Week 7 Post by Justin

For this week’s assignment I interviewed two people through e-mail regarding their use and knowledge of financial statements.  I asked them each the same basic questions to understand two different ways that two people can and do read financial statements.

I chose to interview two different people familiar with financial statements in an attempt to understand how to read them better.  The 52-page PDF from Merrill Lynch How to Read a Financial Report” was a bit dense.

First is JT Sandone – Vanguard Strategy and Finance division

Could you introduce yourself and give us a little background about yourself professionally?  Where do you currently work and what is your role within that organization?

My name is J. T. Sandone and I’ve worked for the Strategy and Finance division of Vanguard for the past four and a half years during which time I’ve supported our International business.  Throughout my tenure, I’ve been an individual contributor and a people leader both in the United States and on assignment in Australia and Canada.  Currently, I lead a small team responsible for the evaluation of customized pricing in pooled fund and separately managed account structures for the International institutional business as well as the mechanisms by which we implement these customized pricing arrangements.  I joined Vanguard after completing graduate school.

Prior to business school and graduate school, my experience as an individual contributor and a leader in sales and operations management in science and information technology spans a little over a decade.

In my role with Vanguard, I do not work with financial statements; my responses below represent my personal perspective about the usage and value of financial statements.  For all responses below, I am speaking about audited financial statements unless otherwise stated.

Why are financial statements important to those not only in the financial services industry, but those that are not as well?

Financial statements are important to any investor (whether individual or institutional) because they are intended to accurately depict an entity’s financial health.  Each financial statement provides different information; when evaluated as a collection, the statements help to provide a more comprehensive perspective about the entity.

Financial statements are created according to a large body of well-established rules, they translate an entity’s activities into objective measures, they are certified by an entity’s management to be accurate and complete, and they are further validated by an independent third-party from a risk and controls perspective.

What do financial statements tell us (please remember we don’t all work in the financial services industry when answering)?

Because financial statements are created according to a very specific set of rules, they are able to provide us with insight we otherwise would not be able to discern.  The value of financial statements can discussed two ways – when they are evaluated singularly and also when they are evaluated in comparison to other entities in the same industry.

When looking at the financial statements of a specific entity, we are able to evaluate the financial health of the entity.  The statements provide us with both point-in-time information (balance sheet) as well as period information (income statement and cash-flow statement).  Accordingly, we have a basis for an intelligent analysis about the viability of an entity.

When looking at the financial statements of a specific entity against the backdrop of other entities in the same industry, we are able to evaluate the relative performance and effectiveness of the management team.  From the statements, ratios can be derived and common-sized statements can be compared.  With these, we have a basis for intelligent analysis about the competitiveness of an entity.

When you first take a look at a financial report what is the first thing someone should look at?  Why would they look at that first?

Financial statements are useful only if they contain accurate information.  Accurate information can only be assured if effective controls are in place.  Because the auditor is responsible to certify the controls, my advice is to start with the Auditor’s Opinion.  After reading the opinion, you are better equipped to evaluate all other financial data presented.  After the Auditor’s Opinion, I’d suggest looking at the Balance Sheet to get an idea of how the period-end balances compare for Shareholder’s Equity to discern the trend.

If there is one segment of a financial statement that someone should be the most familiar with, what section is that?  Why?

No single financial statement provides a complete financial picture of the entity’s finances and all should be reviewed together to understand the financial health of the entity.  To choose one statement that someone should be most familiar with, I might say the Cash Flow Statement.

The other two financial statements are affected by accrual-based accounting (an attempt to match the timing of revenues and expenses to the period in which they are generated).  In the Cash Flow Statement, accrual impacts are reversed out.  As such, the Cash Flow Statement indicates whether the entity is generating cash from its operations and if the cash generation exceeds its cash consumption needs.  With this information, you can intelligently analyze the solvency of the entity.

Martin L. Ward – Assistant Regional Audit Manager for the U.S. Department of Justice - Office of the Inspector General (DOJ-OIG)

Could you introduce yourself and give us a little background about yourself professionally?  Where do you currently work and what is your role within that organization?

I graduated Temple University in 1980 with a degree in Accounting (BBA-Accounting concentration).  I am a Certified Public Accountant (CPA), a Certified Management Accountant (CMA), and a Certified Government Financial Manager (CGFM).

After graduating college I worked in the private sector for over 10 years with major fortune 500 companies as a management accountant and internal auditor.  I've also worked in public accounting as a tax accountant and manager, and I spent 5 years working in the banking industry as a Controller of a small community bank.  The bulk of my accounting work more recently has been with the federal government.  I worked for the Government Accountability Office (GAO) as an Audit Manager for several years and currently work for the Justice Department. 

In my current position I am the Assistant Regional Audit Manager for the U.S. Department of Justice - Office of the Inspector General (DOJ-OIG).  For the DOJ-OIG I work in the Audit Division.  The Audit Division’s mission is to promote efficiency and effectiveness while identifying waste, fraud, and abuse by conducting sophisticated program and financial audits of Department of Justice operations. In addition to performing independent evaluations and financial reviews of programs, activities, and functions in the Department of Justice, the Division also audits state and local governments as well as other organizations receiving Department of Justice funding.  My role is to oversee the work of 2-3 staff member teams conducting audit assignments both within and external to the Department of Justice.  I also serve as the Fraud Coordinator for the DOJ-OIG in Philadelphia assisting staff (Special Agents) from the OIG Investigative Division on an as needed basis during the course of ongoing investigations that require auditor assistance. 

Why are financial statements important to those not only in the financial services industry, but those that are not as well?

I think the value of financial statements (FS) is dependent on the user.  I use FS mostly to evaluate a public company from the standpoint of a potential investor.  From my perspective financial statements let me assess past and present performance (trends) so I can make an educated decision on the future potential of a company. If I'm investing my money I want currently profitable companies and those that will remain so and continue to grow profitability in the future. 

What do financial statements tell us (please remember we don’t all work in the financial services industry when answering)?

I think FS can tell multiple stories depending on the needs of the user.  In my case, I like to use the balance sheet (Statement of Financial Condition) to assess current position at a point in time (generally year-end) and compare it between the current and prior year end to see any trends...favorable or not.  I like the Cash Flows statement because it lets me assess the ability of a company to meet its current obligations as well as fund future growth.  The Income Statement (sometimes referred to as the Profit and Loss...P&L) is more of a glimpse of activity throughout the year but good nonetheless in assessing year-to-year trends.     

  

When you first take a look at a financial report what is the first thing someone should look at?  Why would they look at that first?

I actually like to look at the amount of debt (current and long-term) that a company reports as its liabilities on the balance sheet relative to total assets (ratio analysis).  It tells me how "leveraged" the company is and I look at this versus how much income the company generates and assess its ability to cover its debt (repay loan obligations) and still have positive growth (earnings).  I also focus on the balance sheet current assests versus current liabilities to see the ability of a company to meet its current liabilities.  A "low or poor "cash position on the balance sheet causes me concern.  Another important thing I look at is the Notes to the FS to gain some insight on how the company operates.      

  

If there is one segment of a financial statement that someone should be the most familiar with, what section is that?  Why?

This is difficult to say because it depends on the needs of the user.  In my case I'm looking at historical and current trends from all of the FS to assess whether I want to invest in the company.  I'm a big fan of using various financial ratios that can be calculated based on the information on the FS.  When I was working in the banking industry I always looked at the Audit Report from the CPA firm that did the audit of the FS, and my biggest concern was the ability of the company to fully and timely repay the loan obligation.  Personally, I like to trend earnings and expenses from year to year from the Income Statement and then assess a company’s debt position from the Balance Sheet by calculating and analyzing various ratios. 

After reading both their answers I thought it was interesting to note the similarities and differences in a few answers.  Both mentioned the importance of learning an organizations health but Ward mentions how it’s dependent on the user and the information you are trying to learn.      

Sandone mentioned the importance of the Auditor’s Opinion first so that you are ready to understand the rest of the data.  Ward, however, looks at the amount of debt.

Receiving different answers just showed how, although Financial Statements may see cut and dry, they really aren’t.