Profitability Analysis CHAPTER
Profitability Analysis 9 CHAPTER
Analyzing Profitability Focus of Profitability Analysis Profitability analysis is a key part of financial statement analysis All financial statements are pertinent to profitability analysis Emphasis of profitability analysis is on the income statement
Analyzing Profitability Focus of Profitability Analysis ➢ Profitability analysis is a key part of financial statement analysis ➢ All financial statements are pertinent to profitability analysis ➢ Emphasis of profitability analysis is on the income statement
Analyzing Profitability Focus of Profitability Analysis Profitability analysis helps address questions such as What is a company's relevant income measure? What is the quality of income? What income components are important for forecasting? How persistent are income and its components? What is a company' s earning power?
Analyzing Profitability Focus of Profitability Analysis Profitability analysis helps address questions such as: What is a company’s relevant income measure? What is the quality of income? What income components are important for forecasting? How persistent are income and its components? What is a company’s earning power?
Analyzing Profitability Measuring Income Income is defined as revenues less expenses over a reporting period This definition does not yield a unique amount because ofa 三 stimation ssues ☆ Accounting Methods Incentives for Disclosure A Diversity across Users
Analyzing Profitability Measuring Income Income is defined as revenues less expenses over a reporting period This definition does not yield a unique amount because of: ❖ Estimation Issues ❖ Accounting Methods ❖ Incentives for Disclosure ❖ Diversity across Users
Analyzing Profitability Measuring Income--Estimation Issues Income measurement depends on estimates of future events These estimates require: Use of judgment and probabilities Allocations of revenues and expenses across periods I. Prediction of the future usefulness of many assets I. Forecasts of future obligations
Analyzing Profitability Measuring Income--Estimation Issues Income measurement depends on estimates of future events These estimates require: • Use of judgment and probabilities • Allocations of revenues and expenses across periods • Prediction of the future usefulness of many assets • Forecasts of future obligations
Analyzing Profitability Measuring Income--Estimation Issues Management discretion is part of income measurement Estimates of skilled and experienced professionals Some consensus (less variability)
Analyzing Profitability Measuring Income--Estimation Issues Management discretion is part of income measurement Estimates of skilled and experienced professionals → Some consensus (less variability)
Analyzing Profitability Measuring Income-Accounting Methods Professional Social experience Influences Accounting standards Regulatory Political governing agendas Income pressures measurement Business Academic happenings research
Analyzing Profitability Measuring Income--Accounting Methods Professional experience Regulatory agendas Business happenings Academic research Social Influences Political pressures Accounting standards governing income measurement
Analyzing Profitability Measuring Income-Accounting Methods Methods reflect the outcome of numerous factors including compromises Discretion is permitted to accommodate different business circumstances Methods geared toward"general-purpose financial statements
Analyzing Profitability Measuring Income--Accounting Methods Methods reflect the outcome of numerous factors, including compromises Discretion is permitted to accommodate different business circumstances Methods geared toward “general-purpose” financial statements
Analyzing Profitability Measuring Income--Incentives for Disclosure Ideally: O Financial statements fairly present transactions and events 2 Accounting is neutral--not affecting how transactions and events are perceived 3 Methods chosen that are most applicable to the circumstances 4 Relevant information is disclosed--favorable and unfavorable
Analyzing Profitability Measuring Income--Incentives for Disclosure Ideally: Financial statements fairly present transactions and events Accounting is neutral—not affecting how transactions and events are perceived Methods chosen that are most applicable to the circumstances Relevant information is disclosed—favorable and unfavorable
Analyzing Profitability Measuring Income--Incentives for Disclosure Reality: O Each of us possess opinions-we see the world from different perspectives 2 Managers bring strong views to the table 3 Managers feel pressures of com petition and society 4 Directors expect results s Shareholders concentrate on the bottom line 6 Creditors want safeguards o Financial analysts dislike surprises 8 Accounting preparers and auditors demand acceptable practices
Analyzing Profitability Measuring Income--Incentives for Disclosure Reality: Each of us possess opinions--we see the world from different perspectives Managers bring strong views to the table Managers feel pressuresof competition and society Directors expectresults Shareholders concentrate on the bottom line Creditors want safeguards Financial analysts dislike surprises Accounting preparers and auditorsdemand acceptable practices
