¶ … nature of a firm's business and its environment are big factors in determining what the firm's financial statements look like."
Industries vary wildly in terms of how they account for profits, losses, depreciation of assets, and other critical components that affect the appearance of their financial statements. Some industries are more apt to operate on credit on a regular basis than others; some industries make the bulk of their profits on a seasonal basis (such as retailers which make most of their money at Christmas) or have profits which vary markedly from year to year. For example, a pharmaceutical company may experience a notable drop in revenue when one of its most popular drugs loses its patent; it may gain sharp windfall that lasts for a fixed period of time while it can exclusively profit from a new drug. Some industries are extremely risky to invest in because of innate volatility such as the entertainment industry and the apparel industry: consumer tastes and fads can be very difficult to predict and once again cash flow and operating costs can be extremely difficult to determine from year to year. The relationship of the firm to its shareholders and its willingness to use assets to pay off liabilities may also vary.
Environmental circumstances, such as the cost of fuel, will affect almost all firms to some degree but not all firms equally. For example, firms which are directly dependent upon...
Depreciation of assets will also be more manifest in specific industries than others, including ones highly dependent upon technology. Changes in technology can also substantially affect the firm's business model and cause a sharp and unexpected decline in revenue, as was the case with AOL and Blockbuster. Bad publicity for a firm may be more of a factor in terms of generating unexpected problems for the firm's revenue than expected.
Response to student 1
I agree that there is no 'cookie cutter' or 'one-size-fits-all' way to read a financial statement and having a familiarity with both the company and the industry can be extremely helpful. Some companies may appear to show losses one year but there is a strong likelihood that the company's fortunes may revive. For example, if an apparel company has one bad Christmas, it may be able to turn its fortunes around with a new line of clothing, especially given the volatility of the demand for consumer goods. Consistent losses year to year when the firm should be in the black relative to other retailers, of course, would be concerning. Some firms must also operate on a revolving basis of credit based upon the needs of their industry (like agriculture) more than others; it would be more concerning to have high levels of debt in…
