CHAPTER 3 UNDERSTANDING FINANCIAL STATEMENTS

11 CHAPTER 3 UNDERSTANDING FINANCIAL STATEMENTSF inancial STATEMENTS provide the fundamental information that we use to analyze andanswer valuation questions. It is important, therefore, that we understand the principlesgoverning these STATEMENTS by looking at four questions: How valuable are the assets of a firm? The assets of a firm can come in several forms assets with long lives such as land and buildings, assets with shorter lives suchinventory, and intangible assets that still produce revenues for the firm such as patentsand trademarks. How did the firm raise the funds to finance these assets? In acquiring these assets, firmscan use the funds of the owners (equity) or borrowed money (debt), and the mix islikely to change as the assets age. How profitable are these assets? A good investment, we argued, is one that makes areturn greater than the hurdle rate. To evaluate whether the investments that a firm hasalready made are good investments, we need to estimate what returns we are making onthese investments.

• A Distrust of Market or Estimated Value: When a current market value exists for an asset that is different from the book value, accounting convention seems to view this market value with suspicion. The market price of an asset is often viewed as both much too volatile and too easily manipulated to be used as an estimate of value for an asset.

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  Value, Testament, Financial, Financial statements

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