Financial Statement Analysis and Accounting
Earnings quality and cash conversion
Financial statement analysis for research focuses on the sustainability of earnings and cash flow. Know revenue recognition, accrual accounting, working capital, operating versus non-operating items, and the difference between GAAP and adjusted figures. Review the cash flow statement: cash from operations (CFO), capital expenditures, and free cash flow. Check whether CFO is helped by stretching payables, factoring receivables, or delaying inventory write-downs. Watch capitalized costs, changes in accounting estimates, and recurring "one-time" charges.
Traps: adding back stock-based compensation and recurring restructuring costs to EBITDA without noting dilution or recurrence; using EBITDA for capital-intensive or leveraged firms; ignoring pension or lease obligations; comparing LIFO and FIFO peers without adjustment; treating gains on asset sales as operating; missing dilution from options or RSUs. Segment and geographic mix can hide margin deterioration.
Worked example / rule of thumb: FCF = CFO - capex. If CFO rises because days payable outstanding increased from 45 to 70, normalized CFO = reported CFO - the increase in payables. Rule: adjust CFO for non-recurring working-capital benefits before calling it recurring.