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Financial Statement Analysis: A Practitioner's Guide, Fourth Edition by FERNANDO ALVAREZ, MARTIN FRIDSON

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Chapter 3

The Income Statement

The goal of analyzing an income statement is essentially to determine whether the story it tells is good, bad, or indifferent. To accomplish this objective, the analyst draws a few initial conclusions, then puts the income statement into context by comparing it with income statements of earlier periods, as well as statements of other companies. These steps are described in the section of this chapter titled “Making the Numbers Talk.”

Simple techniques of analysis can extract a great deal of information from an income statement, but the quality of the information is no less a concern than the quantity. A conscientious analyst must determine how accurately the statement reflects the issuer's revenues, expenses, and earnings. This deeper level of scrutiny requires an awareness of imperfections in the accounting system that can distort economic reality.

The section titled “How Real Are the Numbers?” documents the indefatigability of issuers in devising novel gambits for exploiting these vulnerabilities. Analysts must be equally resourceful. In particular, students of financial statements must keep up with innovations in transforming rising stock values into revenues of dubious quality.

MAKING THE NUMBERS TALK

By observing an income statement in its raw form, the reader can make several useful, albeit limited, observations. Peet's Coffee & Tea's income statement for 2009 (Exhibit 3.1) shows, for example, that the company was profitable rather than unprofitable. ...

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