Outline
  2.1Introduction
  2.2Financial statements: A brief review 
  2.3Critique of accounting information 
  2.4Static ratio analysis and its extension
  2.5Cost-volume-profit analysis and its applications
  2.6Accounting income vs. economic income
  2.7Summary
  Appendix 2A. Simple regression and multiple 
    regression
  Appendix 2.B. Using Indirect Method to 
    Compile Cash Flow Statement                         2
   2.2 Financial statements: A brief review 
        Balance sheet
        Income statement
        Equity statement 
         Cash flow statement
         Annual vs. quarterly financial data
                                                    3
     2.2 Financial statements: A brief review 
    Corporate annual and quarterly reports generally contain 
      four basic financial statements: balance sheet, statement 
      of earnings, statement of retained earnings, and statement 
      of changes in financial position. Using Johnson & Johnson 
      (JNJ) annual consolidated financial statements as 
      examples, we discuss the usefulness and problems 
      associated with each of these statements in financial 
      analysis and planning. Finally, the use of annual versus 
      quarterly financial data is addressed.
                                                                  4
                    Balance Sheet
   The balance sheet describes a firm’s financial 
      position at one specific point in time. It is a static 
      representation, such as a snapshot, of the firm’s 
      financial composition of assets and liabilities at 
      one point in time. The balance sheet of JNJ, 
      shown in Table 2.1, is broken down into two basic 
      areas of classification — total assets (debit) and 
      total liabilities and shareholders’ equity (credit).
                                                               5
                Balance Sheet
    On the debit side, accounts are divided into six groups: current assets, 
     marketable securities — non-current, property, plant and equipment 
     (PP&E), intangible assets, deferred taxes on income, and other assets. 
     Current assets represents short-term accounts, such as cash and cash 
     equivalents, marketable securities and accounts receivable, 
     inventories, deferred tax on income, and prepaid expense. It should be 
     noted that deferred tax on income in this group is a current deferred 
     tax and will be converted into income tax within 1 year.
    Property encompasses all fixed or capital assets such as real estate, 
     plant and equipment, special tools, and the allowance for depreciation 
     and amortization. Intangible assets refer to the assets of research and 
     development (R&D).
                                                  6