Reading Financial Reports for Dummies (57 page)

You don’t see much about mergers and acquisitions in the three key financial statements (income statement, balance sheet, and statement of cash flows); they rarely take up more than a line item. The key place to find out about the impact of mergers and acquisitions is in the notes to the financial statements, which I talk more about in Chapter 9.

Some mergers destroy stockholders’

and employees’ portfolios

Just ask Time Warner stockholders or employ-

Time Warner stock dropped from a market value

ees what they think about their company’s of $52.56 per share in January 2001, when the merger with AOL — I’m sure you’ll hear many

merger was approved by the U.S. government,

words of disgust, most not printable. Many of

to $15.11 per share in September 2003, when

these employees held large chunks of stock in

the Time Warner board decided to drop AOL

their retirement portfolios, which have lost most

from its name, acknowledging the failure of the

of their value. The AOL–Time Warner merger

merger that was valued at $112 billion when it

proved to be so bad for Time Warner sharehold-

happened in 2000. In July 2008, the market value

ers that AOL was even dropped from the com-

of the company was $49.3 billion, and stock sold

pany name. The company also reverted to using

for $13.78 at the close of the stock market on

its old stock symbol, TWX, rather than AOL.

July 11, 2008.

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Part VI: The Part of Tens

I can’t tell you how to read the tea leaves and figure out whether a merger or acquisition is ultimately a good idea, but I can warn you to stay away if you don’t already own the stock. If you’re a shareholder who will eventually have to vote on the merger or acquisition before it can be approved, I urge you to read everything you can get your hands on that discusses the financial impact the merger or acquisition may have on the company.

Slow Inventory Turnover

One way to see whether a company is slowing down is to look at its
inventory
turnover
(how quickly the inventory the company holds is sold). As a product’s life span nears its end, moving that product off the shelf tends to be harder and harder.

When you see a company’s inventory turnover slowing down, it may indicate a long-term or short-term problem. Economic conditions, such as a recession —

which isn’t company-specific — may be the cause of a short-term problem. A long-term problem may be a product line that isn’t kept up to date, causing customers to look to other companies or products to meet their needs. I show you how to pick up on inventory-turnover problems in Chapter 15 by using numbers from the income statement and balance sheet.

Slow-Paying Customers

Companies report their sales when the initial transaction occurs, even if the customer hasn’t yet paid cash for the product. When a customer pays with a credit card issued by a bank or other financial institution, the company considers it cash. But credit issued to the customer directly by the company selling the product is not reported as cash received. The reason is that the customer doesn’t have to pay cash until the company that issues the credit bills him. For example, if you have an account at Office Depot that you charge your office supplies to, Office Depot won’t get cash for those supplies until you pay your monthly statement. If, instead, you buy those same supplies using a Visa or MasterCard, the credit card company deposits cash into Office Depot’s account and then works to collect the cash from you.

Businesses track noncash sales to customers who buy on credit in an account called
accounts receivable.
Customers are billed for payments, but not all customers pay their bills on time. If you see a company’s accounts receivable numbers continuing to rise, it may be a sign that customers are slowing down their payments, and eventually, the company may face a cash-flow problem. See Chapter 16 to find out how to detect accounts receivable problems.

Glossary

accounts payable:
An account that tracks the money a company owes to its suppliers, vendors, contractors, and others who provide goods and services to the company.

accounts receivable:
An account that tracks individual customer accounts, listing money that customers owe the company for products or services they’ve purchased.

accrual accounting:
An accounting method in which a company records revenues and expenses when the actual transaction is completed rather than when cash is received or paid out.

accrued liabilities:
The expenses a company has incurred but not yet paid for at the time the company closes its accounting books for the period to prepare its financial statements.

amortize:
To reduce the value of an intangible asset by a certain percentage each year to show that it’s being used up.

arm’s length transaction:
A transaction that involves a buyer and a seller who can act independently of each other and have no financial relationship with each other.

assets:
Things a company owns, such as buildings, inventory, tools, equipment, vehicles, copyrights, patents, furniture, and any other items it needs to run the business.

audit:
The process by which a certified public accountant verifies that a company’s financial statements have met the requirements of the generally accepted accounting principles.

auditors’ report:
A letter from the auditors stating that a company’s financial statements have been completed in accordance with the generally accepted accounting principles; the company includes this letter in its annual report.

balance sheet:
The financial statement that gives you a snapshot of a company’s assets, liabilities, and shareholders’ equity as of a particular date.

buy-side analysts:
Professionals who analyze the financial results of companies for large institutions and investment firms that manage mutual funds, pension funds, or other types of multimillion-dollar private accounts.

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Reading Financial Reports For Dummies, 2nd Edition
C corporations:
Separate legal entities formed for the purpose of operating a business and to limit the owners’ liability for actions the corporation takes.

capital expenditures:
Money a company spends to buy or upgrade major assets, such as buildings and factories.

capital gains:
The profits a company makes when it sells an asset for more than it originally paid for that asset.

cash-basis accounting:
An accounting method in which companies record expenses and revenues in their financial accounts when cash actually changes hands rather than when the transaction is completed.

cash-equivalent accounts:
Asset accounts that a company can easily convert to cash, including checking accounts, savings accounts, and other holdings.

cash flow:
The amount of money that moves into and out of a business.

cash flow from operations:
Cash a company receives from the day-to-day operations of the business, usually from sales of products or services.

Chart of Accounts:
A listing of all a company’s open accounts that the accounting department can use to record transactions.

common stock:
A portion of a company bought by investors, who are given the right to vote on board membership and other issues taken to the stockholders for a vote.

consolidated financial statement:
A report that combines the assets, liabilities, revenues, and expenses of a parent company with that of any companies that it owns.

contingent liabilities:
Possible financial obligations that a company should report when it determines that an event is likely to happen.

convertibles:
Shares of stock promised to a lender who owns bonds that can be converted to stock.

corporate governance:
The way a board of directors conducts its own business and oversees a corporation’s operations.

cost of goods sold:
A line item on the income statement that summarizes any costs directly related to selling a company’s products.

current assets:
Things a company owns that will be used up in the next 12 months.

current liabilities:
Payments on bills or debts that a company owes in the next 12 months.

Glossary

337

depreciate:
To reduce the value of a tangible asset by a certain percentage each year to show that the asset is being used up (aging).

discontinued operations:
Business activities that a company halts, such as the closing of a factory; can also refer to the sale of a division within a company.

dividends:
The portion of a company’s profits that it pays out to investors according to the number of shares that the investor holds.

double-entry accounting:
An accounting method that requires a company to record every transaction using debits and credits to show both sides of the transaction.

durable goods:
Goods that last for more than one year.

earnings per share:
The amount of net income that a company makes per share of stock available on the market.

EBITDA:
An acronym for
earnings before interest, taxes, depreciation, and
amortization,
which is a line item on the income statement.

equity:
Claims, such as shares of stock, that investors make against the company’s assets.

expenses:
Any costs not directly related to generating revenues
.
Expenses fall into four categories: operating, interest, depreciation/amortization, and taxes.

Financial Accounting Standards Board (FASB):
A private sector organization that establishes standards of financial accounting and reporting that the Securities and Exchange Commission and the American Institute of Certified Public Accountants recognize.

financial statements:
A company’s reports of its financial transactions over various periods, such as monthly, quarterly, or annually. The three key statements are the balance sheet, income statement, and statement of cash flows.

fixed costs:
A company’s expenses for assets it holds long term, such as manufacturing facilities, equipment, and labor.

fraudulent financial reporting:
A deliberate attempt by a company to distort its financial statements to make its financial results look better than they actually are.

generally accepted accounting principles (GAAP):
Rules for financial reporting that dictate that companies’
financial reporting is relevant, reliable, consistent, and presented in a way that allows the report reader to compare the results to prior years as well as to financial results for other companies.

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Reading Financial Reports For Dummies, 2nd Edition
going-concern problem:
An indication in an auditors’ report that the auditors have substantial doubt that a company has the ability to stay in business
.

goodwill account:
An account that appears on the balance sheet when a company has bought another company for more than the actual value of its assets minus its liabilities. Goodwill includes things such as customer loyalty, exceptional workforce, and a great location.

gross margin:
A calculation of one type of profit based solely on sales and the cost of producing those sales.

gross profit:
The revenue earned minus any direct costs of generating that revenue, such as costs related to the purchase or production of goods before any expenses, including operating, taxes, interest, depreciation, and amortization.

income statement:
A document that shows a company’s revenues and expenses over a set period of time; an income statement is also known as a
profit and loss statement
or
P&L.

initial public offering (IPO):
The first time a company’s stock is offered for sale on a public stock market.

insolvent:
No longer able to pay bills and debt obligations.

in-store credit:
Money lent directly by a company to its customers for purchases of its products or services.

intangible assets:
Anything a company owns that isn’t physical, such as patents, copyrights, trademarks, and goodwill.

intellectual property:
Works, products, or marketing identities for which a company owns the exclusive rights, such as copyrights, patents, and trademarks.

interest expenses:
Charges that must be paid on borrowed money, usually a percentage of the debt.

internal financial report:
A summary of a company’s financial results that’s distributed only inside the company.

liabilities:
Money a company owes to its creditors for debts such as loans, bonds, and unpaid bills.

liquidity:
A company’s ability to quickly turn an asset to cash.

long-term assets:
Holdings that a company will use for more than a 12-month period, such as buildings, land, and equipment.

Glossary

339

long-term debt or liabilities:
Financial obligations that a company must pay more than 12 months into the future, such as mortgages on buildings.

majority interest:
The position a company has when it owns more than 50

percent of another company’s stock.

managing earnings:
Using legitimate accounting methods in aggressive ways to get the bottom-line results that a company needs.

marketable securities:
Holdings that companies can easily convert to cash, such as stocks and bonds.

material changes:
Changes that may have a significant financial impact on a company’s earnings.

material misstatement:
An error that significantly impacts a company’s financial position.

net assets:
The value of things owned by a company after the company has subtracted all liabilities from its total assets.