Martin S. Fridson - Financial Statement Analysis: A Practitioners Guide

Additional Praise for Financial Statement Analysis, Fourth Edition

This is an illuminating and insightful tour of financial statements, how they can be used to inform, how they can be used to mislead, and how they can be used to analyze the financial health of a company.

Jay O. Light, Dean Emeritus, Harvard Business School

Financial Statement Analysis should be required reading for anyone who puts a dime to work in the securities markets or recommends that others do the same.

Jack L. Rivkin, Director, Neuberger Berman Mutual Funds and Idealab

Fridson and Alvarez provide a valuable practical guide for understanding, interpreting, and critically assessing financial reports put out by firms. Their discussion of profitsquality of earningsis particularly insightful given the recent spate of reporting problems encountered by firms. I highly recommend their book to anyone interested in getting behind the numbers as a means of predicting future profits and stock prices.

Paul Brown, Associate Dean, Executive MBA Programs, Leonard N. Stern School of Business, New York University

Let this book assist in financial awareness and transparency and higher standards of reporting, and accountability to all stakeholders.

Patricia A. Small, Treasurer Emeritus, University of California; Partner, KCM Investment Advisors

This book is a polished gem covering the analysis of financial statements. It is thorough, skeptical, and extremely practical in its review.

Daniel J. Fuss, Vice Chairman, Loomis, Sayles & Company, LP

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Copyright 2011 by Martin Fridson and Fernando Alvarez. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data

Fridson, Martin S.
Financial statement analysis : a practitioner's guide / Martin S. Fridson and Fernando Alvarez. 4th ed.
p. cm. (Wiley finance ; 597)
Includes bibliographical references and index.
ISBN 978-0-470-63560-5 (hardback); ISBN 978-1-118-06418-4 (ebk);
ISBN 978-1-118-06419-1 (ebk); ISBN 978-1-118-06420-7 (ebk)
1. Financial statements. 2. Ratio analysis.I. Alvarez, Fernando, 1964II. Title.
HF5681.B2F772 2011
657.3--dc22
2010054229

In memory of my father, Harry Yale Fridson, who introduced me to accounting, economics, and logic, as well as the fourth discipline essential to the creation of this bookhard work!

M. F.

For Shari, Virginia, and Armando.

F. A

Preface to Fourth Edition

This fourth edition of Financial Statement Analysis, like its predecessors, seeks to equip its readers for the practical challenges of contemporary business. Once again, the intention is to acquaint readers who have already acquired basic accounting skills with the complications that arise in applying textbook-derived knowledge to the real world of extending credit and investing in securities. Just as a swiftly changing environment necessitated extensive revisions and additions in the second and third editions, new concerns and challenges for users of financial statements have emerged during the first decade of the twenty-first century.

A fundamental change reflected in the third edition was the shift of corporations executive compensation plans from a focus on reported earnings toward enhancing shareholder value. In theory, this new approach aligned the interests of management and shareholders, but the concept had a dark side. Chief executive officers who were under growing pressure to boost their corporations share prices could no longer increase their bonuses by goosing reported earnings through financial reporting tricks that were transparent to the stock market. Instead, they had to devise more opaque methods that gulled investors into believing that the reported earnings gains were real.

To adapt to the new environment, corporate managers became far more aggressive in misrepresenting their performance. They moved beyond exaggeration to outright fabrication of earnings through the use of derivatives and special purpose vehicles that never showed up in financial statements and had little to do with the production and sale of goods and services. This insidious trend culminated in colossal accounting scandals involving companies such as Enron and WorldCom, which shook confidence not only in financial reporting but also in the securities markets.

Government responded to the outrage over financial frauds by enacting the Sarbanes-Oxley Act of 2002. Under its provisions, a companys chief executive officer and chief financial officer were required to attest to the integrity of the financial statements. They were thereby exposed to greater risk than formerly of prosecution and conviction for misrepresentation. Sarbanes-Oxley did create a deterrent to untruthful reporting, but as case studies in this new edition demonstrate, users of financial statements still cannot breathe easy.