public Equity	146
Debt for Equity Swaps	147

Chapter 11 - Financial Leverage150

The Financial Leverage Concept	150
Issues Impacting Leverage	154
Leverage Risk	154
Impact of Compensation on Leverage	155

Chapter 12 - Capital Structure Analysis158

Optimal Capital Structure	158
Capital Structure Analysis	159
Line of Credit Issues	160
Tax Shield Effects	160
Future Financing Flexibility	161
Loan Covenant Issues	161
Maturity Structure of Debt	161
Creditor Position Considerations	162
Debt Paydown	163
Cost of Capital Reduction	163
Planning for a Bond Rating	163
Capital Structure Measurements	165
Interest Coverage Ratio	165
Debt Service Coverage Ratio	165
Recapitalization	166
Timing of Changes to the Capital Structure	166

Chapter 13 - Dividend Analysis169

The Investor Viewpoint	169
The Company Viewpoint	170
How to Set a Dividend Policy	172
The Stock Buyback Option	172
The Stock Dividend	173

Chapter 14 - Foreign Exchange Risk Analysis176

Foreign Exchange Risk Overview	176
Foreign Exchange Risk Management	177
Take No Action	178
Avoid Risk	178
Shift Risk	179
Time Compression	179
Payment Leading and Lagging	180
Build Reserves	180
Maintain Local Reserves	180
Hedging	180
Types of Foreign Exchange Hedges	181
Loan Denominated in a Foreign Currency	181
The Forward Contract	182
The Futures Contract	183
The Currency Option	183
The Cylinder Option	185
Swaps	185
Netting	186

Chapter 15 - Interest Rate Risk Analysis189

Interest Risk Overview	189
Interest Rate Risk Management	189
Take No Action	190
Avoid Risk	190
Asset and Liability Matching	190
Hedging	190
Types of Interest Rate Hedges	191
The Forward Rate Agreement	191
The Futures Contract	193
The Interest Rate Swap	194
Interest Rate Options	195
Interest Rate Swaptions	198

Chapter 16 - Financial Forecasting201

The Differences between a Budget and a Forecast	201
Budget Construction Tools	202
The Run Rate Concept	202
The Learning Curve	203
Sensitivity Analysis	204
Revenue Forecasting	205
The System of Budgets	209
The Number of Budget Scenarios	212
The Rolling Forecast	213
The Cash Forecast	216
The Short-Term Cash Forecast	217
The Medium-Term Cash Forecast	220
The Long-Term Cash Forecast	221
The Use of Averages	221
The Use of Clearing Dates in a Forecast	222

Chapter 17 - Managing the Rate of Growth225

The Funding of Growth	225
Contribution Margins and Sustainable Growth	227
Organic Growth	227
Step Costs and Sales Growth	228
Other Constraints on Growth	229
Negative Effects of Excessive Growth	230
The Ideal Rate of Growth	230

Chapter 18 - The Cost of Capital233

Cost of Capital Derivation	233
Cost of Debt	233
Cost of Preferred Stock	234
Cost of Common Stock	234
Weighted Average Cost of Capital	235
Variations in the Cost of Capital	235
Adjustments to the Cost of Capital	237
Cost of Capital as a Threshold Value	238

Chapter 19 - Discounted Cash Flow Techniques241

Time Value of Money	241
Present and Future Value Tables	242
Net Present Value	244
Internal Rate of Return	245
Incremental Internal Rate of Return	246
Terminal Value	247
Inclusions in Cash Flow Analysis	247

Chapter 20 - Capital Budgeting250

Overview of Capital Budgeting	250
The Capital Request Form	251
The Payback Method	252
Real Options	254
Capital Budget Proposal Analysis	255
Complex Systems Analysis	257
Research and Development Funding Analysis	257
The Outsourcing Decision	258
The Post Installation Review	259

Chapter 21 - The Lease or Buy Decision262

The Lease Arrangement	262
The Lease or Buy Decision	262
Leasing Concerns	263
Leasing Advantages	264

Chapter 22 - Acquisition Valuation267

Liquidation Value	267
Real Estate Value	268
Relief-from-Royalty Method	268
Book Value	269
Enterprise Value	270
Multiples Analysis	271
Discounted Cash Flows	274
Post Five-Year Cash Flows	274
Negotiation of DCF Contents	275
Replication Value	277
Comparison Analysis	278
The Comparison of Sales Multiples	278
The Comparison of Cash Flows	279
The Comparison of Contract Revenues	279
52-Week High	280
Influencer Price Point	280
The Initial Public Offering Valuation	280
The Strategic Purchase	281
Intellectual Property Valuation	281
Extraneous Valuation Factors	282
The Control Premium	282
The Earnout	282
Synergy Analysis	284
The Valuation Floor and Ceiling	286

Chapter 23 - The Enhancement of Shareholder Value289

Return on Equity	289
Economic Value Added	291
Cash Flow Analysis	293
Opportunity Cost of Capital	294
Key Success Factors	294
Stock Price Enhancement	295
Long-Term and Short-Term Value Considerations	295
The Industry Setting	296

Answers to Chapter Questions299

Glossary319

Index324

Course Details

Author: Steven M. Bragg, CPA

Steven Bragg, CPA, has been the chief financial officer or controller of four companies, as well as a consulting manager at Ernst & Young. He received a master’s degree in finance from Bentley College, an MBA from Babson College, and a Bachelor’s degree in Economics from the University of Maine. He has been a two-time president of the Colorado Mountain Club, and is an avid alpine skier, mountain biker, and certified master diver. Mr. Bragg resides in Centennial, Colorado. He has written more than 300 books and courses, including New Controller Guidebook, GAAP Guidebook, and Payroll Management.

Publication/Revision Date: 10/5/2023

Course Exam Questions (online): 95 (multiple-choice)

Program Delivery Method: NASBA QAS Self-Study

Available Formats of Course Text: PDF or PDF plus printed copy sent in the mail

Course Level, Prerequisites, and Advance Preparation Requirements

License	Course Level	Prerequisites	Advance Preparation Requirements
CPA	Overview	None	None

* This program is appropriate for professionals at all organizational levels.

Sponsor ID Numbers

National Registry of CPE Sponsors ID: 107615

State CPA Board Sponsor ID Numbers (where applicable)

Florida Division of Certified Public Accounting: 0004761

Hawaii Board of Public Accountancy: 14003

New York State Board for Public Accountancy: 002146

Ohio Accountancy Board: CPE .51 PSR

Pennsylvania State Board of Accountancy: PX178025

Texas State Board of Public Accountancy: 009349

Learning Objectives

As a result of studying the course material, you should be able to meet the objectives listed below:

Specify the situations in which different types of financial analysis could be used.
Specify the issues to consider when making recommendations as the result of financial analysis.
Identify the financial statements, their contents, and how they are formatted.
Cite the key accounting concepts that can alter the information presented in the financial statements.
State the methods used to interpret the information in the financial statements.
Identify the components of the cost-volume-profit relationship, and how they are used.
Identify the advantages of the various pricing methodologies.
Cite the issues that can impact the cost of a cost object, and whether that cost is recognized.
Identify the key constraint concepts and how they can be used to improve profitability.
Specify the concepts under which credit is granted to customers, as well as indicators of possible future delinquency.
Identify the financing choices available to a company.
Cite the impact and risks of financial leverage on a business, as well as when leverage is more likely to be used.
State the issues impacting the capital structure of a business, as well as situations in which the capital structure should be reviewed.
Identify the measurements used by investors to track the adequacy of dividend payments.
Identify the risks and mitigating actions associated with foreign exchange.
Cite the risks and mitigating actions associated with interest rates, as well as the terms of the various interest rate hedging instruments.
State the elements of a system of forecasting and budgeting.
Identify the issues impacting the rate of growth of a company.
Identify the elements of the cost of capital, and note how the cost of capital is calculated.
Cite the basis for the use of discounted cash flows, the types of annuities, and how discounted cash flows can be used.
State the methods available for analyzing requests for capital projects, and the issues to be reviewed when examining such requests.
Specify the concepts involved in the lease or buy decision process, the information to include in or exclude from the decision, and the circumstances under which different lease types would be used.
Identify the techniques used to place a value on a target company.
Cite the methods used to measure and improve shareholder value, and the situations in which certain methods are more applicable.

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