Best- Financial Analysis Steps

Consider quality of financial info

Look at big picture

Dig into details- methodical review of IS, BS, SCF

Is cash flow consistent with income statement?

Operating Cash Flow compared to Net Income

Identify preliminary hypothesis

Consider all relevant ratios

Follow up on any unusual items

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ZZZZ Best – Financial Analysis

Quality of financial info may be suspect:

Audits of ‘84 and ‘85- sole practitioner in CA

Audit of ‘86- NJ based CPA

Review of Q1 ‘87- E&Y

Why change in auditors?

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ZZZZ Best – Financial Analysis

Look at big picture:

(in millions) 1984 1985 1986 1987 Est

Revenue .5 1.2 4.8 43

Net Income .1 .3 .9 8

ROS 20% 26% 20% 19%

Questions :

Spectacular growth in insurance restoration – how big is the market ?

Gross margin in excess of 50%- very high for a low tech service business ?

Why is ROS so consistent given huge increase in sales?

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ZZZZ Best – Financial Analysis

Income Statement Trend & Common Size analysis:

Most sales thru one customer, Interstate Appraisal, related?

Sales growth of 7.5X for Q1’87. Reasonable for low tech?

Gross margin decrease from 58% in ‘86 to 45 % in ’87. Why?

Shift in cost from operating to cost of revenue. Why?

Income tax accounting- cash paid? Reclass of DT to current?

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Balance Sheet changes:

Large increase in A/R- DSO 41.6 What about bad debts?

Advances on material purchases. Business reason for this?

Property and Equipment. Why $600k in purchases?

Why large increase in other assets?

Income tax liabilities. Why shift to current?

Debt- most is short term. Why not long term?

Who purchased shares in 1986? Proceeds used for?

ZZZZ Best – Financial Analysis

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Cash Flow Statement:

(in thousands) FY 1986 Q1 1987

Net income $946 $896

Cash Flow operations 561 (941)

Purchase of PPE (3,100) (744)

Free cash flow (2,539) (1,685)

Company dependent on short term borrowing. Why?

ZZZZ Best – Financial Analysis

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Any other relevant ratios?

FY 85 FY 86 Q1 87

Return on sales 26% 20% 16%

Debt to equity – 1.5 1.8

Current ratio 36 .98 1.03

Net working capital is close to zero. Trouble sign for growing company.

ZZZZ Best – Financial Analysis

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ZZZZ Best – Prelim Hypothesis

Sales growth may indicate violation of GAAP

ZZZZ Best may not have recorded appropriate income tax entries

Advances on Material Purchases may indicate a cash flow problem that is suggestive of A/R management

Excessive PPE purchases may not be appropriate

CFFO significantly less than Net Income could signal earnings management

Changes in GM may indicate accounting problems

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Insurance Restoration sales exceeded total such sales for all companies in entire US. AR paid by funds raised from investors, friends

Taxes- they paid no taxes as tax expense is mostly recorded in deferred taxes. Why show deferreds as current unles they would be paying them in cash in 1987?

Advances on material purchases were bogus entries. Just an entry to offset losses or to reclassify A/R if too high.

Recorded PPE just to show stronger balance sheet. No supporting purchases.

As a service business shouldn’t CFFO be close to NI? DSO of 41 days not unusual.

Need to understand why gross margin is decreasing so significantly just as they are going public. Larger contracts are less profitable?


Green Mountain- Assignment for Oct 9

Green Mountain, now known as Keurig Green Mountain, Inc is a leader in the specialty coffee and coffeemaker business. Your assignment is to perform a financial analysis for 2007-11 similar to what we conducted in class today. Use the financial statement information in Appendix 5-A of the text. You should cover:

Consider quality of financial information

Look at big picture

Dig into details- IS, BS, SCF

Consider all relevant ratios

Discuss any unusual items

Assignment- Write a short memo (no more than 4 pages) to me summarizing your findings.

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Green Mountain – Financial Analysis

A few comments to assist you:

Assume all equity transactions are correct. They issued stock in 2009 and 2011

There were significant acquisitions made in 2010-11. Assume the accounting for these is correct

Assume income tax accounting is appropriate

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Green Mountain Disclosures

To assist you in your analysis, here are certain disclosures the Co made:

9/28/10 SEC informal inquiry of accounting practices

9/28/10 discovery of immaterial accounting error ( gross margin)

11/19/10 discovery of 4 material errors that will require restatement of 2007-10

2010 – Shareholder class action lawsuits alleging revenue recognition violations of GAAP ( sales to related party Mblock )

2011- Hedge Fund investor David Einhorn attacks Green Mountain accounting practices and calls it “GAAP-uccino”

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