Financial Statement Analysis Research Paper

Question: Describe about the Financial Statement Analysis Research Paper? Answer: Introduction Financial statements help to understand the financial health of a company. However, when accounts are manipulated, it provides a negative usage to stakeholders. Stakeholders face many issues in reading the market such as improper guidelines, fraudulent practices and manipulations. This research paper makes a study of the financial statement analysis issue. The methodology involved is to study the issue through a case study of the financial statement of Apple Inc. The ratio analysis made is through the horizontal method and vertical method. The horizontal method is done through the financial statement analysis, growth expectations and equity valuation of Apple Inc., over a period of 4 years from 2012 to 2015. The analysis is made through figures presented in the annual reports of the company and the issues that stakeholders face while reading the annual reports of a firm. The literature relating to manipulation issues, the causes, methods involved in manipulations is analyzed through Apple Inc. The findings are made and conclusions of the study provided through detailed study. Literature Overview Jerry M Rosenberg has defined Accounting Ratios as any relationship of a companys earnings to the firms market price of its stock. They are also called as financial ratios as they show the relationship between various figures stated in the financial statements. Ratio analysis is the most widely used financial analysis tool. These ratios help to assess the liquidity, profitability and the capital structure of the business, especially to compare the performance of the firm in relation to its previous performance (Sarngadharan kumar, 2011). Financial Statement Analysis Users view the financial statements of a firm for various reasons. Investors look at the profitability of the firm over time and by comparing them with other firms in the same industry. The continuity, stability and solvency of a firm is seen by a strong cash flow. The capital structure gives them a picture of the value of holdings by investors. Other stakeholders include the lenders, pension fund managers, banks, employees and suppliers. The business managers read the financial statements to know the performance of the firm and to spot problems that arise in the firm(Fridson Alvarez, 2002). Securities and Exchange Commission (SEC) The role of the SEC is to protect the interest of stakeholders and to maintain an orderly and efficient market to facilitate capital formation so that firms confirm to transparent accounting practice and also confirm the standards of disclosure as specified(SEC, 2013). Methodology: Case Study-Apple Inc. The research paper consists of current issues regarding the financial statement analysis of stakeholders. The methodology used in this research is through a case study of Apple Inc. The current issues that stakeholders face in reading financial statements are analyzed. Issues arise regarding financial analysis under horizontal and vertical methods. Details regarding Apple Inc and stakeholders involved in Apple Inc. are seen by using various analytical tools. Though the Securities and Exchange Commission (SEC) takes steps to prevent fraudulent practices manipulations, there are many reasons why corporate make use of loopholes in presenting incorrect financial statements. History Apple is an American international company which manufactures personal computers, computer software, mobile phones and computer peripherals. This company was co-founded by Steve Jobs in 1976. It is the third largest mobile phone makers. Some of its well-known products are the iPhone, iPod, the iPad, and the Macintosh line of computers. The financial statement analysis helps to inspect the productivity and feasibility of Apple Inc. through the income statement, the balance sheet, statement of retained earnings and statement of cash flows. Stakeholders of Apple Inc. The interests of the stakeholders are the main concern of Apple Inc in while considering the different aspects of its business. They are Customers or consumers: They are the companys top stakeholders. Providing effective and good products at reasonable prices to customers is the priority of the firm. But customers of Apple have accepted the premium pricing policy along with the superior quality of the product. Employees of Apple Inc Investors Employees of distributors and suppliers Impact of financial statement manipulation The stakeholders are the main users of the financial statement projected annually by the firm The investors, bankers, suppliers, creditors, employees are various stakeholders who read the financial reports and take decisions regarding the relationship with the firm. Unless the stakeholders understand the issues and read between the lines, they will be misled into taking wrong decisions regarding the firm. Big corporate like General Motors, Lehman Brothers, Enron, AIG, Freddie Mac, are some examples of bankrupt firms which predicted wrong financial statements and had to close their firms as they were bankrupt while stakeholders lost their investments in these firms. Financial Statement Analysis(Cook, Apple Inc. - Annual Report, 2015, 2015)(Cook T. , 2014)(Cook, Apple Inc.- Annual Report, 2013)(Cook, Apple Inc.- Annual Report, 2012) (Ernst Young, 2015) Financial Statements are analyzed from the annual reports of companies. A study is made on how stakeholders analyze the financial statement of Apple Inc. Key methods of analyzing financial statements are the horizontal method and the vertical method. The horizontal method analyzes the financial statement over a series of periods. In this sample the financial statements are studied for a period of four years from 2012 to 2015 of Apple Inc. The financial statement analysis, growth expectation and equity valuations are studied. The vertical method analyzes the financial statement between competing firms and between the industry figures. Horizontal method Under the horizontal method, the financial analysis made within the firm by means of ratio analysis over a time-frame. The time-frame considered here is four years from 2012 2015. The ratios analyzed on Apple Inc are to gain knowledge about financial analysis, growth expectation and equity valuation (Sarngadharan kumar, 2011) Financial Analysis Liquidity Ratios Liquidity Ratios 2012 2013 2014 2015 Current Ratio 1.50 1.68 1.08 1.11 Quick Ratio 1.48 1.64 1.05 1.08 Cash Ratio 0.76 0.93 0.40 0.52 Source: Nasdaq(Nasdaq, 2016) Liquidity ratios help to analyze if the firm has the ability to meet its current or short-term obligations The current ratio is very good in 2012 while it has come down in 2015. The current assets are just able to meet the current liabilities in 2015 and are just satisfactory. The Quick ratio shows the overall liquidity position of the firm. This is also known as the liquid ratio. It places more emphasis on the ability of the firm to convert current assets into cash. Quick assets are current assets less inventory and prepaid expenses. A liquid ratio of 1:1 is considered satisfactory and Apple Inc has just satisfactory liquid assets to meet liquid liabilities(Palepu Healy, 2013). The Cash Ratio is a liquidity ratio that reflects the ability of the firm to pay its current liabilities with its cash and cash equivalents. This ratio is analyzed by its creditors. Apple Inc has a cash ratio of less than 1 which shows that it does not have the required cash balance to pay off its debts. In fact, this ratio shows deterioration over the years. The cash balance consists of cash obtained through tax evasion as reported through new articles.(TOI, 2016). Profitability Ratios 2012 2013 2014 2015 Gross Margin 44% 38% 39% 40% Operating Margin 35% 29% 29% 30% Net Margin 27% 22% 22% 23% ROE 43% 31% 34% 46% ROA 42% 26% 26% 31% Source: Morningstar(MorningStar, 2016) Gross Margin: This shows the percentage of revenue that is available to cover operating expenditures and other expenditure. Apple Inc.s GP margin has decreased after 2012 though it is recovering over the years showing that it is increasing its revenue to cover expenses Net margin: This indicates profitability. Apple Inc.s net profit margin has also fallen since 2012, showing a marginal improvement after its fall in 201 . Year on year, the companys revenue has increased to 233.72bn from 192.80bn which is a 27.86 % increase. It has also decreased its cost of goods sold, selling and administrative expenses as well as interest paid as a percentage of sales. These improvements have increased the growth of net income to 53.39bn from 39. T5bn which is 35.14% (Marketwatch, 201). ROE: This measures how much a company generates as profit from the shareholder money invested. It compares the profitability of the company with that of other firms in the same industry. This ratio has also improved after 2013 showing that investments made with the shareholder money get good returns adding to the profit of the business ROA: We find that the ROE exceeds ROA in 2012 and 2015 showing that earnings is more than sufficient to pay the interest charges on levered capital structure(Billingsley, 2006) Growth Expectation Current Qtr Mar 16 Next Qtr June 16 Current Year Sep 16 Next Year Sep 17 Earnings estimate 2.00 1.78 9.07 10.02 Revenue Estimate 52.10B 47.76B 227.45B 240.84B Earnings 2.16 1.81 1.88 3.23 EPS 2.00 1.78 9.07 10.02 Source: Yahoo Finance(Yahoo, 2016) The dividend per share (at a five year average) at 1.26% has grown at 8.7%. This is a noteworthy positive trend since there are not many companies in the communication equipment industry paying such good dividend. The EPS (at 5 year average) is at its highest in 2015. The industry average is 9.39 which show that the company has attained good growth. The estimated growth for September 2017 is 10.02(Yahoo, 2016) The revenue estimate shows a positive trend for the next year The growth-stock newsletter: The Motely Fool has recommended that Apple Inc. will triple its stock markets return over its last 13 year performance. Apple CEO Tim Cook has made bullish statements in its last employee meeting regarding its iPad business Equity Valuation (value in 000s) 2012 2013 2014 2015 Common Stocks $16,422,000 $19,764,000 $23,313,000 $27,416,000 Retained Earnings $101,289,000 $104,256,000 $87,152,000 $92,284,000 Total Equity $118,210,000 $123,549,000 $111,547,000 $119,355,000 EPS 6.31 5.68 6.45 9.07 Dividend 0.38 1.63 1.81 1.98 Source: Nasdaq(Nasdaq, 2016) Balance Sheet (value in 000s) 2012 2013 2014 2015 Current Assets $57,653,000 $73,286,000 $68,531,000 $89,378,000 Total Assets $176,064,000 $207,000,000 $231,839,000 290,479,000 Current Liabilities $38,542,000 $43,658,000 $63,448,000 $80,610,000 Total Liabilities $57,854,000 $83,451,000 $120,292,000 $171,124,000 Source: Nasdaq(Nasdaq, 2016) Current assets include cash and cash equivalents; short-term investments; net receivables and other current assets. Total assets include current assets, long-term investments, fixed assets, goodwill, intangible assets and other assets Current liabilities include accounts payable, short-term debt and other current liabilities have increased significantly from last year Total liabilities include current liabilities, long-term debt, other liabilities and deferred liability charges (Wahlen, 2015). Porters five forces determine the ability of the firm to earn returns on capital that exceeds cost of capital Rivalry within existing firms Threat from new entrants Threat of substitutes Suppliers bargaining power Buyer bargaining power(Viebig, Poddig, Varmaz, 2008). Issues in Horizontal Analysis On analyzing the companys Balance Sheet, we find that The total assets and the total liabilities of the company have grown. However, we find that the liabilities are growing at a higher rate than the total assets though the profits projected are good. The shareholders equity has improved from last year. However, it has not been able to cross the 2013 figure. The statement of financial position and stockholders equity gives information to stakeholders about the company resources which is its assets and the source of capital which is its liabilities and equity Accounting based equity valuation is criticized as the earnings are subject to distortion and manipulation. The accounting numbers reported, affect their personal objectives. Leading Investment banks use the DCF model for equity valuation as investors prefer the present value of the future cash flows low risk, high returns and liquidity. (Wild, Subramanyam, Halsey, 2007) We find that the financial statement analysis through ratios, growth expectation and equity valuation project a good report of Apple Inc. However, we find that profit, sales and value of the firm are not steady as sales are lopsided depends only on iPad and iPhone (Benner, 2015). Vertical Method Through vertical analysis, financial statements, growth expectation and equity valuation are studied between firms within the same industry and compared to industry standards. However, stakeholders face various issues through such comparisons. Apple plays a major role in the cell phone industry and other products. Some of its competitors taken for comparison are HP Inc.and Alphabet Inc. within the electronic equipment industry Comparison between competing firms and industry standards (as of 2015) Apple Inc. HP Inc. Alphabet Inc. Industry Market Cap 589.3 21.06 509.08 993.9 Revenue 234.99 101.74 74.99 637.90 Gross Margin 0.40 0.24 0.62 0.22 Operating Margin 0.30 0.8 0.26 0.05 Net Income 53.73 4.43 16.35 0.05 EPS 9.40 2.08 23.59 0.09 RD Expenses 3.5% - 16.1% - Source: Yahoo Finance(Yahoo, 2016) Issues in Vertical Analysis Hp Inc has a comparatively low market cap but is able to generate higher revenue than Apple Inc. The gross margin and the net margin is also high showing that on a percentage basis, HP inc. generates more profits than Apple Inc. Stakeholders especially shareholders do not make such intimate study on the industry as a whole while making investments. The amount spent on research and development is also comparatively less showing that future products will be impacted by this low expenditure which would affect the future growth of the company(Yahoo, 2016) If Apple has to be compared with software companies, it should be compared to Dell, HP. Lenovo and Microsoft. Hence, with different segments within industries, it is difficult to classify firms within particular industries and make comparisons, as their line of business varies along with its revenues which confuses its stakeholders Apple has product lines like iPad, iPhone, iTunes, Mac, Software and Peripherals while Microsoft has various business divisions like Online Services, Server and Tools, Windows and Windows Live, Entertainment, Devices and Business (Office). From 2007 to 2011, the revenue has increased from $5,000 m to $27,000m for Apple while it has grown from $5,000m to 21,000, for Microsoft. However, the chief reason of growth of Apple is due to iPhone and iPad while it is an overall growth for Microsoft. Though the rate of growth of Microsoft is not as high as Apple, it shows overall growth in revenue which is healthier than Apple(Dediu, 2011). Stakeholders are the main users of the financial statements. By projecting a positive statement, firms are able to attract stakeholders to invest in their firms. This helps them in decision-making regarding investments in firms. Through financial analysis they get an idea of the performance of the firm as they help stakeholders analyse financial statements, study its growth expectation and equity valuation before investing in them(Mohana, 2011). Manipulation Issues Cause for manipulation Statutory flaws The Financial Accounting Standard Board (FASB) which is responsible for the GAAP standards provides various provisions that corporate management makes use of while preparing accounts. Firms make use of the flexibility in GAAP standards to paint a rosy picture of the companys financial position Management Corporate executives are paid in proportion to the financial performance of companies and hence project a positive statement As auditors and corporate executives have a good relationship, the auditors are influenced by corporate to bend accounting rules to keep away negative projections and bolster incomes so that stakeholders get a positive idea about the firm(Gibson, 2011). The accounts are manipulated for various reasons. a) The firm shows bad performance during the current period and can look strong in the years ahead b) To put all poor financial information into the current period so that the fault can be attributed to the current economic environment c) To project good financial information for the future period when the company can get more identity(Wahlen, 2015) Methods of Manipulation of Financial Statements Inflate earnings during the current period through artificially inflating incomes and revenues. Deflate expenses during the current period, artificially to meet expectations. Deflate earnings during the current period as a counterintuitive measure to project a poor performance of the firm. Failing to record expenses or reducing liabilities improperly. Holding back revenue to bolster future performance of the company as a revenue source. To shift future expenses into the current period, such as provision of depreciation and depletion through manipulation of accounting standards. To shift current expenses into the future period or earlier period, such as writing off impaired assets Increase profits through the sale of assets and investments and recording the sale as revenue To record fictitious revenue of sales that do not exist or showing loan proceeds as revenue To record revenue before completing the entire service and before product shipment Issues raised by stakeholders of Apple Inc. Currency Issues Apple Inc has to depend on various countries like China, Korea and India for its products. Currency fluctuations and political factors are ever-persistent risks that the company faces every year and hence comparison over time-period and between industries is tough(FinancialTimes, 2016) P/E ratio Bajarin an industry analyzer on his analysis of Apple Inc, states that market trends and business strategies are being distorted throughout the tech industry which he calls as the reality distortion theory. In the last quarter, Apple has shown a healthy profit margin with its revenue more than $48 billion. Fortune has listed Apple Inc first in four major categories. However the P/E ratio is much lesser than Amazon, Google, Facebook and Dell. Bajarin argues that investors who invest in companies after reading the annual reports come to the conclusion that Apple Inc. is a good investment but if the stock prices are less than that of its peers, they would lose out on their investments(Bajarin, 2013). Cash balance Apple Inc. (AAPL) In the 2015 annual report, Apple has shown that it holds cash of $187 billion. This amount is equal to about 88% of the annual sales of the company. Usually such high cash balance is held as precautionary cash. The reason stated, is that if such cash balances are not held, they will have to depend on debt and capital markets. Another tech company in the late 1970s was Intel, faced such as the situation when it entered innovative technology and had to depend on external capital markets for its fund. However, Faulkner argues that Apple is not using this cash balance as a precautionary reason but to get around the high corporate tax made on the company by the US. He also feels that investors would find such huge cash balance as a positive indication on the stock (Faulkender, 2016). Tax evasion Tax avoidance is an illegal and unethical perspective followed by multinationals like Microsoft, Apple, Google and Starbucks. Apple is described as the largest tax avoider by the Senate Subcommittee on Investigations in US. It has avoided 44billion pounds over the past four years through the Double Irish scheme. It has saved over $12.5 billion through intellectual property rights through commercial benefit in US corporation tax (Colle, 2014). Stock prices Time to time, Apple Inc., stock prices show irregularities. The instance taken for analysis is between September 19, 2013 to December 28, 2013 when the stock closed at $702.10 and 509.8 respectively. The stock had drifted low without any concrete reason such as low earnings or poor product line development. This stock manipulation also took place during July 25, 2013 and August 2013when shares soared 24%. This was an increase of about $135 within 42 trading sessions. These manipulations are due to the ground breaking innovations brought about by Apple and hence movement of these stocks is easier than Microsoft or other firms in the same sector(Johnson, 2013). These stock movements are due to rumors spread deliberately by the management to make use of market movement Forecast rumors Apple has project revenue for the end-of-quarter at $75.5-$77.5 billion. Though the numbers are high, it has fallen below the Wall Street forecast. Forecasts are artificially created by firms to get investor attention. Lopsided growth Another reason for its slow growth is the poor sales in iPad though iPhone continues its growth Though Apple Inc. shows good overall growth, the sales figures are high, mainly due to its iPad and iPhone turnover showing that the company has a lopsided growth. If these products fail, the company will not be able to survive for long (Fool, 2016). Findings The research paper has made a study on the financial statement analysis, growth expectation and equity valuation. The projections that the stakeholder will read through these analysis and the true picture of Apple Inc. through the horizontal and vertical analysis present a vast difference. This is because financial analysis faces various issues. A definite underlying theory to analyze financial statements does not exist: With no definite theory, ratios are subject to untested assertions and are replete Conglomerate firms are large firms having a wide range of industries and diversified product lines. They do not have suitable benchmarks for financial evaluation Window dressing is part of financial accounting practice to present a rosy picture to its stakeholders Price level changes are not included in price level changes Variations in accounting policies between companies such as depreciation policy, valuation of stock, foreign exchange transaction, provision of reserves, research and development and revaluation of assets Interpretation of results have varying yardsticks with industry averages. Hence whether a certain ratio is good or bad cannot be judged easily(Chandra, 2008) Conclusion Apple Inc. is a successful company on a global level playing an important role by producing innovative models and marketing good quality products. The research paper has taken Apple Inc. for its case study to study the financial statement analysis issues. The study has done the financial statement analysis through the horizontal and vertical method by using various ratios from the reports of Apple Inc. Through comparative study over a time period and within firms and the industry, the issues that stakeholders face when they invest their money into Apple Inc. is projected. Manipulations issues affect the financial statement analysis, growth expectation and equity valuation distorting the view of stakeholders who are the real users of the financial statements of the firms. Bibliography Bajarin, B. (2013, March 4). Apple's Reality Distortion Field Relocates to Wall Street. Retrieved March 23, 2016, from Techland Time: https://techland.time.com/2013/03/04/apples-reality-distortion-field-relocates-to-wall-street/ Benner, K. (2015, October 28). Apple's sees another quarter of enviable growth; but can the iPhone grow in fiscal 2016. The Economic Times , pp. 1-10. Billingsley, R. (2006). Understanding Arbitrage: An Intuitive Approach to Financial Anlaysis. New Delhi: Wharton School Publishing. Chandra, P. (2008). Financial Management: Theory and Practice. New Delhi: Mc-Graw-Hill. Colle, S. (2014). State-induced, Strategic, or Toxic? An Ethical Analysis of Tax Avoidance Practices. Business and Professional Ethics Journal , 53-82. Cook, T. (2014). Apple Inc. - Annual Report. Washington: Apple Inc. Cook, T. (2015). Apple Inc. - Annual Report, 2015. Washington D.C.: Apple Inc. Cook, T. (2012). Apple Inc.- Annual Report. Washington D.C.: Apple Inc. Cook, T. (2013). Apple Inc.- Annual Report. Washington D.C.: Apple Inc. Dediu, H. (2011, September 29). Comparing Top Lines: Apple vs. Microsoft. Retrieved March 3, 2016, from ASYMCO: https://www.asymco.com/2011/09/29/c Ernst, Young. (2015). Apple Inc. - Current Report. California: Apple Inc. Faulkender, M. (2016, February 5). Apple Inc. (AAPL) Sitting on $187 billion to Avoid US Tax; Economic Distortion Not Clear. Retrieved March 23, 2016, from Value Walk: https://www.valuewalk.com/2016/02/apple-inc-aapl-sitting-on-187-billion-to-avoid-u-s-tax-economic-distortion FinancialTimes. (2016, March 20). Equities: Apple Inc. Financial Times , pp. 1-5. Fool, M. (2016, February 19). Motely Fool: Investing. Retrieved March 20, 2016, from The Motley Fool: https://www.fool.com/investing/general/2016/02/ Fridson, M., Alvarez, F. (2002). Financial Statement Analysis: A Practioner's Guide. New York: John Wiley Sons. Gibson, C. (2011). Financial Reporting and Analysis: Using Financial Accounting Informatiopn. Australia: Cengage Learning. Johnson, S. (2013, July 1). Apple Inc. (AAPL) Stock Manipulation Report. Retrieved March 23, 2016, from Personal Finance: https://www.pfhub.com/apple-inc-aapl-stock-manipulation-report Marketwatch. (201, March 24). Fact Set Research Systems Inc. Retrieved March 24, 2016, from Market Watch: https://www.marketwatch.com/investing/stock/aapl/financials Mohana, P. (2011). Financial Statement Analysis and Reporting. New Delhi: PHI Learning. MorningStar. (2016, March 17). Financials-Morningstar. Retrieved March 17, 2016, from Apple In AAPL: https://financials.morningstar.com/ratios/r.html?t=AAPL Nasdaq. (2016, March 17). Nasdaq. Retrieved March 17, 2016, from AAPL Company Financials: https://www.nasdaq.com/symbol/aapl/financials?query=ratios Palepu, K., Healy, P. (2013). Business Analysis and Valuation: Using Financial Statements. South-Western: Cengage Learning. Sarngadharan, kumar, R. S. (2011). Financial Analysis for Management Decisions. New Delhi: PHI Learning Priviate Limited. SEC. (2013, June 10). US SEC: What We Do. Retrieved March 24, 2016, from US Securities and Exchange Commission: https://www.sec.gov/about/whatwedo.shtml TOI. (2016, March 20). Apple: News. Times of India , pp. 1-5. Viebig, J., Poddig, T., Varmaz, A. (2008). Equity Valuation: Models from Leading Investment Banks. West Sussex: John Wiley Sons. Wahlen, J. (2015). Financial Reporting, Financial statement Analysis and Valuation. Mason: Content Technologies. Wells, J. (2011). Corporate Fraud Handbook: Prevention and Detection. New Jersey: John Wiley Sons. Wild, J., Subramanyam, Halsey, R. (2007). Financial Statement Analysis. New Delhi: Tata McGraw-Hill. Yahoo. (2016, March 24). Apple Inc (AAPL). Retrieved March 24, 2016, from Yahoo Finance: https://in.finance.yahoo.com/q/co?s=AAPL