When it comes to investing, shareholders usually the financial information of a company or an organization to assist them in making a sound decision. Financial statement analysis provides investors with an accurate view of a business’s financial position and strength. These paper majors on the topic of financial statement analysis.
GAAP is a set of guidelines that publicly traded companies follow to ensure a smooth and efficient process when creating their financial statements. Shareholders and creditors rely on these GAAP-based financial statements before making investment decisions. Another factor stakeholder looks in a company is its valuation in the stock market. Companies that engage in transparent reporting are valued higher than those that are opaque when it comes to making their financial information public. The price of the stocks reflects the uncertainty in financial information. Although most companies prepare their financial information while working within GAAP, earning manipulation is an accounting method of financial reporting that works outside of GAAP.
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There are various means of financial management. These means include accrual management, which involves recognizing an economic event even when a cash transaction occurs. Analysts divide Accruals into discretionary accruals, which deal with earnings management. An example is the estimation of allowance for doubtful accounts and non-discretionary accruals like sales made on credit.
Another means of financial management is revenue and expense recognition. In the method, revenue is recognized in the period they are earned, and expenses are matched with those revenues. Within revenue and expense recognition arises the concepts of inflation of earnings. There are two primary techniques that have companies use to inflate earnings. They include cookie jar reserves and channel stiffing.
Extraordinary and nonrecurring items form another means of financial management. In the means, Nonrecurring items are the result of unusual events and are reported as part of operating expenses. For example, a company on the losing side of a lawsuit reports the settlement as a nonrecurring charge against income. On the other hand, extraordinary items are defined as unusual and infrequent and are presented in the income statement after continuing operations net of cash. When it comes to reporting, an analyst will account for a nonrecurring item in the operating portion of the income statement. In contrast, extraordinary items are reported in the non-operating part of the financial statement.
Other means of financial management include goodwill impairment which the FASB requires that companies test goodwill annually for impairment. Inventory accounting which features three methods that hold different assumptions regarding the cost flow of goods and inventory costs. Depreciation, whereby a company’s depreciation expense can significantly impact the firm’s financial statements. There are three depreciation methods straight line, accelerated depreciation, and unit production.
The last means of financial management is income and expense related to segments. Companies must provide profit and loss on specific business segments to make predictions for future periods easy and robust, as a business segment may be affected by different factors. Additionally, to assess the quality of earnings, if a business derives its gross revenue from a segment that is not its core business, it may suggest that its gains are not sustainable.
