Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionII. Financial Statements
and Long−Term Financial
Planning- Working with Financial
Statements
(^114) © The McGraw−Hill
Companies, 2002
One particularly severe problem is that many firms are conglomerates, owning more-
or-less unrelated lines of business. The consolidated financial statements for such firms
don’t really fit any neat industry category. Going back to department stores, for exam-
ple, Sears has an SIC code of 6710 (Holding Offices) because of its diverse financial
and retailing operations. More generally, the kind of peer group analysis we have been
describing is going to work best when the firms are strictly in the same line of business,
the industry is competitive, and there is only one way of operating.
Another problem that is becoming increasingly common is that major competitors
and natural peer group members in an industry may be scattered around the globe. The
automobile industry is an obvious example. The problem here is that financial state-
ments from outside the United States do not necessarily conform at all to GAAP. The
existence of different standards and procedures makes it very difficult to compare fi-
nancial statements across national borders.
Even companies that are clearly in the same line of business may not be comparable.
For example, electric utilities engaged primarily in power generation are all classified in
the same group (SIC 4911). This group is often thought to be relatively homogeneous.
However, most utilities operate as regulated monopolies, so they don’t compete very
much with each other, at least not historically. Many have stockholders, and many are
organized as cooperatives with no stockholders. There are several different ways of gen-
erating power, ranging from hydroelectric to nuclear, so the operating activities of these
utilities can differ quite a bit. Finally, profitability is strongly affected by regulatory en-
vironment, so utilities in different locations can be very similar but show very different
profits.
Several other general problems frequently crop up. First, different firms use different
accounting procedures—for inventory, for example. This makes it difficult to compare
statements. Second, different firms end their fiscal years at different times. For firms in
seasonal businesses (such as a retailer with a large Christmas season), this can lead to
difficulties in comparing balance sheets because of fluctuations in accounts during the
year. Finally, for any particular firm, unusual or transient events, such as a one-time
profit from an asset sale, may affect financial performance. In comparing firms, such
events can give misleading signals.
SUMMARY AND CONCLUSIONS
This chapter has discussed aspects of financial statement analysis:
- Sources and uses of cash. We discussed how to identify the ways in which
businesses obtain and use cash, and we described how to trace the flow of cash
through the business over the course of the year. We briefly looked at the statement
of cash flows.
CONCEPT QUESTIONS
3.5a What are some uses for financial statement analysis?
3.5bWhat are SIC codes and how might they be useful?
3.5c Why do we say that financial statement analysis is management by exception?
3.5dWhat are some of the problems that can come up with financial statement
analysis?82 PART TWO Financial Statements and Long-Term Financial Planning