Financial Statement Analysis: A Practitioner's Guide, 4th Edition


Praise for Financial Statement Analysis FOURTH EDITION

"I love this book. It helps to develop the questioning mind—the mind of a financial detective. It teaches the art of skepticism and critical thinking. Readers go beyond definition and calculation and learn interpretation."—Philip L. Cooley, PhD, Prassel Distinguished Professor of Business, Trinity University

"Over my decades of involvement with high-yield bonds, Marty Fridson has been the leading speaker of truth. As he so accurately states in Financial Statement Analysis, the credit investor is required to engage in a game of cat-and-mouse with company management's intent on minimizing their cost of capital by putting a positive gloss on their financial statements. The Fourth Edition of Marty's terrific book is the bible on how to detect and deal with these efforts."—Howard Marks, Chairman, Oaktree Capital Management

"Financial Statement Analysis is a unique text; it combines great academic work with numerous real-life examples to form a highly useful reference for equity investors, debt holders, and investors who straddle both asset classes. Whether you are an investor, an investment advisor, or a teacher, Financial Statement Analysis will prove very valuable."—Margaret M. Cannella, former head of Global Credit Research, J.P. Morgan and Adjunct Professor, Columbia Business School

"Marty has seen it all! He has had a front-row seat to see the birth, death, and rebirth of the high-yield bond market . . . several times over! In the Fourth Edition of Financial Statement Analysis, Marty clearly demonstrates that despite the enactment of Sarbanes-Oxley in 2002, and other attempts to curtail abuse of the system, one needs a critical analytical eye to be certain that management is not trying to obfuscate the truth. The case studies provide excellent and timely examples of some of the techniques that companies have used to mislead investors."—Edward Z. Emmer, former global head of Corporate and Government Ratings and Equity Research, Standard & Poor's

"Those who read financial statements without understanding the strategic context in which they are written will land on the losing end of the gripping episodes with which bond-market legend Marty Fridson illustrates in the Fourth Edition of his classic reference, Financial Statement Analysis. And all of us who depend on the markets sending capital to its best use should hope that investors read this book first."—David Musto, Professor of Finance, the Wharton School of the University of Pennsylvania

"This book rightly urges resolute skepticism when inspecting financial statements. Its great value, though, is in the plain-spoken stripping down of real-world and illustrative examples that show how to see past the numbers to the practicalities and incentives behind them—and so help analysts and journalists alike ask the right questions."—Richard Beales, Assistant Editor, Reuters Breakingviews

MARTIN FRIDSON is Global Credit Strategist at BNP Paribas Investment Partners, one of the world's largest asset managers. Over a twenty-five-year span with brokerage firms including Salomon Brothers, Morgan Stanley, and Merrill Lynch, he became known for his innovative work in credit analysis and investment strategy. Fridson has served as president of the Fixed Income Analysts Society, governor of the Association for Investment Management and Research (now CFA Institute), and director of the New York Society of Security Analysts.

FERNANDO ALVAREZ is currently an Adjunct Associate Professor of Finance and Economics at the Columbia University Graduate Business School, where he teaches entrepreneurship finance. From 2003 until 2008, he was associate professor in the Finance and Economics Department and director of entrepreneurship programs at Rutgers Business School, Newark and New Brunswick. Alvarez has taught at New York University's Stern School of Business where he was associate professor on innovation and entrepreneurship, and Babson College where he was assistant professor of finance.

Preface to Fourth Edition.


Part I: Reading between the Lines.

Chapter 1: The Adversarial Nature of Financial Reporting.

The Purpose of Financial Reporting.

The Flaws in the Reasoning.

Small Profits and Big Baths.

Maximizing Growth Expectations.

Downplaying Contingencies.

The Importance of Being Skeptical.


Part II: The Basic Financial Statements.

Chapter 2: The Balance Sheet.

The Value Problem.

Comparability Problems in the Valuation of Financial Assets.

“Instantaneous” Wipeout of Value.

How Good Is Goodwill?

Losing Value the Old-Fashioned Way.

“True” Equity Is Elusive.

Pros and Cons of a Market-Based Equity Figure.

The Common Form Balance Sheet.


Chapter 3: The Income Statement.

Making the Numbers Talk.

How Real Are the Numbers?


Chapter 4: The Statement of Cash Flows.

The Cash Flow Statement and the LBO.

Analytical Applications.

Cash Flow and the Company Life Cycle.

The Concept of Financial Flexibility.

In Defense of Slack.


Part III: A Closer Look at Profits.

Chapter 5: What Is Profit?

Bona Fide Profits versus Accounting Profits.

What Is Revenue?

Which Costs Count?

How Far Can the Concept Be Stretched?


Chapter 6: Revenue Recognition.

Channel-Stuffing in the Drug Business.

A Second Take on Earnings.

Astray on Layaway.

Recognizing Membership Fees.

A Potpourri of Liberal Revenue Recognition Techniques.

Fattening Earnings with Empty Calories.

Tardy Disclosure at Halliburton.

Managing Earnings with “Rainy Day” Reserves.

Fudging the Numbers: A Systematic Problem.


Chapter 7: Expense Recognition.

Nortel's Deferred Profit Plan.

Grasping for Earnings at GM.

Time-Shifting at Freddie Mac.


Chapter 8: The Applications and Limitations of EBITDA.

EBIT, EBITDA, and Total Enterprise Value.

The Role of EBITDA in Credit Analysis.

Abusing EBITDA.

A More Comprehensive Cash Flow Measure.

Working Capital Adds Punch to Cash Flow Analysis.


Chapter 9: The Reliability of Disclosure and Audits.

An Artful Deal.

Death Duties.

Systematic Problems in Auditing.


Chapter 10: Mergers-and-Acquisitions Accounting.

Maximizing Postacquisition Reported Earnings.

Managing Acquisition Dates and Avoiding Restatements.


Chapter 11: Is Fraud Detectable?

Telltale Signs of Manipulation.

Fraudsters Know Few Limits.

Enron: A Media Sensation.

HealthSouth's Excruciating Ordeal.

Milk and Other Liquid Assets.


Part IV: Forecasts and Security Analysis.

Chapter 12: Forecasting Financial Statements.

A Typical One-Year Projection.

Sensitivity Analysis with Projected Financial Statements.

Projecting Financial Flexibility.

Pro Forma Financial Statements.

Pro Forma Statements for Acquisitions.

Multiyear Projections.


Chapter 13: Credit Analysis.

Balance Sheet Ratios.

Income Statement Ratios.

Statement of Cash Flows Ratios.

Combination Ratios.

Relating Ratios to Credit Risk.


Chapter 14: Equity Analysis.

The Dividend Discount Model.

The Price-Earnings Ratio.

Why P/E Multiples Vary.

The Du Pont Formula.

Valuation through Restructuring Potential.


APPENDIX: Explanation of Pro Forma Adjustments for Hertz Global Holdings, Inc./DTG.




About the Authors.