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H OW TO R E A D A W R I N G I N G V I T A L S I G N S O U T O F
Eighth Edition
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F I N A N C I A L R E P O RTT H E N U M B E R S
JOHN A. TRACY AND TAGE C. TRACY
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Cover Design: WileyCover Illustration: Wiley
Copyright © 2014 by John A. Tracy and Tage C. Tracy All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
The Seventh Edition of How to Read a Financial Report: Wringing Vital Signs Out of the Numbers was published by John Wiley & Sons, Inc, in 2009.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
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Library of Congress Cataloging-in-Publication Data:
Tracy, John A. How to read a fi nancial report: wringing vital signs out of the numbers / John A. Tracy, CPA, Tage Tracy. — 8th ed. pages cm Includes index. ISBN 978-1-118-73584-8 (pbk.); ISBN 978-1-118-73558-9 (ebk); ISBN 978-1-118-73592-3 (ebk) 1. Financial statements. I. Tracy, Tage C. II. Title. HF5681.B2T733 2014 657'.3—dc23 2013035597
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
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CONTENTS
List of Exhibits ixPreface to the Eighth Edition xiii
Part One—Fundamentals
1 Starting with Cash Flows 3 2 Three Financial Statements 11 3 Profi t Accounting 23 4 Profi t Isn’t Everything 33
Part Two—Connections
5 Sales Revenue and Accounts Receivable 43 6 Cost of Goods Sold Expense and Inventory 49 7 Inventory and Accounts Payable 55 8 Operating Expenses and Accounts Payable 61
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vi Contents
9 Operating Expenses and Prepaid Expenses 6710 Depreciation Expense and Property, Plant, and
Equipment; Intangible Assets 7311 Accruing the Liability for Unpaid Expenses 8312 Income Tax Expense and Its Liability 8913 Net Income and Retained Earnings;
Earnings per Share (EPS) 95
Part Three—Cash Flow
14 Cash Flow from Operating (Profi t-Making) Activities 103
15 Cash Flows from Investing and Financing Activities 111
16 Growth and Decline Impacts on Cash Flow 119
Part Four—Analysis
17 Footnotes to Financial Statements 13318 Financial Statement Ratios 14319 Profi t Analysis for Business Managers 157
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Contents vii
Part Five—Truthfulness
20 Choosing Accounting Methods and Massaging the Numbers 171
21 Audits of Financial Reports 18122 Basic Questions, Basic Answers 19323 Small Business Financial Reporting 209
About the Authors 215
Index 217
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LIST OF EXHIBITS
Exhibit 1.1 Summary of Cash Flows during Year 5Exhibit 2.1 Year-End Balance Sheets 13Exhibit 2.2 Income Statement for Year 14Exhibit 2.3 Statement of Cash Flows for Year 14Exhibit 2.4 Single Step Income Statement 15Exhibit 3.1 Income Statement and Balance
Sheet Changes during Year from Profi t-Making Activities 26
Exhibit 4.1 Connections between the Three Financial Statements 37
Exhibit 5.1 Sales Revenue and Accounts Receivable 44Exhibit 6.1 Cost of Goods Sold Expense and Inventory 50Exhibit 7.1 Inventory and Accounts Payable 56Exhibit 8.1 Selling, General, and Administrative
Expenses and Accounts Payable 62Exhibit 9.1 Selling, General, and Administrative
Expenses and Prepaid Expenses 68
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x List of Exhibits
Exhibit 10.1 Property, Plant, and Equipment, Depreciation Expense and Accumulated Depreciation 74
Exhibit 11.1 Accruing Unpaid Expenses 84Exhibit 12.1 Income Tax Expense and Income
Tax Payable 90Exhibit 13.1 Net Income and Retained Earnings,
Earnings per Share 96Exhibit 14.1 Cash Flow from Operating
(Profi t-Making) Activities 104Exhibit 14.2 Direct Method Format for Reporting
Cash Flow from Operating Activities in the Statement of Cash Flows 108
Exhibit 15.1 Cash Flows from Investing and Financing Activities 112
Exhibit 16.1 Cash Flow from Operating (Profi t-Making) Activities in Steady-State Scenario 121
Exhibit 16.2 Cash Flow from Operating (Profi t-Making) Activities in Growth Scenario 124
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List of Exhibits xi
Exhibit 16.3 Cash Flow from Operating (Profi t-Making) Activities in Decline Scenario 127
Exhibit 17.1 Three Financial Statements and Footnotes 134
Exhibit 18.1 External Financial Statements of Business (without Footnotes) 146
Exhibit 19.1 External Income Statement for Year 160Exhibit 19.2 Management Profi t Report for Year 163Exhibit 19.3 5% Sales Prices versus 5% Sales
Volume Increase 165Exhibit 19.4 EBIT Breakeven Point for Lower
Sales Prices and Lower Sales Volume 167
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PREFACE TO THE EIGHTH EDITION
When I started this book my new co-author on this edition, my son Tage, was entering his senior year of high school. Today he is a successful business and fi nancial consultant in San Diego. Truth be known, he writes better than his old man. So, it is with great personal pleasure and pride that I welcome my son Tage as co-author on this edition. He’s a chip off the old block. In case you’re wondering about his name, it is Swedish and Danish in origin.
At the time the fi rst edition was released in 1980, the Dow Jones Industrial Average hovered around 850 (really!). This most-watched stock market index reached 11,700 in early 2000, and then it abruptly plunged, causing a big dent in my retirement savings. The Dow recovered over the following years, but then dropped again. As I write this sentence the Dow is about 15,000. As J. P. Morgan once said, “The market will fl uctuate.” Millions of individuals keep their money in the stock market, and stock investments are a large part of most retirement plans. Knowing how to read a fi nancial report is as important as ever.
This edition catches up with the major changes in fi nancial reporting since the previous edition. At the top of this list is the movement toward different fi nan-cial reporting standards for private and small businesses. At the same time, the basic architecture of the book remains unchanged. The framework of the book has proved very successful for more than 33 years. I’d be a fool to mess with this suc-cess formula. My mother did not raise a fool. Cash fl ows are underscored through-out the book. This cash fl ow emphasis is the hallmark of the book.
I prepared all the exhibits in the book as Excel worksheets. To request a copy of the workbook file of all the exhibits, please contact me at my e-mail
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