Annual Reports

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EMI Music: A Financial Analysis (Conclusion)

Published January 17, 2014 by Mayrbear's Lair

Pyramid of percents

Capital Structure

The nature of a company is mostly determined from the proportion of debt they have relative to their equity. This is known as the company’s capital structure and it reveals how much debt is outstanding and how well the debt was serviced. Understanding EMI’s corporate capital structure helps identify the most available options that management can pursue to reach successful outcomes by their use for example, of financing strategies from their equity as opposed to financing with debt; each have different effects on the long-term health of a company’s financial condition (How to determine your capital structure, n.d.). Due to the economic state of the industry, EMI faced considerable financial challenges during this period with £3038 million in outstanding debt and payment due dates scheduled between 2014 and 2017. The financial notes disclosed that EMI was able to generate adequate cash to service their interest payments on borrowings, however, the company still faced issues with respect to the steady tightening of financial support because of banking policies. In the meantime, due to the restructuring strategy, EMI’s debt had unlimited equity cure rights. This allowed shareholders to contribute additional funds as necessary to ensure the company met their requirements. For example, when Terra Firm purchased the firm they injected an additional £105 million in equity funding to meet their commitments. This indicated to shareholders EMI’s continued dedication to achieving successful outcomes.

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Profitability

The financial statements from a company’s Annual Report can help analysts determine consistent trends in the company’s earning to determine the level of profitability. Loth (2013) postulates that there are four levels of profit margins: (a) gross profit, (b) operating profit, (c) pretax profit, and (d) net profit that help determine a firm’s profitability (Loth, 2013). EMI’s report divulged that the firm faced considerable risks including uncertain economic global conditions that resulted in a declining market for recorded music products. This added pressure to bring down the pricing of music products which also played a role in the reduction of their profit margins. Additional risks they faced included their dependency on identifying, signing, and retaining artists with long term potential as well as the continued success of their current roster. Furthermore, their business was reliant on discovering and exploiting new income streams due to revenue losses from such occurrences like illegal music downloads and sharing, as well as the eventual erosion of copyright protection that introduced concerns of potential exploitation of their intellectual property and publishing assets.

In spite of these conditions, EMI Music experienced phenomenal success during that period due to their release of the Beatles Remastered Collection. This was the company’s bestselling project and broke multiple chart records globally including the most simultaneous titles released by a single artist. This proved to be one of most beneficial outcomes they achieved that resulted from their effective consumer insight and marketing strategies.  It also changed the way EMI developed and promoted their music products to drive sales. This improved their EBITDA by 15% to £184 in 2010 from £160 in 2009. In the meantime, EMI Music Publishing also experienced a 13% increase in profits going from £150 in 2009 to £184 in 2010 which consisted of some of the best songs and songwriters in the world. In addition, EMI worked diligently to create new relationships with brands and businesses to support their music products.  As a result, they reported sharp increases in licensing revenue from a variety of media outlets and continued diversifying their publishing revenue streams.  This strategy proved effective in enabling the firm to maintain growth during a period of economic downturn.

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Outlook for EMI

EMI’s financial statements provided significant information that revealed their financial condition and overall performance to help forecast their future. Friedlob and Welton (2008) explained that annual reports not only clarify how well a company is performing they can also help strategists predict the direction they are headed (Friedlob & Welton, 2008). The major question in the outlook of the EMI’s liquidity was their ability to produce cash from operations. As the statements revealed, the condition of the changing music industry was partially to blame for a depressed economical state. However, in a world where music is ubiquitous with demand from consumers and businesses growing at lightning speed, EMI seized the opportunity to expand and continued to deliver successful outcomes for the company and the artists they represent. New music remained at the core of their operations with the discovery and development of new talent as an essential component to the future and continued growth of the firm.

Exhibit H Income Statement

Exhibit H

The significant operational performance, together with equity injections provided by the company shareholders enabled EMI to meet their ongoing needs for working capital and debt service obligations. However, due to banking facility covenants based on debt/EBITDA that decreased significantly each year, there were concerns over these progressively difficult conditions for EMI to achieve their required ratios. This meant that they experienced shortfalls to financial commitments and (due to the continual tightening of the financial covenants) they anticipated ongoing issues to occur. The principal concern was whether additional equity funding would be available in future periods to enable the firm to comply with their financial requirements under the banking policies. For example, EMI’s income statement revealed (see Appendix H) that the group incurred a net loss of £512 during the period ending 2010. At that time, the firm’s current liabilities exceeded their current assets by £3,255 which resulted from the reclassification of bank loans from non-current liabilities to current liabilities. In other words, the ability of the company to continue was an ongoing concern because of their dependency from the continued availability of existing banking facilities, which required the firm to comply with their policies.

Bright Future Ahead

Bright Future Ahead

Conclusion

The elements presented in EMI’s Annual Report helped provide a more transparent image of the company’s activities and overall functionality. The notes also disclosed that the profits before impairment and restructuring costs increased 34% from £143 in 2009 to £192 in 2010 and the cash they generated from operations increased 42% from £192 in 2009 to £273 in 2010. This meant that their enhanced operational performance, together with equity injections, provided EMI with enough revenue to meet their capital needs and debt obligations. The findings of this research deduced that EMI’s financial statements were indicative of a high level of financial reporting and provided a true and fair picture of the firm’s financial condition. In conclusion, the report revealed that EMI’s operating performance improved considerably during that period and provided shareholders sufficient evidence to give them confidence in the firm’s future performance abilities.

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This concludes my research work on the financial analysis series in organizational management. Thank you everyone for being a part of this journey. Although this is the last post in this blog series, stay tuned for upcoming articles that reveal my current research work in the application of strategic management where I will provide a close analysis that reveals the strategic management tactics successful companies like Apple, Disney, and Starbucks incorporate that are significant in their achieving and maintaining the long term mega success status they continue to enjoy in the marketplace.

Thanks again for sharing this experience with me. I hope you were able to find something of value to enhance your own experiences, both personally and professionally, as I have.

Stay tuned …

Until then, I bid you adieu my friends …

Mayr

References

(2011). EMI annual review 2009/2010. Finances. Hollywood: Maltby Capital Ltd.

The Johnny Mercer Research Guide. (2012). Retrieved October 30, 2013, from The Johnny Mercer Foundation: http://www.johnnymercerfoundation.org/initiatives-charities/for-researchers/johnny-mercer-research-guide/

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Friedlob, G., & Welton, R. (2008). Keys to reading annual report. Hauppauge, NY: Barron’s Educational Series.

Loth, R. (2013). Profitability indicator ratios: Profit margin analysis. Retrieved December 5, 2013, from investopedia.com: http://www.investopedia.com/university/ratios/profitability-indicator/ratio1.asp

How to determine your capital structure. (n.d.). Retrieved December 5, 2013, from Structuringfinance.com: http://www.structuringfinance.com/capital-structure/how-to-determine-your-capital-structure

Roth, R. (2008). The writers guide to annual reports. Atlanta, GA: Booksurge.com.

Scherreik, S. (2002, December 22). How efficient is that company? Retrieved December 5, 2013, from businessweek.com: http://www.businessweek.com/stories/2002-12-22/how-efficient-is-that-company

EMI Music: A Financial Analysis (Part 2)

Published January 15, 2014 by Mayrbear's Lair

Islamic Finance18

Short Term Liquidity

Even though PR fluff can misrepresent the true nature of a company’s financial condition, the statements from their annual reports provide sufficient data to help analysts discover the truth about a company’s financial health and overall performance. Fraser and Ormiston (2010) assert that examining a firm’s short term liquidity can give insight into their ability to meet cash demands (Fraser & Ormiston, 2010). EMI’s financial overview charts revealed (see Exhibit A) that during this accounting period the firm had a prosperous year, especially given the economic condition of the music industry in the global marketplace.  For example, EMI delivered worldwide revenues of about £1.65 billion and showed increased levels in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of 14% from £293 million reported in 2009 that rose to £334 in 2010. The Chairman’s statement revealed it resulted from the efforts of the firm’s restructuring strategy that commenced in 2007 when EMI was acquired by the Terra Firma Corporation. The merger implemented innovative new management plans to make the company more relevant to developers and consumers of music alike. The Terra Firma alliance proved effective revealing impressive EBITDA levels that jumped almost 400% from £68 million in 2007 to £334 million in 2010. The acquisition also helped reduce the cost base of the corporation allowing EMI to benefit in both earnings and cash flow in spite of their streamlining tactics.

Exhibit A Chart

Exhibit A

In the meantime, EMI’s receivables (see Exhibit B) decreased from £577 (in the millions) in to 2009 to £564 in 2010, with inventories also decreasing from £27 in 2009 to £25 in 2010 (see Exhibit C). This decrease resulted from the company having written down inventories by £10. The notes revealed this was because of the global economic slowdown at the time and the general uncertainty in reduction to the market estimates of growth from digital and online music markets, as well as the continual rapid decline of the physical market. Due to this condition, management concluded there was sufficient doubt over the recoverability of the carrying value of certain intangible assets. As a result, an impairment review of the music catalogs was conducted which ended in a reduction of the carrying values of goodwill and intangible assets from amortization and impairment charges.

Exhibit B Receivables

Exhibit B

Exhibit C Inventories

Exhibit C

The statements also revealed that EMI’s financial liabilities totaled £3,662 (see Exhibit D) having dipped a bit from the 2009 figure of £3,811 which decreased partly due to the foreign-exchange rate at the time. The shareholder loan figure increased to £398 million in 2010 from £346 in 2009. The notes revealed this increase was due to accrued interest charges. Cash and cash equivalents in the meantime (see Exhibit E), showed an upward trend rising from £336 in 2009 to £343 in 2010. This was because their cash earned interest at a floating rate based on the daily bank deposit rates. Short-term deposits, for example were made for periods that varied between one day and one month, which sometimes extended up to three months.

Exhibit D Financial Liabilities

Exhibit D

Exhibit E Financial Position Statement

Exhibit E

Exhibit F

Exhibit F

Additional evidence of short-term liquidity was revealed from the financial ratio trends in comparison with industry averages. For example, quick ratios revealed an upward trend reporting a loss of (4.8) times in 2009 to (1.3) times in 2010. This indicated they were in a stronger position, especially considering the music industry drifts that they and other companies were up against as well during that time. The cash flow liquidity ratios also increased from a loss of (.25) times reported in 2009 that jumped to in 2010 to a loss of (.10) times indicating an improvement in their short-run solvency. These figures revealed that EMI experienced steady improvement generating cash from their operations and that they did not have major problems with short-term liquidity during that reporting period (see Exhibit F).

Tab-5-Operating-Efficiency

Operating Efficiency

The financial statements from a company’s annual report also provide data that help analysts determine the operating efficiency of the firm. One way to accomplish this is by examining the firm’s turnover ratios. Scherreik (2002) suggested that in order for companies to run effectively, they must keep costs to a minimum and reduce their need to seek loans. One way to achieve this is to trim down inventories and speed up the collection of outstanding payments (Scherreik, 2002). EMI’s financial statements disclosed that their operational performance continued to improve after the acquisition of the company by Terra Firma. For example, EBITDA figures, excluding restructuring, increased from £68 in 2007 to £334 in 2010 (see Exhibit A). In addition, operating results increased by almost 200% when in 2007 they reported a loss of £135 million then showed a profit of £121 million in 2010. This was accomplished in spite of the global economic crisis. Furthermore, the firm was able to maintain steady revenue increases and successfully launched a variety of new music from artists including Katy Perry, Lady Antebellum, and Cold Play. In the meantime, even though their global recorded music market share increased from 1.0% in 2009 to 10.4% in 2010, the firm was still challenged by an overall decline in physical sales that was not offset by growth in digital sales. Due to the market decline, EMI Music continued to develop its strategy of diversifying their revenue streams into areas like merchandising, live recordings, and other innovative digital platforms. In addition, they continued to extend their reach and income streams for their artists’ and their videos through a variety of new distribution partnerships.

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Publishing revenues on the other hand, remained robust and continued to excel in the discovery of new music with an unmatched ability to find and nurture the very best songwriting talent. EMI appeared to have managed the company efficiently during this period with the Music division having achieved operating margins that rose from 14.5% in 2009 to 15.7% in 2010. The publishing division showed an improvement of 15% in EBITDA from the £184 million reported from the 2009 to 2010 period which reflects a margin increase of 13% from £133 to £150 million (see Exhibit G). These figures indicate that their operating margin rose from 28% in 2009 to 31% in 2010. The notes revealed this was partially due to revenues collected from mechanical royalties of CDs, DVDs and digital download sales; performance royalties from radio, TV, webcasts, and concerts; synchronization royalties from the use of music in TV, films, computer games and commercials; as well as other uses including ringtones, mobile products, stage productions, and sheet music. Based on this evidence it appeared that EMI was operating efficiently during that time because they continued to collect revenue, show improvement, and had enough cash on hand to meet their short term demands.

Exhibit G Music and Publishing Operational Performance Statement

Exhibit G

References

(2011). EMI annual review 2009/2010. Finances. Hollywood: Maltby Capital Ltd.

The Johnny Mercer Research Guide. (2012). Retrieved October 30, 2013, from The Johnny Mercer Foundation: http://www.johnnymercerfoundation.org/initiatives-charities/for-researchers/johnny-mercer-research-guide/

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Friedlob, G., & Welton, R. (2008). Keys to reading annual report. Hauppauge, NY: Barron’s Educational Series.

Loth, R. (2013). Profitability indicator ratios: Profit margin analysis. Retrieved December 5, 2013, from investopedia.com: http://www.investopedia.com/university/ratios/profitability-indicator/ratio1.asp

How to determine your capital structure. (n.d.). Retrieved December 5, 2013, from Structuringfinance.com: http://www.structuringfinance.com/capital-structure/how-to-determine-your-capital-structure

Roth, R. (2008). The writers guide to annual reports. Atlanta, GA: Booksurge.com.

Scherreik, S. (2002, December 22). How efficient is that company? Retrieved December 5, 2013, from businessweek.com: http://www.businessweek.com/stories/2002-12-22/how-efficient-is-that-company

EMI Music: A Financial Analysis (Part 1)

Published January 13, 2014 by Mayrbear's Lair

 Emi_music_logo_2012

To conclude my research work in organizational management with respect to the analysis of a company’s financial reports, this week we will wrap things up with a three part examination of the various components contained within the 2010 Annual Report of my former place of employment, the privately owned corporation known as EMI Music (EMI) to help us determine their financial condition and forecast their outlook. To help present a clearer picture of the company’s activities and overall functionality, the study will draw information from the report’s financial statements to evaluate such elements as assets, liabilities, and stockholders’ equity to help determine EMI’s viability as a business. The research will also include a closer look at the following components: (a) the economy, industry, and background of the firm; (b) their short term liquidity; (c) how efficiently they operated; (d) an examination of their capital structures; and (e) an assessment of their profitability levels, to reveal EMI’s financial condition as well as forecast their future potential. My research will also focus on the information retrieved from their financial data, ratios, and trends that were contained within the notes and statements to evaluate the firm’s use of their operating, financing, and equity activities to determine whether the corporation was managed efficiently and was profitable. The findings of this research will conclude that EMI’s financial statements provided sufficient evidence to reveal an authentic representation of their financial health during that time.

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Introduction

A corporation’s annual report helps provide shareholders a glimpse into a company’s overall performance and financial effectiveness. They are developed to satisfy the many needs of a variety of different people, including shareholders, creditors, economists, and strategists. Roth (2008) explains they have become the platforms that are used to launch new products, promotional strategies, and even shape the company’s cultural attitudes (Roth, 2008). They typically include an opening statement from the chief executive officer (CEO), the company’s financial statements, market segment information, new product strategies, subsidiary activities, as well as research and development (R&D) plans, all of which serve to bring a transparent view of the company’s operating, financing, and investing activities.  To fully understand and appreciate the information provided in EMI’s Annual report the examination will commence with a brief look at the company’s background.

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Background, Industry, and Economy

The true nature of a company’s image can be ascertained through a comprehensive analysis provided by the data contained within their annual reports. Fraser and Ormiston (2010) purport that in order to comprehend how to navigate through the vast amount of data in the reports, familiarity with accounting is helpful (Fraser & Ormiston, 2010). Learning more about the company’s background in the meantime, also helps provide valuable information that can help analysts forecast the firm’s future based on past performances.

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For instance, EMI is considered a prestigious primary-market record label. It is recognized worldwide and conducts business in 32 countries with a network of licenses to operate elsewhere as well. It is part of the EMI Music Group, which is a subsidiary of the Universal Music Group. EMI owns some of the most famous record labels in the world, including Capitol, Parlophone, Virgin, Blue Note, Capitol Records Nashville, EMI Christian Music Group and EMI and Virgin Classics.The firm is organized into two core divisions: EMI Music, which specializes in the signing, developing, and marketing of recording artists and their intellectual property; and EMI Music Publishing, which specializes in the signing, developing and marketing songwriters.

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The company was founded in 1942 by American lyricist, songwriter, and recording artist Johnny Mercer, who wrote the famous lyrics to Henry Mancini’s Moon River that later, went on to become the trademark song for singer Andy Williams (The Johnny Mercer Research Guide, 2012). Throughout the years, EMI consisted of an impressive artist roster including such mega stars like David Bowie, Tina Turner, Bob Seger, Coldplay, Lady Antebellum and Katy Perry. They have a wealth of artists in their catalog including such legendary icons like the Beach Boys, Iron Maiden, Depeche Mode, Miles Davis, Frank Sinatra, Duran Duran and the Pet Shop Boys. In the global marketplace, EMI distributes a wide genre of music including, pop, rock, classical, jazz, R&B, and hip-hop through various sister labels. With offices worldwide, the Capitol Records Tower in Los Angeles (where I worked) is their most famous building in America and stands out as a Hollywood landmark that is recognized throughout the world.

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Conditions in the music industry are highly competitive and unpredictable. EMI’s Annual Report, however, revealed that they continued to display the assets, strategic power, positioning, and a staff of top performers worldwide that had the ability to take the firm to the forefront of the industry. For example, one of the company’s strengths lies in their catalog inventory. The release of the complete remastered Beatles catalog during that time, demonstrated EMI’s ability to capitalize from their catalog assets. The remastered Beatles albums sold over 10 million units in one year enabling the firm to experience unprecedented levels of success during that time. In addition, EMI artist Lady Antebellum released an album that was one of their top sellers in 2010.

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The publishing division also proved they were in a leading position in the music industry during that accounting period. For instance, they were named US Publisher of the Year for the 12th consecutive time by the leading trade publication, Billboard Magazine. Furthermore, they had been named Publisher of the Year at the ASCAP Pop Music Awards in the US for eight consecutive years. In the meantime, in the UK, where the report was filed, EMI was named Music Week’s Publisher of the Year for the 14th consecutive year.  These statistics provide sufficient evidence that support the company’s strength of earning abilities in music industry.

Wednesday’s post will reveal Part 2 of this analysis where we analyze EMI’s short term liquidity and take a closer look at their operating efficiency. See you then!

References

(2011). EMI annual review 2009/2010. Finances. Hollywood: Maltby Capital Ltd.

The Johnny Mercer Research Guide. (2012). Retrieved October 30, 2013, from The Johnny Mercer Foundation: http://www.johnnymercerfoundation.org/initiatives-charities/for-researchers/johnny-mercer-research-guide/

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Friedlob, G., & Welton, R. (2008). Keys to reading annual report. Hauppauge, NY: Barron’s Educational Series.

Loth, R. (2013). Profitability indicator ratios: Profit margin analysis. Retrieved December 5, 2013, from investopedia.com: http://www.investopedia.com/university/ratios/profitability-indicator/ratio1.asp

How to determine your capital structure. (n.d.). Retrieved December 5, 2013, from Structuringfinance.com: http://www.structuringfinance.com/capital-structure/how-to-determine-your-capital-structure

Roth, R. (2008). The writers guide to annual reports. Atlanta, GA: Booksurge.com.

Scherreik, S. (2002, December 22). How efficient is that company? Retrieved December 5, 2013, from businessweek.com: http://www.businessweek.com/stories/2002-12-22/how-efficient-is-that-company

An Analysis of Kodak’s Quality Financial Reporting

Published January 10, 2014 by Mayrbear's Lair

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Quality financial reporting (QFR) helps paint a clear picture of a company’s financial condition. Miller (2002) explains that QFR is more of an attitude than a set of practices that involves firms developing relationships with capital market participants to help communicate their needs effectively (Miller, 2002). The focus of this post is to ascertain whether the financial statements of the Kodak Corporation’s 2007 Annual Report revealed a high level of quality financial reporting. To determine this, the statements should reveal: (a) their cash flow potential, (b) how effective they were at raising capital, and (c) whether it painted the real economic picture of the firm or if the data was fabricated to make it appear in better financial health than it was. My research will also determine whether the report provided sufficient explanations about their accounting choices, estimates and judgments, and whether they were relevant, verifiable, consistent, and presented the data fairly with neutrality, all of which are critical criteria for high quality financial reporting. The following components were used as a checklist to help determine the quality of data: (a) the earnings reported for sales, (b) the cost of goods sold, (c) the non-operating revenue and expenses, (d) the operating expenses, and (e) other commitments and contingencies. The findings of this post will deduce that Kodak’s 2007 Annual Report revealed a high level of quality reporting that was effective in representing the economic truth of their financial condition.

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Evidence of Kodak’s QFR

Quality financial reporting helps capital market participants understand a company’s financial condition from the data and ratios that the statements contain which reveal cash flow and profitability outcomes. Bahnson and Miller (2002) explained it more effectively stating that QFR can divulge how companies create opportunities to receive and perpetuate cash flows (Bahnson & Miller, 2002). My research work began with an examination of Kodak’s sales and costs of goods sold figures to search for inconsistencies and trends. Next, I took a look at the inventory valuation methods and determined it was based on fair market value. In addition, there were no clues that would indicate premature revenue recognition. In the meantime, Kodak’s income statement (see Exhibit A) showed a steady decline in net sales figures from 2005 to 2007. A comparison of the accounts receivables and inventories ratios from the Common Size Balance sheet (see Exhibit B) corroborated the decline and confirmed a large ratio of debt to revenue. The common size income statement (see Exhibit C), also revealed a consistency in debt ratios that showed declining patterns in the relationships among sales, accounts receivable, and inventory. The notes offered adequate explanations for their accounting choices and disclosed the declining figures resulted from their restructuring strategy. In other words, to investors, debt implies risk, but Kodak’s report offered relevant details that were verifiable to explain the reasons for these debt ratios. Furthermore, the declining numbers did not raise red flags indicating the possibility of premature revenue recognition. This level of clarification provided a fuller picture that helped explain the low profit and high debt figures to alleviate uncertainty.

Kodak’s report also provided details about their revenue recognition policies explaining how their revenue was derived as well as how they calculated deferred income. In addition, the report included details about reductions to revenue policies and the methods used to measure revenue derived from consumer incentive programs. The statement also provided explanations with neutrality about estimates and judgments that were made based on the firm’s past experiences and historical records. This helped leave little room for unanswered questions about how Kodak’s inventory was valued as well as how it was collected and recognized.

Quality financial reporting can also help skilled analysts identify whether a company is manipulating the figures to show higher profits. For instance, Kodak’s common size income statement (Exhibit C) revealed that the gross profit margin showed a slight increase each year but reported zero operating profits. This means the firm was able to increase sales but not enough to control the substantial growth of operating expenses which was most likely due to their restructuring process. The data also confirmed their ability to raise funds showing a $238 million impairment charge from the sale of their Chinese facility and that selling the Health Group Company was also expected to generate future cost savings.

kodak-logo

What the Report Revealed about Kodak’s Future

High quality financial statements disclose the real economics of the company’s transactions and also reveal how well the company managed their assets to forecast their future. Turner (2000) asserts without QFR analysts lack reliable data to forecast future earnings (Turner, 2000). For example, Kodak’s ratios revealed that cash flow margins continued to decrease which made it difficult for them to service debt, pay dividends, and invest in further capital assets. However, the notes revealed their confidence of strength in future earnings and cash flow potential because of their ownership patents. This data revealed their potential to generate continuous revenue from licensing.

Other clues about Kodak’s future can be determined from explanations that revealed the firm’s other long-term commitments which include rental expenses of real property that showed a decreasing trend beginning with $149 million in 2005, dipping to $130 in 2007 that continued to drop in 2008 to $99 and thereafter. Furthermore, the report disclosed other contingencies stating the company and its subsidiaries were involved in a variety of litigation cases that could have an adverse effect on their future finances. Finally, the consumer price index (CPI) is also considered to help analysts forecast Kodak’s future earnings. For example, statement ratios along with CPI figures that measure the rate of inflation are significant components that are factored in to help strategists forecast future potential earnings. For instance, a 6% rate of inflation occurred during the 2006-2007 accounting period which was measured at 201.6 in 2006 and jumped to 207.3 in 2007. Strategists use these figures to help predict Kodak’s future growth potential based on past performances and factoring in a 6% CPI increase level into their formulas, which was calculated at 215.3 in 2008.

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Conclusion

Incomplete information on a company’s financial statements can create uncertainty for capital market participants. Fraser and Ormiston (2010) remind us that high quality financial statements provide sufficient data that help business owners make more effective decisions (Fraser & Ormiston, 2010). My research work determined that Kodak’s financial statements provided sufficient explanations that: (a) disclosed their cash flow potential from relevant accounting data of past performance to help forecast future behavior; (b) used reliable information that reflected the real economics of activities reported; (c) included verifiable and measurable data developed free of bias towards a predicted result; and (d) provided valuable ratio data for comparison to reveal how effective they were at raising capital. Based on these principles, the findings of this study concluded that Kodak’s 2007 Annual Report met criteria that were consistent with quality reporting that revealed the true nature of their financial condition during that period.

Exhibit A

kodak income statement Exhibit A

(Kodak, 2008)

Exhibit B

Assignment 5 Exhibit B - Common Bal

(Kodak, 2008)

Exhibit C

Assignment 5 Exhibit C - Common Income

(Kodak, 2008)

References

(2008). Kodak. Washington: Securities and Exchange Commission.

Bahnson, P., & Miller, P. (2002). Quality financial reporting. New York, NY: McGraw-Hill.

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Miller, P. (2002, April). Quality Financial Reporting. Retrieved November 25, 2013, from Journal of Accountancy: http://www.journalofaccountancy.com/Issues/2002/Apr/QualityFinancialReporting.htm

Turner, L. (2000, March 23). Speech by SEC staff: Charting a course for high quality financial reporting. Retrieved November 27, 2013, from US Securities and Exchange Commisssion: http://www.sec.gov/news/speech/spch356.htm

Preparing An Annual Report

Published January 8, 2014 by Mayrbear's Lair

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When a corporation’s staff of accountants finish preparing the financial statements for the fiscal year the next order of business is to call a meeting with the company’s CEO, as well as the Director of Investor Relations and representatives from the marketing and art departments to design that current year’s annual report.  Based on the research I conducted in my financial analysis course, this post will provide information on how I would present the main ideas I believe a company should present to shareholders in the annual report.

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To begin with, it is important that the company’s annual report provide investors and division heads with knowledge about the company’s weaknesses while offering shareholders security about the company’s strengths and future growth forecasts. These are important components that will help paint a full transparent picture of the firm. In preparation of the company’s Annual Report the following information consists of the main ideas that should be included in the documentation, in addition to the traditional financial statements that provide an overview of the firm’s financial condition.

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First and foremost, the Chairman’s statement should include their pride in the company’s achievements. For example, a company that holds the title as the third largest retailer of recreational products in the US should state that clearly as well as their many other strengths, such as a favorable economic and industrial outlook. In addition, the report should also include others strengths, for instance their geographical position may produce more favorable results.  A company that sells ski equipment, for example, located in Colorado is in a better position geographically than one located in the Florida region. These kinds of factors can be included to illustrate how the geographic location helps reduce competition and is a beneficial component for economic and industral growth.

policy-body

The financial report should also reveal the company’s policies and a view of the operational, financing, and equity activities. In addition, it should include details about the firm’s marketing tactics and objectives, expansion strategies, and illustrate their efficiency in the management of their accounts receivables and inventory divisions or any other components that have been proven quite effective. Another important component that should be considered is the company’s control of the operating costs, and how successful their use of financial leverage and solid coverage of debt service requirements were. Furthermore, the report should reflect the firm’s continual growth or plans for implementing substantial sales growth with profitability levels as well as results and new strategies that focus on the company’s expansion process. These are significant components that can help confirm a firm’s strengths and weaknesses that supports how well a company performed during that fiscal year.

Quantifying-Small-Business-Risks

The report’s commitments and contingencies section should also disclose the risks, noting the significant one(s) the company faces, for example like an economic vulnerability from unfavorable weather conditions which may increase a firm’s debt financing. In conclusion, on the whole, the report will reflect that the outlook for company stating how well or poorly they did with strategies and plans for the future that will put the firm in a better position that will ensure investors and staff alike, that the firm is a secure company to invest in and includes corporate governance policies to support the artistic and marketing divisions guided by the effective leadership skills of the company’s CEO.

References:

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Conflicts of interest in Financial Reporting

Published December 20, 2013 by Mayrbear's Lair

managing-coi

Conflicts of interest exist between management and capital market participants because shareholders are interested in the economic reality of a firm’s transactions and managers are under pressure to report information that will satisfy them. Berman and Knight (2008) inform us that handling the company’s finances is both an art and a science (Berman & Knight, 2008). While firms are encouraged to follow the Generally Accepted Accounting Principles (GAAP) parameters in their bookkeeping procedures, conflicts of interest can affect the quality and reality of their reports. Miller (2002) asserts that some firms believe Quality Financial Reporting (QFR) offers stockholders more certainty; others argue it reveals too much information to competitors (Miller, 2002).

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The following scenarios can help illustrate how conflicts of interest between management and shareholders can alter a firm’s economic reality by the quality of their reports. Fraser and Ormiston (2010) suggest that red flags are raised immediately when a cash statement reveals significant changes that show a decrease in accounts receivable (A/R) and an increase in cash from operating activities (Fraser & Ormiston, 2010). This could result from a strategy some managers used under duress to inflate CFO figures by selling A/R for cash to appease shareholders. Conflicts of interest can also affect accounting procedures that may occur at a natural gas company, for instance, that utilizes fracking practices. Because of the demand to find alternative gas resources, this industry is banking on the lower rates they offer consumers and managers are under pressure to provide data that supports the enterprise is profitable while environmentally safe. If for example, management has knowledge the industry is not environmentally safe, in an effort to maintain operations, they may use incomplete reporting tactics to shield this data as long as they can along with any other questionable investing activities that could reveal unethical practices such as funds diverted to falsify results. One method shareholders can use to verify the firm’s claims is to scrutinize the outflows of the investment activities and review the notes for clues. Managers want to achieve desired outcomes and shareholders want to hear a company is financially healthy. Because of this component, it presents opportunities for conflicts of interest to develop that can affect the quality of reports that will alter a firm’s economic reality.

Due to the winter holidays, there will be no new posts for the next few weeks. Look for a new blog post Monday, January 6 where I take a closer look at what Annual Report financial ratios reveal.

Thank you for tuning in everyone! Wishing you all a very beautiful winter holiday season.

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References:

Berman, K., & Knight, J. (2008). Financial intelligence for entrepreneurs. Boston, MA: Harvard Business School Press.

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Miller, P. (2002, April). Quality Financial Reporting. Retrieved November 25, 2013, from Journal of Accountancy: http://www.journalofaccountancy.com/Issues/2002/Apr/QualityFinancialReporting.htm

The Quality of Financial Information

Published December 19, 2013 by Mayrbear's Lair

financial-reporting

The holidays are creeping up on us and I just realized, I neglected to post Wednesday’s blog. This post is significant to my research work in financial analysis because it helps us understand that in order to keep apprised of how well a company is doing, the quality of financial reporting is the key component that determines whether the statements paint an accurate portrait of the firm or not. For example, because of scandals that occurred from companies like ENRON, AEI, and WorldCom, a revolution occurred with respect to financial reporting. According to Bahnson and Miller (2002) old practices and habitual thought processes with respect to accounting principles were put aside and replaced with new strategies and systems. As a result, accountants and finance executives are expected to embark on a different path that embraces a new shift in the bookkeeping paradigm called quality financial reporting (QFR). For financial managers to consider investing in a company they are looking for accurate information about two significant components: (1) opportunities to receive future cash flows, and (2) information about those opportunities (Bahnson & Miller, 2002). QFR provides complete information to investors and creditors to give them confidence in a company’s performance abilities. Much of the information provided on financial statements can be intimidating to many managers and entrepreneurs. This is a typical response from those who lack the financial intelligence required that can help them make more effective decisions in running their firms. Berman and Knight (2008) explain that the figures on financial statements help strategists determine a variety of estimates and assumptions. Learning how to assess that information helps planners to identify the bias of the data provided, in one direction or another (Berman & Knight, 2008). In this context, where financial results are considered, bias merely suggests that the numbers may be skewed in a certain direction. In other words, bookkeepers and finance professionals are trained to use certain assumptions and estimates rather than others who view the reports for other purposes. QFR is essential because it provides sufficient information to identify not only the source of those gains, but whether there are any other events or circumstances that could have an effect out the outcome, like pending litigation.

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Much of the information provided on financial statements can be intimidating to many managers and entrepreneurs. This is a typical response from those who lack the financial intelligence required that can help them make more effective decisions in running their firms. QFR is effective at painting an accurate view of the company’s financial condition. For example, revenue should not be recognized until there is evidence that a sale has transpired. In other words, the recipient has received delivery of the product or completion of the services rendered and revenue is collected. Many companies, however, violate this policy and report revenue prematurely without all criteria being met. Analysts can look for clues of false revenue reporting in the financial reports. For instance, the notes can reveal the company’s position with respect to collecting revenue policies to ascertain whether any changes occurred and determine the reason for the changes as well as the impact they can have.  Another clue is an analysis of the financial statements to determine the pattern of movement from sales, inventory, and accounts payable. For example, spikes in revenue during the final quarter may be a sign of revenue reported prematurely unless there is a specified reason for the spike to generate sales (like an end of the year close-out sale to liquidate inventory). Companies do not commonly experience spikes from sales in the fourth-quarter so this immediately raises flags. Other methods companies use to raise revenue levels include keeping the account records open longer at the end of the allotted accounting period. Some corporations on the other hand, use deceptive tactics like reporting gross sales rather than net to show higher revenue. For example, a company that is acting as an agent for another organization may collect their revenue in the form of a commission. According to regulations set forth by the GAAP (generally accepted accounting practices), agents are not considered the owner of merchandise being moved. Fraser and Ormiston (2010) explain that the GAAP requires the reporting of Gross Revenue for Principal Owners and Net Revenue for those who act as a representative in the in the sale of a product or service.  In other words, because agents are not considered the owners or originators of the product who assume the risk of the merchandise, the company acting as the agency can use the net method for recording revenue. Therefore knowing that a company collects revenue as an agency analysts can scrutinize the data closely to determine whether they reported gross or net revenue.

accounttrans

QFR is also important because it can help strategists understand the various inventory valuation methods. For instance, there are times when companies produce lower or higher earnings due to the fluctuation of inflation. Analysts again must look to the financial notes to determine the details of the company’s accounting policies to disclose whether the changes in revenue occurred due to LIFO (last in first out) or FIFO (first in first out) inventory cost flow accounting assumptions. If the value of the products sold, for example, falls under its original cost, the product is written down to reflect the market value and is determined by the cost to replace or produce an equivalent. This means that write downs can also play a part in the company’s profit margins which affects the comparability and quality of financial reporting. Accounting practices that do not provide details and incorporate misleading information is considered an unacceptable practice and any CEO that signs off on documentation that provides a misrepresentation of the truth is putting their career at risk and may face dire consequences as a result. That should be incentive enough to engage in QFR. To surmise, QFR provides investors the ratios that reveal whether companies are able to buy inventory and pay their bills. Furthermore, they provide profitability ratios that help creditors understand how much capital the company is generating while efficiency ratios reveal how well the company is managing their assets. The more complete these reports are the more likely they are to reduce shareholder uncertainty. In the eyes of investors and creditors, certainty reduces risk and reduced risk, provides shareholders with the satisfaction of a lower rate of return. In the long run, a lower rate of return means a lower cost for capital, which ultimately produces a higher stock price for the company. In conclusion, providing quality financial information is an essential component to management that contributes to a company’s long term success.  Tomorrow’s blog will post on schedule and will take a look at how different conflicts of interest can effect quality reporting.

References:

Bahnson, P., & Miller, P. (2002). Quality financial reporting. New York, NY: McGraw-Hill.

Berman, K., & Knight, J. (2008). Financial intelligence for entrepreneurs. Boston, MA: Harvard Business School Press.

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.