Question

1. a) What are some of the reasons that the financial statements will not reflect a fair picture of the company’s financial performance?

(b)Under what circumstances are investors interested in multi-year projections?

2. a) Identify and explain what would make an intense analysis of financial statements superfluous.

(b) Why should users of financial statements provide themselves with an additional layer of protection through the scrutiny of the numbers?

Answer 1

1.

a. There may be an error
b. They are trying to make financial statements look good to investors.

2. a) There are two key methods for analyzing financial statements. The first method is the use of horizontal and vertical analysis. Horizontal analysis is the comparison of financial information over a series of reporting periods, while vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. Typically, this means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets. Thus, horizontal analysis is the review of the results of multiple time periods, while vertical analysis is the review of the proportion of accounts to each other within a single period.

B) The second method for analyzing financial statements is the use of many kinds of ratios. Ratios are used to calculate the relative size of one number in relation to another. After a ratio is calculated, you can then compare it to the same ratio calculated for a prior period, or that is based on an industry average, to see if the company is performing in accordance with expectations. In a typical financial statement analysis, most ratios will be within expectations, while a small number will flag potential problems that will attract the attention of the reviewer.