Analyzing Financial Reports

Project 3: Analyzing Financial Reports

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You have made good progress on the Choice Hotels project. Frank Marinara says “Because of your good work with our client, Choice Hotels, they would like us to continue working with them on a new project. Since this is more challenging than what you did previously in an individual capacity, I am assigning you to a team that will work on this project. I will send over the project details to your team via email."

INBOX (1 NEW EMAIL)

From: Frank Marinara, Director of Finance

To: You and Your Team Members

Choice Hotels would now like MCS to complete a financial statement comparison with their largest competitor, Marriott International. I need your team to compare Choice Hotels’ 10-K reports that we gathered in the last project with Marriott International’s 10-K reports. The team will need to complete a vertical financial statement analysis using the 10-K reports from Choice Hotels and Marriott.

Choice Hotels is exploring ABC cost allocation. They have asked your team to complete the task of allocating overhead to the cost of hotel rooms.

We will need to look at Choice Hotels’ latest 10-K report and Press Release in order to complete a budget and revenue forecast.

Finally, all team members will attend a meeting with other MCS’s finance and accounting analysts to discuss the pros and cons of the strategies of the two firms.

I will need all of the above assignments done within two weeks and suggest you begin right away.

Really proud of your efforts here,

Frank

Click Step 1 to get started!

When your team submits the project, the work will be evaluated using the competencies listed below. Your team can use the list below to check the team's work before submission.

· 1.3: Provide sufficient, correctly cited support that substantiates the writer’s ideas.  

· 1.6: Follow conventions of Standard Written English.  

· 3.1: Identify numerical or mathematical information that is relevant in a problem or situation.

· 3.2: Employ mathematical or statistical operations and data analysis techniques to arrive at a correct or optimal solution.

· 3.3: Analyze mathematical or statistical information, or the results of quantitative inquiry and manipulation of data.

· 3.4: Employ software applications and analytic tools to analyze, visualize, and present data to inform decision-making.

· 4.1: Lead and/or participate in a diverse group to accomplish projects and assignments.

· 4.2: Demonstrate the ability to plan and execute a project, articulating clear objectives and goals for the team.

· 4.3: Contribute to team projects, assignments, or organizational goals as an engaged member of a team.

· 4.4: Demonstrate diversity and inclusiveness in a team setting.

· 10.2: Analyze financial statements to evaluate and optimize organizational performance.

· 10.3: Determine optimal financial decisions in pursuit of an organization's goals.

· 10.5: Develop operating forecasts and budgets and apply managerial accounting techniques to support strategic decisions.

· 12.1: Assess market risk and opportunity.

· 13.1: Identify and analyze new opportunities.

Step 1: Compare Business Performance Using Financial Statements

Choice Hotels International (NYSE: CHH) would like to know how their market share compares with Marriott International (NASDAQ: MAR), their most significant competitor in North America. This comparison will help Choice Hotels develop a strategy to gain a competitive advantage over Marriott.

You will first need to complete a financial statement analysis of both Choice Hotels and Marriott International.

Dialogue with Frank Marinara

“Use the Choice Hotels 10-K reports we gathered in the last project and compare them with Marriott International’s 10-K reports,” Frank tells your team. The team will need to find Marriott’s 10-K reports the same way you did for Choice Hotels, by accessing the Securities Exchange Commission (SEC) website.

Frank continues, “Choice has asked for advice on attracting new investors. Your team needs to complete a vertical analysis by comparing financial reports of the two companies.” Frank recommends using financial ratios for analysis and cost-volume-profit analysis concepts for this task. “I will email the team an Excel Workbook to complete for this project.”

INBOX (1 NEW EMAIL)

From: Frank Marinara, Director of Finance

To: You and Your Team

For this assignment, please complete the Project 3 Excel Workbook with information from the income statement, balance sheet, and statement of cash flow portions of Choice Hotels’ and Marriott International’s 10-K reports. The file contains instructions, an income statement template, balance sheet template, a cash flow template, and a template for the forecast. I have also posed questions for your team to answer so I can provide Choice Hotels with suggestions on improving their financial performance.

Thanks,

Frank

Attachments:

Choice Hotels Workbook.xlsx (see attachment)

Answer the associated questions on the Income Statement, Balance Sheet, and Cash Flow worksheets within the Project 3 Excel Workbook to help Choice Hotels make sound investment decisions.

Now that you have completed Step 1, proceed to Step 2, where your team will analyze potential investment decisions.

Step 2: Analyze Cost and Investment Decisions

Choice Hotels is interested in bolstering their assets and improving their costing model to account for these assets. Choice Hotels has been building their own guest rooms and selling them to their franchise owners. The company allocates overhead costs equally to each guest room and prices them to achieve a greater profit on the higher-priced rooms. Choice Hotels is concerned that this traditional costing model may not be accurately assigning costs. For example, the selling price of one of its guest rooms, "Presidential Suite," may not be covering its true cost. You and your team will need to apply  activity-based costing (ABC)  to advise Choice Hotels on resolving the company’s costing issue with the Presidential Suite guest room.

Also, your team will need to understand the concepts of  production cost allocation , and  breakeven  to compare costing models. Two cost allocation methods of production are under consideration by Choice Hotels. Frank needs your team's help in determining if overhead cost allocation (Choice’s traditional model) or ABC (a new model) is better for their business.

Using the same Project 3 Excel Workbook your team used in Step 1, complete the Cost and Investing worksheet. The worksheet contains information that will aid in comparing the cost allocation methods for building guest rooms for Choice Hotels’ franchise owners. When your team has finished, submit the workbook to the submission folder located in the final step of this project. 

Then proceed to Step 3, where your team will develop a budget and forecast for Choice Hotels.

Step 3: Complete a Budget and Forecast

Frank recently informed your team that Choice Hotels also needs assistance in creating next year’s budget and developing revenue forecasts. Choice Hotels recently acquired a new hotel brand. This recent acquisition needs to be taken into consideration as your team develops the forecast. Choice Hotels recently held a press conference where the company disclosed their full-year guidance. Your team will need to use this information to develop their budget and forecast.

Using the same Project 3 Excel Workbook  (see attachment) you will use in Steps 2 and 3, complete the Budget and Forecast worksheet.

Now that your team has completed Step 3, proceed to Step 4, where you will discuss strategy with other finance and accounting analysts.

Step 4: Discuss Strategy

Discussion with Colleagues

Earlier, Frank mentioned you would need to attend a meeting with other finance and accounting analysts at MCS to discuss the differences in strategy between Choice Hotels and Marriott. Both companies have a BBB debt rating from Standard & Poor’s. This is the lowest investment grade rating and indicates that both companies have been aggressive with growth, finance, and Treasury Stock purchases.

· Discuss the differences in strategy related to business growth, finance, and Treasury Stock purchases.

· Discuss the similarities in strategy.

· Discuss any strategy recommendations for Choice Hotels’ management.

Submit one original posting of at least 250

When you have finished Step 4, proceed to Step 5, where you will summarize your team’s project findings in a report to management.

Step 5: Prepare a Report to Management

At the conclusion of your project, Frank requests a report based on your team's analysis and recommendations in the previous steps. He is planning on using this report to provide the client, Choice Hotels, with guidance on a potential changes in their strategy. This report, along with citations for any sources your team uses, should be about three to five pages. The report should highlight your team's analysis and recommendations based on the work you and your team completed in the workbook. Be creative and use charts, graphs, or any other tools your team feels would be useful to convey your team's analysis and recommendations.

When you and your team have completed Step 5, proceed to Step 6, where you will submit all work for Project 3.

Step 6: Submit Your Work

Final Deliverable Instructions

· Step 1: Complete Income Statement, Balance Sheet, and Cash Flows worksheets

· Step 2: Complete Cost and Investing worksheet

· Step 3: Budget and Forecast worksheet

· Step 4: Discuss and Compare Choice Hotels and Marriott Strategies. Write at least 250 words.

· Step 5: Report to management (3-5 pages)

Project Resources

Financial Statement Analysis

Financial statement analysis provides information to those interested in the financial condition and operating results of a company. When financial statement items are considered individually, they usually will have a limited significance. A better perspective is gained when comparisons are made with previous statements, other businesses, and industry averages. The main purpose of conducting financial analysis is to measure profitability and solvency. A business that is not able to make interest payments will experience difficulty in obtaining credit. This situation could lead either to reduced profitability or bankruptcy. A company with lower than average earnings may also find credit harder and more expensive to obtain.

Analytical Procedures

Most analytical measures are expressed as percentages or ratios, allowing for easy comparison with other businesses regardless of size. Horizontal and vertical analyses express entire financial statements in percentages. The horizontal analysis is an analysis of the rate of change in items of financial statements from year to year. The vertical (or common size) analysis presents each item as a percentage of total assets for the balance sheet and sales for income statement. When using these analytical measures, one should take the following factors into consideration: 

·  industry trends 

· changes in price levels 

·  future economic conditions

Current Position Analysis

A current position analysis is used to measure the ability of a firm to meet its current (and noncurrent) obligations. Three popular methods of analysis include the following: 

· determining working capital 

· current ratio

· quick ratio 

The primary users of current position analysis are creditors. Working capital information is less meaningful than current or quick ratios. These ratios must be compared with other firms in the same industry to see if they are in line.

Accounts Receivable Analysis

An accounts receivable analysis is used to measure a firm's solvency. The size and composition of accounts receivable is under continuous change, and therefore must be watched closely. Since funds tied up in accounts receivable yield no benefits or interest, it is best to keep this balance to a minimum. The quicker a firm is able to turn over its accounts receivable, the lesser the risk of loss from uncollectible accounts. In addition, the firm has the option to put these funds into more productive uses.

Two commonly used methods to analyze accounts receivable are (1) accounts receivable turnover and (2) the number of days’ sales in receivables (or days sales outstanding).

Both methods measure a firm's ability to generate sales and quickly collect its accounts receivable. A lower number of days' sales in receivables indicates a firm is collecting receivables quicker. Both of these measures must be compared with other firms in the same industry.

Inventory Analysis

A business should maintain an adequate inventory balance to meet demands of its operations, but at the same time keep this balance to a minimum. When a firm has excess inventory, it will have higher operating expenses, reduced solvency, increased risks of losses due to price declines and obsolescence, and limited chances to take advantage of more favorable investment opportunities. Two measures commonly used to assess inventory management efficiency are (1)  inventory turnover ratios and (2) the number of days' sales in inventory.

These figures must be compared with industry averages to properly evaluate inventory management.

Solvency Analysis: Long-Term Liabilities

The following methods are commonly used to evaluate the safety of long-term creditors:

·  ratio of shareholders' equity to liabilities (debt-to-equity)

·  ratio of plant assets to long-term liabilities

·  operating income divided by interest expense, as well as other payments (known as times-interest-earned or coverage ratios)

For all these methods of analysis, the higher the number, the greater the amount of safety. This information is used by investors, creditors, shareholders, and management. It indicates the ability of a firm to meet its financial obligations.

Profitability Analysis

Profitability analysis measures the ability to generate income. Common measures used include the following:

· profit margin—sales divided by net income

· total assets turnover—ratio of net sales to total assets

· return on assets—net income divided by total assets

· return on equity—net income divided by either shareholders' total equity or common stock only

· earnings per share of common stock

· dividends per share of common stock

In addition, investors use the price-earnings ratio and dividend yield.

Review of Analytical Measures

Analytical measures are used to assess solvency and profitability. The type of analytical measure chosen usually is dependent on the following factors: 

· the size of the company 

· its capital structure

· the type of business activity 

Analytical measures are useful for evaluating the financial results of a business and the performance of management. They are also used to predict future performance.

Corporate Annual Reports

Corporate annual reports contain information that summarizes the activities of the past year, and the future plans of the company. No standard or required format exists. However, annual reports must by law provide accurate financial statements. Most annual reports contain the following sections:

· financial highlights

· management report

·  president's letter

·  an independent auditor's' opinion

·  historical data

Common Ratios

The two tables below depict the practical use of some common financial ratios and the results of ratio analysis.

Common Financial Ratios
Ratio	Calculation	Question it helps to answer
Net income margin	Net income / total Income	How much income is used up by expenses?
Return on assets	Net income / total assets	How big is the income supporting the assets?
Return on net worth	Net income / net worth	How big is income relative to net worth?
Debt to assets	Total debt / total assets	How much asset value is financed by debt? or how much asset value is there to satisfy debt?
Total debt	Total debt / net worth	How large is debt relative to net worth?
Interest coverage	Income before interest / interest expense	How well does income cover interest expense?
Cash flow to income	Net cash flow / net income	How much do payments for investments and financing take from income?
Cash flow to assets	Net cash flow / total assets	How much cash flow supports assets?
Free cash flow	Free cash flow / net cash flow	How much cash is left to invest after covering living expenses and debt repayments?
Results of Ratio Analysis
Ratio	Calculation	Question it helps to answer	Better as it gets...
Net income margin	Net income / total income	How much income is used up by expenses?	Bigger will be < 1
Return on assets	Net income / total assets	How big is the income supporting the assets?	Bigger
Return on net worth	Net income / net worth	How big is income relative to net worth?	Bigger
Debt to assets	Total debt / total assets	How much asset value is financed by debt? or how much asset value is there to satisfy debt?	Smaller Should be <1
Total debt	Total debt / net worth	How large is debt relative to net worth?	Smaller Should be <1
Interest coverage	Income before interest / interest expense	How well does income cover interest expense?	Bigger Will be >1
Cash flow to income	Net cash flow / net income	How much do payments for investments and financing take from income?	Bigger
Cash flow to assets	Net cash flow / total assets	How much cash flow supports assets?	Bigger
Free cash flow	Free cash flow / net cash flow	How much cash is left to invest after covering living expenses and debt repayments?	Bigger