Business Analysis and Valuation,
j j j j
Using Financial Statements 5th
j j j j
Edition by Paul M. Healy
j j j j
Complete Chapter Solutions Manual are
j j j j j
included (Ch 1 to 12) j j j j
** Immediate Download
j j
** Swift Response
j j
** All Chapters included
j j j
, Chapterj1
AjFrameworkjforjBusinessjAnalysisjandjValuationjUsingj
FinancialjStatements
DiscussionjQuestions
1. John,jwhojhasjjustjcompletedjhisjfirstjfinancejcourse,jisjunsurejwhetherjhejshouldjtakejajcoursejinjbusine
ssjanalysisjandjvaluationjusingjfinancialjstatements,jsincejhejbelievesjthatjfinancialjanalysisjaddsjlittlejvalue
,jgivenjthejefficiencyjofjcapitaljmarkets.jExplainjtojJohnjwhenjfinancialjanalysisjcanjaddj value,jevenjifjcapit
aljmarketsjarejgenerallyjseenjasjbeingjefficient.
Thejefficientjmarketjhypothesisjstatesjthatjsecurityjpricesjreflectjalljavailablejinformation,jasjifjsuchjinf
ormationjcouldjbejcostlesslyjdigestedjandjtranslatedjimmediatelyjintojdemandsjforjbuysjorjsells.jThejef
ficientjmarketjhypothesisjimpliesjthatjtherejisjnojfurtherjneedjforjanalysisjinvolvingjajsearchjforjmispri
cedjsecurities.
However,jifjalljinvestorsjadoptedjthisjattitude,jnojequityjanalysisjwouldjbejconducted,jmispricingjwoul
djgojuncorrected,jandjmarketsjwouldjnojlongerjbejefficient.jThisjisjwhyjtherejmustjbejjustjenoughjmisp
ricingjtojprovidejincentivesjforjthejinvestmentjofjresourcesjinjsecurityjanalysis.
Evenjinjanjextremelyjefficientjmarket,jwherejinformationjisjfullyjimpoundedjinjpricesjwithinjminutesjo
fjitsjrevelationj(i.e.,jwherejmispricingjexistsjonlyjforjminutes),jJohnjcanjgetjrewardsjwithjstrongjfinanci
aljanalysisjskills:
1. Johnjcanjinterpretjthejnewlyjannouncedjfinancialjdatajfasterjthanjothersjandjtradejonjitjwithinjmi
nutes;jand
2. FinancialjanalysisjhelpsjJohnjtojunderstandjthejfirmjbetter,jplacingjhimjinjajbetterjpositionjtojint
erpretjotherjnewsjmorejaccuratelyjasjitjarrives.
Marketsjmayjbejnotjefficientjunderjcertainjcircumstances.jMispricingjofjsecuritiesjmayjexistjdaysjorje
venjmonthsjafterjthejpublicjrevelationjofjajfinancialjstatementjwhenjthejfollowingjthreejconditionsjare
jsatisfied:
1. relativejtojinvestors,jmanagersjhavejsuperiorjinformationjonjtheirjfirms’jbusinessjstrategiesjandjop
eration;
2. managers’jincentivesjarejnotjperfectlyjalignedjwithjalljshareholders’jinterests;jand
3. accountingjrulesjandjauditingjarejimperfect.
Whenjthesejconditionsjarejmetjinjreality,jJohnjcouldjgetjprofitjbyjusingjtradingjstrategiesjdesignedjtoj
exploitjanyjsystematicjwaysjinjwhichjthejpubliclyjavailablejdatajarejignoredjorjdiscountedjinjthejprice-
settingjprocess.
Capitaljinjmarketjefficiencyjisjnotjrelevantjinjsomejareas.jJohnjcanjgetjbenefitsjbyjusingjfinancialjanaly
sisjskillsjinjthosejareas.jForjexample,jhejcanjassessjhowjmuchjvaluejcanjbejcreatedjthrough
,acquisitionjofjtargetjcompany,jestimatejthejstockjpricejofjajcompanyjconsideringjinitialjpublicjoffering,
jandjpredictjthejlikelihoodjofjajfirm’sjfuturejfinancialjdistress.
2. Inj2009,jLarryjSummers,jformerjSecretaryjofjthejTreasury,jobservedjthatj“injthejpastj20-
yearjperiod,jwejhavejseenjthej1987jstockjmarketjcrash.jWejhavejseenjthejSavingsj&jLoanjdebaclejandjcom
mercialjrealjestatejcollapsejofjthejlatej80’sjandjearlyj90’s.jWejhavejseenjthejMexicanjfinancialjcrisis,jthejAs
ianjfinancialjcrisis,jthejLongjTermjCapitaljManagementjliquidityjcrisis,jthejburstingjofjthejNASDAQjbubbl
ejandjthejassociatedjEnronjthreatjtojcorporatejgovernance.jAndjnowjwe’vejseenjthisj[globaljeconomicjcrisi
s],jwhichjisjmorejseriousjthanjanyjofjthat.j Twentyjyears,j7jmajorjcrises.jOnejmajorjcrisisjeveryj3jyears.”j H
owjcouldjthisjhappenjgivenjthejlargejnumberjofjfinancialjandjinformationjintermediariesjworkingjinjfinan
cialjmarketsjthroughoutjthejworld?jCanjcrisesjbejavertedjbyjmorejeffectivejfinancialjanalysis?
Financialjintermediariesjperformjajvarietyjofjfunctionsjthatjarejdesignedjtojmitigatejproblemsjinjourjfinanci
aljmarkets.
Auditorsjcertifyjthejcredibilityjofjfinancialjreports;jauditjcommitteesjhirejthejexternaljauditorsjandjoverseej
bothjthejinternaljandjexternaljauditorsjtojensurejthatjtheyjdojajthoroughjjobjofjassuringjthejcompany’sjfinan
cialjinformationjisjreliablejandjnotjfraudulent.jCorporatejboardsjarejtaskedjwithjmonitoringjandjappointingj
thejfirm’sjCEOjandjwithjoverseeingjitsjstrategy.jFinancialjanalystsjevaluatejajfirm’sjfinancialjperformancej
andjvaluationjandjassessjwhetherjajstockjisjajworthwhilejinvestment,jandjalsojensurejthatjtherejisjcommonj
informationjonjajstockjinjthejmarketjtojreducejadversejselectionjproblems.jInvestmentjbanksjhelpjtojprovid
ejgoodjcompaniesjwithjaccessjtojcapitaljandjtojhelpjinsurejthatjinvestorsjcanjallocatejcapitaljtojgoodjbusine
sses.jAndjsojthejlistjgoesjon,jincludingjinvestmentjmanagers,jhedgejfundjmanagers,jandjthejbusinessjpress.
Itjisjanjinterestingjquestionjasjtojwhyjthesejvariousjinstitutionsjfailedjtojdetectjthejproblemsjunderlyingjthejc
risisjidentifiedjbyjLarryjSummers.jOnejexplanationjisjthatjtheyjfacejtheirjownjconflictsjofjinterest.jAuditorsj
havejcertainlyjreceivedjcriticismjforjauditjfailures.jSomejsuggestjthatjthisjarisesjbecausejauditorsjarej(perha
psjunconsciously)jreluctantjtojtakejajhardjlinejagainstjimportantjclientsjforjfearjofjlosingjthejaccount.jSimila
rjconcernsjhavejbeenjraisedjaboutjfinancialjanalysts,jwhichjeitherjworryjaboutjthejreactionsjofjcorporatejma
nagers,jmajorjclients,jorjinvestmentjbankersjatjtheirjfirmjifjtheyjwritejnegativejreportsjaboutjcompaniesjthe
yjfollow.jCorporatejboardsjhavejbeenjcriticizedjforjbeingjbeholdenjtojthejseniorjexecutivesjofjthejcompanie
sjtheyjoversee.jRecentjgovernancejchangesjwerejintendedjtojcorrectjsomejofjthesejconflictsjofjinterest.jForje
xample,jinjthejU.S.jthejSarbanesjOxleyjActjwasjintendedjtojgivejAuditjCommitteesjmorejcloutjandjchangejt
hejincentivesjofjauditors.jThejGlobaljFinancialjSettlementjandjRegulationjFairjDisclosurejwerejintendedjtoj
reducejthejconflictsjofjinterestjforjfinancialjanalysts.jManyjofjthesejchangesjwerejalsojimplementedjoutsidej
thejU.S.jHowever,jitjisjdifficultjtojeliminatejthejconflictingjincentivesjofjintermediaries,jwhojbyjtheirjnature
jarejinjthejdifficultjpositionjofjtryingjtojworkjforjtwojbosses.
Ajsecondjpotentialjexplanationjisjthatjhumanjbeingsjarejsubjectjtojbehavioraljbiasesjthatjleadjthemjtojmakej
commonjmistakes.jForjexample,jmostjretailjinvestorsjextrapolatedjperformancesjatjEnron,jinternetjstocks,ja
ndjmortgagejbackedjsecuritiesjtojconcludejthatjthesejwouldjcontinuejtojbejterrificjinvestments.jTheyjpoure
djmoneyjintojthesejsectorsjandjstocksjandjshowedjlittlejinterestjinjhearingjfromjanalysts,jauditors,jinvestme
ntjbankers,jetc.jwhojhadjajcontrarianjpointjofjview.jForjexample,jatjthejheightjofjthejinternetjboom,jWarrenj
Buffetjexpressedjconcernjaboutjthejsectorjbutjwasjdismissedjasjajdinosaurjwhojdidn’tjunderstandjthejnewje
conomy.jLessjinformedjorjlessjconfidentjintermediariesjwouldjfindjit
, difficultjtojchallengejthejpopularjviewjofjsuchjhotjmarketsjorjtojjudgejwhenjsuchjhotjmarketsjwouldjcrash.
Givenjthesejproblems,jwejwilljprobablyjcontinuejtojhavejcrisesjunlessjwejcanjcorrectjthejfundamentaljconfli
ctsjofjinterestjthatjpervadejthejindustryjandjcanjfigurejoutjhowjtojmodifyjhumanjbehavior.
3. Accountingjstatementsjrarelyjreportjfinancialjperformancejwithoutjerror.jListjthreejtypesjofjerrorsjthatjca
njarisejinjfinancialjreporting.
Threejtypesjofjpotentialjerrorsjinjfinancialjreportingjinclude:
1. errorjintroducedjbyjrigidityjinjaccountingjrules;
2. randomjforecastjerrors;jand
3. systematicjreportingjchoicesjmadejbyjcorporatejmanagersjtojachievejspecificjobjectives.
AccountingjRules.jUniformjaccountingjstandardsjmayjintroducejerrorsjbecausejtheyjrestrictjmanage
mentjdiscretionjofjaccountingjchoice,jlimitingjthejopportunityjforjmanagers’jsuperiorjknowledgejtojbej
representedjthroughjaccountingjchoice.jForjexample,jSFASjNo.j2jrequiresjfirmsjtojexpensejalljresearc
hjandjdevelopmentjexpendituresjwhenjtheyjarejoccurred.jNotejthatjsomej researchjexpendituresjhavejf
uturejeconomicjvaluej(thus,jtojbejcapitalized)jwhilejothersjdojnotj(thus,jtojbejexpensed).jSFASjNo.j2jdo
esjnotjallowjmanagers,jwhojknowjthejfirmjbetterjthanjoutsiders,jtojdistinguishjbetweenjthejtwojtypesjofj
expenditures.jUniformjaccountingjrulesjmayjrestrictjmanagers’jdiscretion,jforgojthejopportunityjtojpor
trayjthejeconomicjrealityjofjfirmjbetterjand,jthus,jresultjinjerrors.
ForecastjErrors.jRandomjforecastjerrorsjmayjarisejbecausejmanagersjcannotjpredictjfuturejconseque
ncesjofjcurrentjtransactionsjperfectly.jForjexample,jwhenjajfirmjsellsjproductsjonjcredit,jmanagersjmak
ejanjestimatejofjthejproportionjofjreceivablesjthatjwilljnotjbejcollectedj(allowancejforjdoubtfuljaccounts
).jBecausejmanagersjdojnotjhavejperfectjforesight,jactualjdefaultsjarejlikelyjtojbejdifferentjfromjestimat
edjcustomerjdefaults,jleadingjtojajforecastjerror.
Managers’jAccountingjChoices.jManagersjmayjintroducejerrorsjintojfinancialjreportingjthroughjthei
rjownjaccountingjdecisions.jManagersjhavejmanyjincentivesjtojexercisejtheirjaccountingjdiscretionjtoj
achievejcertainjobjectives,jleadingjtojsystematicjinfluencesjonjtheirjfirms’jreporting.jForjexample,jman
yjtopjmanagersjreceivejbonusjcompensationjifjtheyjexceedjcertainjprespecifiedjprofitjtargets.jThisjprov
idesjmotivationjforjmanagersjtojchoosejaccountingjpoliciesjandjestimatesjtojmaximizejtheirjexpectedjc
ompensation.
4. JoejSmithjarguesjthatj“learningjhowjtojdojbusinessjanalysisjandjvaluationjusingjfinancialjstatementsjisjno
tjveryjuseful,junlessjyoujarejinterestedjinjbecomingjajfinancialjanalyst.”jComment.
Businessjanalysisjandjvaluationjskillsjarejusefuljnotjonlyjforjfinancialjanalystsjbutjalsojforjcorporatejm
anagersjandjloanjofficers.jBusinessjanalysisjandjvaluationjskillsjhelpjcorporatejmanagersjinjseveraljw
ays.jFirst,jbyjusingjbusinessjanalysisjforjequityjsecurityjvaluation,jcorporatejmanagersjcanjassessjwhet
herjthejfirmjisjproperlyjvaluedjbyjinvestors.jWithjsuperiorjinformationjon
j j j j
Using Financial Statements 5th
j j j j
Edition by Paul M. Healy
j j j j
Complete Chapter Solutions Manual are
j j j j j
included (Ch 1 to 12) j j j j
** Immediate Download
j j
** Swift Response
j j
** All Chapters included
j j j
, Chapterj1
AjFrameworkjforjBusinessjAnalysisjandjValuationjUsingj
FinancialjStatements
DiscussionjQuestions
1. John,jwhojhasjjustjcompletedjhisjfirstjfinancejcourse,jisjunsurejwhetherjhejshouldjtakejajcoursejinjbusine
ssjanalysisjandjvaluationjusingjfinancialjstatements,jsincejhejbelievesjthatjfinancialjanalysisjaddsjlittlejvalue
,jgivenjthejefficiencyjofjcapitaljmarkets.jExplainjtojJohnjwhenjfinancialjanalysisjcanjaddj value,jevenjifjcapit
aljmarketsjarejgenerallyjseenjasjbeingjefficient.
Thejefficientjmarketjhypothesisjstatesjthatjsecurityjpricesjreflectjalljavailablejinformation,jasjifjsuchjinf
ormationjcouldjbejcostlesslyjdigestedjandjtranslatedjimmediatelyjintojdemandsjforjbuysjorjsells.jThejef
ficientjmarketjhypothesisjimpliesjthatjtherejisjnojfurtherjneedjforjanalysisjinvolvingjajsearchjforjmispri
cedjsecurities.
However,jifjalljinvestorsjadoptedjthisjattitude,jnojequityjanalysisjwouldjbejconducted,jmispricingjwoul
djgojuncorrected,jandjmarketsjwouldjnojlongerjbejefficient.jThisjisjwhyjtherejmustjbejjustjenoughjmisp
ricingjtojprovidejincentivesjforjthejinvestmentjofjresourcesjinjsecurityjanalysis.
Evenjinjanjextremelyjefficientjmarket,jwherejinformationjisjfullyjimpoundedjinjpricesjwithinjminutesjo
fjitsjrevelationj(i.e.,jwherejmispricingjexistsjonlyjforjminutes),jJohnjcanjgetjrewardsjwithjstrongjfinanci
aljanalysisjskills:
1. Johnjcanjinterpretjthejnewlyjannouncedjfinancialjdatajfasterjthanjothersjandjtradejonjitjwithinjmi
nutes;jand
2. FinancialjanalysisjhelpsjJohnjtojunderstandjthejfirmjbetter,jplacingjhimjinjajbetterjpositionjtojint
erpretjotherjnewsjmorejaccuratelyjasjitjarrives.
Marketsjmayjbejnotjefficientjunderjcertainjcircumstances.jMispricingjofjsecuritiesjmayjexistjdaysjorje
venjmonthsjafterjthejpublicjrevelationjofjajfinancialjstatementjwhenjthejfollowingjthreejconditionsjare
jsatisfied:
1. relativejtojinvestors,jmanagersjhavejsuperiorjinformationjonjtheirjfirms’jbusinessjstrategiesjandjop
eration;
2. managers’jincentivesjarejnotjperfectlyjalignedjwithjalljshareholders’jinterests;jand
3. accountingjrulesjandjauditingjarejimperfect.
Whenjthesejconditionsjarejmetjinjreality,jJohnjcouldjgetjprofitjbyjusingjtradingjstrategiesjdesignedjtoj
exploitjanyjsystematicjwaysjinjwhichjthejpubliclyjavailablejdatajarejignoredjorjdiscountedjinjthejprice-
settingjprocess.
Capitaljinjmarketjefficiencyjisjnotjrelevantjinjsomejareas.jJohnjcanjgetjbenefitsjbyjusingjfinancialjanaly
sisjskillsjinjthosejareas.jForjexample,jhejcanjassessjhowjmuchjvaluejcanjbejcreatedjthrough
,acquisitionjofjtargetjcompany,jestimatejthejstockjpricejofjajcompanyjconsideringjinitialjpublicjoffering,
jandjpredictjthejlikelihoodjofjajfirm’sjfuturejfinancialjdistress.
2. Inj2009,jLarryjSummers,jformerjSecretaryjofjthejTreasury,jobservedjthatj“injthejpastj20-
yearjperiod,jwejhavejseenjthej1987jstockjmarketjcrash.jWejhavejseenjthejSavingsj&jLoanjdebaclejandjcom
mercialjrealjestatejcollapsejofjthejlatej80’sjandjearlyj90’s.jWejhavejseenjthejMexicanjfinancialjcrisis,jthejAs
ianjfinancialjcrisis,jthejLongjTermjCapitaljManagementjliquidityjcrisis,jthejburstingjofjthejNASDAQjbubbl
ejandjthejassociatedjEnronjthreatjtojcorporatejgovernance.jAndjnowjwe’vejseenjthisj[globaljeconomicjcrisi
s],jwhichjisjmorejseriousjthanjanyjofjthat.j Twentyjyears,j7jmajorjcrises.jOnejmajorjcrisisjeveryj3jyears.”j H
owjcouldjthisjhappenjgivenjthejlargejnumberjofjfinancialjandjinformationjintermediariesjworkingjinjfinan
cialjmarketsjthroughoutjthejworld?jCanjcrisesjbejavertedjbyjmorejeffectivejfinancialjanalysis?
Financialjintermediariesjperformjajvarietyjofjfunctionsjthatjarejdesignedjtojmitigatejproblemsjinjourjfinanci
aljmarkets.
Auditorsjcertifyjthejcredibilityjofjfinancialjreports;jauditjcommitteesjhirejthejexternaljauditorsjandjoverseej
bothjthejinternaljandjexternaljauditorsjtojensurejthatjtheyjdojajthoroughjjobjofjassuringjthejcompany’sjfinan
cialjinformationjisjreliablejandjnotjfraudulent.jCorporatejboardsjarejtaskedjwithjmonitoringjandjappointingj
thejfirm’sjCEOjandjwithjoverseeingjitsjstrategy.jFinancialjanalystsjevaluatejajfirm’sjfinancialjperformancej
andjvaluationjandjassessjwhetherjajstockjisjajworthwhilejinvestment,jandjalsojensurejthatjtherejisjcommonj
informationjonjajstockjinjthejmarketjtojreducejadversejselectionjproblems.jInvestmentjbanksjhelpjtojprovid
ejgoodjcompaniesjwithjaccessjtojcapitaljandjtojhelpjinsurejthatjinvestorsjcanjallocatejcapitaljtojgoodjbusine
sses.jAndjsojthejlistjgoesjon,jincludingjinvestmentjmanagers,jhedgejfundjmanagers,jandjthejbusinessjpress.
Itjisjanjinterestingjquestionjasjtojwhyjthesejvariousjinstitutionsjfailedjtojdetectjthejproblemsjunderlyingjthejc
risisjidentifiedjbyjLarryjSummers.jOnejexplanationjisjthatjtheyjfacejtheirjownjconflictsjofjinterest.jAuditorsj
havejcertainlyjreceivedjcriticismjforjauditjfailures.jSomejsuggestjthatjthisjarisesjbecausejauditorsjarej(perha
psjunconsciously)jreluctantjtojtakejajhardjlinejagainstjimportantjclientsjforjfearjofjlosingjthejaccount.jSimila
rjconcernsjhavejbeenjraisedjaboutjfinancialjanalysts,jwhichjeitherjworryjaboutjthejreactionsjofjcorporatejma
nagers,jmajorjclients,jorjinvestmentjbankersjatjtheirjfirmjifjtheyjwritejnegativejreportsjaboutjcompaniesjthe
yjfollow.jCorporatejboardsjhavejbeenjcriticizedjforjbeingjbeholdenjtojthejseniorjexecutivesjofjthejcompanie
sjtheyjoversee.jRecentjgovernancejchangesjwerejintendedjtojcorrectjsomejofjthesejconflictsjofjinterest.jForje
xample,jinjthejU.S.jthejSarbanesjOxleyjActjwasjintendedjtojgivejAuditjCommitteesjmorejcloutjandjchangejt
hejincentivesjofjauditors.jThejGlobaljFinancialjSettlementjandjRegulationjFairjDisclosurejwerejintendedjtoj
reducejthejconflictsjofjinterestjforjfinancialjanalysts.jManyjofjthesejchangesjwerejalsojimplementedjoutsidej
thejU.S.jHowever,jitjisjdifficultjtojeliminatejthejconflictingjincentivesjofjintermediaries,jwhojbyjtheirjnature
jarejinjthejdifficultjpositionjofjtryingjtojworkjforjtwojbosses.
Ajsecondjpotentialjexplanationjisjthatjhumanjbeingsjarejsubjectjtojbehavioraljbiasesjthatjleadjthemjtojmakej
commonjmistakes.jForjexample,jmostjretailjinvestorsjextrapolatedjperformancesjatjEnron,jinternetjstocks,ja
ndjmortgagejbackedjsecuritiesjtojconcludejthatjthesejwouldjcontinuejtojbejterrificjinvestments.jTheyjpoure
djmoneyjintojthesejsectorsjandjstocksjandjshowedjlittlejinterestjinjhearingjfromjanalysts,jauditors,jinvestme
ntjbankers,jetc.jwhojhadjajcontrarianjpointjofjview.jForjexample,jatjthejheightjofjthejinternetjboom,jWarrenj
Buffetjexpressedjconcernjaboutjthejsectorjbutjwasjdismissedjasjajdinosaurjwhojdidn’tjunderstandjthejnewje
conomy.jLessjinformedjorjlessjconfidentjintermediariesjwouldjfindjit
, difficultjtojchallengejthejpopularjviewjofjsuchjhotjmarketsjorjtojjudgejwhenjsuchjhotjmarketsjwouldjcrash.
Givenjthesejproblems,jwejwilljprobablyjcontinuejtojhavejcrisesjunlessjwejcanjcorrectjthejfundamentaljconfli
ctsjofjinterestjthatjpervadejthejindustryjandjcanjfigurejoutjhowjtojmodifyjhumanjbehavior.
3. Accountingjstatementsjrarelyjreportjfinancialjperformancejwithoutjerror.jListjthreejtypesjofjerrorsjthatjca
njarisejinjfinancialjreporting.
Threejtypesjofjpotentialjerrorsjinjfinancialjreportingjinclude:
1. errorjintroducedjbyjrigidityjinjaccountingjrules;
2. randomjforecastjerrors;jand
3. systematicjreportingjchoicesjmadejbyjcorporatejmanagersjtojachievejspecificjobjectives.
AccountingjRules.jUniformjaccountingjstandardsjmayjintroducejerrorsjbecausejtheyjrestrictjmanage
mentjdiscretionjofjaccountingjchoice,jlimitingjthejopportunityjforjmanagers’jsuperiorjknowledgejtojbej
representedjthroughjaccountingjchoice.jForjexample,jSFASjNo.j2jrequiresjfirmsjtojexpensejalljresearc
hjandjdevelopmentjexpendituresjwhenjtheyjarejoccurred.jNotejthatjsomej researchjexpendituresjhavejf
uturejeconomicjvaluej(thus,jtojbejcapitalized)jwhilejothersjdojnotj(thus,jtojbejexpensed).jSFASjNo.j2jdo
esjnotjallowjmanagers,jwhojknowjthejfirmjbetterjthanjoutsiders,jtojdistinguishjbetweenjthejtwojtypesjofj
expenditures.jUniformjaccountingjrulesjmayjrestrictjmanagers’jdiscretion,jforgojthejopportunityjtojpor
trayjthejeconomicjrealityjofjfirmjbetterjand,jthus,jresultjinjerrors.
ForecastjErrors.jRandomjforecastjerrorsjmayjarisejbecausejmanagersjcannotjpredictjfuturejconseque
ncesjofjcurrentjtransactionsjperfectly.jForjexample,jwhenjajfirmjsellsjproductsjonjcredit,jmanagersjmak
ejanjestimatejofjthejproportionjofjreceivablesjthatjwilljnotjbejcollectedj(allowancejforjdoubtfuljaccounts
).jBecausejmanagersjdojnotjhavejperfectjforesight,jactualjdefaultsjarejlikelyjtojbejdifferentjfromjestimat
edjcustomerjdefaults,jleadingjtojajforecastjerror.
Managers’jAccountingjChoices.jManagersjmayjintroducejerrorsjintojfinancialjreportingjthroughjthei
rjownjaccountingjdecisions.jManagersjhavejmanyjincentivesjtojexercisejtheirjaccountingjdiscretionjtoj
achievejcertainjobjectives,jleadingjtojsystematicjinfluencesjonjtheirjfirms’jreporting.jForjexample,jman
yjtopjmanagersjreceivejbonusjcompensationjifjtheyjexceedjcertainjprespecifiedjprofitjtargets.jThisjprov
idesjmotivationjforjmanagersjtojchoosejaccountingjpoliciesjandjestimatesjtojmaximizejtheirjexpectedjc
ompensation.
4. JoejSmithjarguesjthatj“learningjhowjtojdojbusinessjanalysisjandjvaluationjusingjfinancialjstatementsjisjno
tjveryjuseful,junlessjyoujarejinterestedjinjbecomingjajfinancialjanalyst.”jComment.
Businessjanalysisjandjvaluationjskillsjarejusefuljnotjonlyjforjfinancialjanalystsjbutjalsojforjcorporatejm
anagersjandjloanjofficers.jBusinessjanalysisjandjvaluationjskillsjhelpjcorporatejmanagersjinjseveraljw
ays.jFirst,jbyjusingjbusinessjanalysisjforjequityjsecurityjvaluation,jcorporatejmanagersjcanjassessjwhet
herjthejfirmjisjproperlyjvaluedjbyjinvestors.jWithjsuperiorjinformationjon
