Principles of Managerial Finance

CHAPTER 2 Financial Statements and Analysis 49

Financial Accounting Standards
Board (FASB) Standard No. 52
Mandates that U.S.-based
companies translate their
foreign-currency-denominated
assets and liabilities into dollars,
for consolidation with the parent
company’s financial statements.
This is done by using the current
rate (translation) method.

current rate (translation) method
Technique used by U.S.-based
companies to translate their
foreign-currency-denominated
assets and liabilities into dollars,
for consolidation with the parent
company’s financial statements,
using the exchange rate prevail-
ing at the fiscal year ending date
(the current rate).

ratio analysis
Involves methods of calculating
and interpreting financial ratios
to analyze and monitor the firm’s
performance.

Hint Management should
be the most interested party of
this group. Managers not only
have to worry abut the
financial situation of the firm,
but they are also critically
interested in what the other
parties think about the firm.

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rent policy is described in Financial Accounting Standards Board (FASB) Stan-

dard No. 52,which mandates that U.S.-based companies translate their foreign-

currency-denominated assets and liabilities into dollars, for consolidation with

the parent company’s financial statements. This is done by using a technique

called the current rate (translation) method,under which all of a U.S. parent

company’s foreign-currency-denominated assets and liabilities are converted into

dollar values using the exchange rate prevailing at the fiscal year ending date (the

current rate). Income statement items are treated similarly. Equity accounts, on

the other hand, are translated into dollars by using the exchange rate that pre-

vailed when the parent’s equity investment was made (the historical rate).

Retained earnings are adjusted to reflect each year’s operating profits or losses.

Further details on this procedure can be found at the book’s Web site at

http://www.aw.com/gitmanor in an intermediate accounting text.

Review Questions

2–1 Describe the purpose of each of the four major financial statements.

2–2 Why are the notes to the financial statements important to professional

securities analysts?

2–3 How is the current rate (translation) methodused to consolidate a firm’s

foreign and domestic financial statements?

2.2 Using Financial Ratios

The information contained in the four basic financial statements is of major sig-

nificance to various interested parties who regularly need to have relative mea-

sures of the company’s operating efficiency. Relativeis the key word here,

because the analysis of financial statements is based on the use of ratios orrela-

tive values.Ratio analysisinvolves methods of calculating and interpreting finan-

cial ratios to analyze and monitor the firm’s performance. The basic inputs to

ratio analysis are the firm’s income statement and balance sheet.

Interested Parties

Ratio analysis of a firm’s financial statements is of interest to shareholders, credi-

tors, and the firm’s own management. Both present and prospective shareholders

are interested in the firm’s current and future level of risk and return, which

directly affect share price. The firm’s creditors are interested primarily in the

short-term liquidity of the company and its ability to make interest and principal

payments. A secondary concern of creditors is the firm’s profitability; they want

assurance that the business is healthy. Management, like stockholders, is con-

cerned with all aspects of the firm’s financial situation, and it attempts to produce

financial ratios that will be considered favorable by both owners and creditors. In

addition, management uses ratios to monitor the firm’s performance from period

to period.