Explain the process for judging how good a company's financial reports are
The idea
An evaluation follows a sequence. First understand the company, its industry and how it creates value, so the accounting can be judged against the economics. Then identify key estimates and policies, especially revenue recognition, capitalisation, reserves and fair value inputs, and compare them with peers and history. Look for signs of pressure such as bonus targets, debt covenants or equity issues. Reconcile earnings with operating cash flow and examine accruals, related-party dealings, changes in auditor and non-GAAP measures. Screening models such as the Beneish M-score for manipulation and the Altman Z-score for bankruptcy risk help rank companies. The trap is relying on a screening score alone, since models built on past data miss new schemes and flag innocent firms.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Evaluating Quality of Financial Reports
- Show how a conceptual framework is used to judge how reliable and useful a company's financial reporting is
- Explain problems that can undermine the quality of financial reports
- Judge how good a company's financial reports are
- Explain the signs that indicate earnings quality
- Explain what is meant by sustainable (persistent) earnings
- Explain why earnings revert to the mean and how accruals change how quickly they do so
- Judge the quality of a company's earnings
- Judge the quality of a company's cash flows
- Explain the signs that indicate balance sheet quality
- Judge the quality of a company's balance sheet
- Explain the signs that indicate cash flow quality
- Set out where information about risk can be found