Modern financial statement analysis in a post-Sarbanes-Oxley world

In this paper we describe how techniques of financial statement analysis can be used by executives to determine whether financial disclosures are appropriate as they prepare to fulfill section 302 certification requirements of the Sarbanes-Oxley Act. Our description is based on developments in the accounting and finance literatures that expand the scope of FSA beyond the customary analysis of ratios to include adjustments to the data, examination of accounting quality and security valuation. We illustrate with an example that compares three large publicly traded retail companies.

A blueprint for reliable business valuation

Valuation errors are common and can be extraordinarily costly. The rediscovery of the residual income valuation model creates an opportunity to diminish the frequency of valuation errors by comparing the results of two valuation techniques that must produce identical results: one based on cash flows, the other on residual income. Another necessary condition for reliable valuations is that the value of assets must be equal to the combined value of the firm’s outstanding debt and equity securities. Based on these two necessary conditions for reliability we propose a modeling framework to limit the vulnerability of valuation analysts to challenges resulting from blatant errors of input or from a lack of internal consistency in valuation models. (Seattle, February 2006)