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Equity, Cash Flow, and Notes Analysis
Equity, Cash Flow, and Notes Analysis Paper
Kathy Wahl, Jerry Kennedy, and Jerry Craig
Accounting 529
Lewis Worcester
August 2, 2017
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Equity, Cash Flow, and Notes Analysis
Equity, Cash Flow, and Notes Analysis for IBM
Introduction
This document has been prepared as a report to assist the IBM management team
in its decision process, to assure they are obtaining their goal to encourage investment.
Changes in Stock Holders' Equity and Cash Flows will be the financial statements
discussed. Specific components of these statements will be analyzed for changes
between fiscal 2002 and 2003. The report will cover the relevance of the changes and
how this information can be leveraged for future business decisions.
Statement of Changes in Stockholders’ Equity
The Statement of Changes in Stockholders’ Equity reflects the increases or
decreases of the amounts of rights the owners have within the period being reviewed.
The analysis is based on the reports below:
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Equity, Cash Flow, and Notes Analysis
Figure 1: IBM Statement of Stockholders Equity 2002 (source: IBM 2003 Annual Report)
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Equity, Cash Flow, and Notes Analysis
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Figure 2: IBM Statement of Stockholders Equity 2003 (source: IBM 2003 Annual Report)
Changes in Stockholders Equity
In 2003 stockholders’ equity increased; in 2002 there was a decrease. A comparison
and explanation of the equity changes follows:

stockholders’ equity January 1, 2002 was $23,448M; ending equity December 31,
2002 was $22,782M; $666M loss of equity

stockholders’ equity January 1, 2003 was $22,782M; ending equity December 31,
2003 was $27,664M; result was a $5,082M gain in equity
There was a significant increase in the 2003 net income over 2002
Equity, Cash Flow, and Notes Analysis

Net Income 2002: $3,579M

Net Income 2003: $7,583M
Gains and Losses Not Affecting Retained Earnings
The gains (losses) not affecting retained earnings also had some significant
differences:
Line Item
Net unrealized losses on SFAS No. 133
Cash flow hedge derivatives.
Foreign currency translation adjustments
Minimum pension liability adjustment
Net unrealized gains/(losses) on
marketable securities
Total gains and (loses) not affecting retained
earnings
2002
2003
$(659M)
$(91M)
850M
(2,765M)
(16M)
1,768M
(162M)
7M
(2,590M)
1,522M
Differences Between Net Income; 2002 and 2003
There was a significant difference between the subtotals of the net income plus
gains (losses) not affecting retained earnings between 2002 and 2003. In 2002 the
amount was $989M; 2003 the number increased to $9,105M, an $8,116M difference. in
2003 there was a $4,004M increase in net income over 2002; this does not fully account
for 2003 increases. 2003 realized lower pension adjustments, better gains on marketable
securities, and better foreign currency translation adjustments.
Other differences:

cash dividends declared in 2003 were $80M over 2002

$479M increase in common stocks issuance

$500M difference in net purchases and sales of treasury stocks with 2003
employee plans .
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Equity, Cash Flow, and Notes Analysis
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
other treasury shares purchased and not retired were almost equal

-$1,535M increase in treasury shares issued in 2002 to fund pension plan

PricewaterhouseCooper (PwCC) acquisition required share issuance; significantly
greater in 2003; $255M (2002); $8M (2003)
Notes in the 2003 annual report explain that $255M of treasury stocks were issued
for the purchase of PwCC; $30M were slated for future issuance. Even though the
$254M in 2002 was significantly larger than the issues in 2003, it did not positively affect
the increase in stockholders equity as compared to 2003. This section helped explain the
details of the acquisition, and provided insight to the strength of 2003. The acquisitions
of 2002 leveraged the strong return on equity in 2003 (IBM, 2004, p. 100).
Return on Stockholders Equity, EPS, Profits, and Entity Rankings
Owners’ equity increases in 2003 indicate that the ownerships’ value had greatly
improved over 2002. Return on the stockholders’ equity had favorable results as well in
2003, over 2002:

2003 ROE was 27.2%

2002 ROE was 15.7%
It is important understand how IBM’s ROE compares to other companies. A
favorable position will entice investors. Fortune reports the following on IBM’s 2003
performance:

revenues: $89,131M, a 7.2% increase from 2002

profits: $7,583M; 111.9% increase over 2002

stockholders’ equity: $27,864M; ranks IBM 24th of entities

profits as a % of stockholders’ equity: 27.2%; ranks 51st among entities
Equity, Cash Flow, and Notes Analysis

EPS: $4.32; 109.7% increase over 2002

total return: 20.5%; rank of 313 among other entities (Anonymous, 2004, p. F-1).
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Cash Flow
According to Williams (2002, Chapter Summary), the purpose of a statement of
cash flows is to provide information about the cash receipts and cash payments of the
entity, and how they relate to the entity's operating, investing, and financing activities.
Readers of financial statements use this information to assess the solvency of a business
and to evaluate its ability to generate positive cash flows in future periods, pay dividends,
and finance growth.
IBM uses the indirect method in the development of the organization’s Cash Flow
Statement. This method differs from the direct method in the presentation of operating
activities. Line items are more reflective of accruals than true cash from operations; cash
flows are recorded for non-cash activities such as amortization and depreciation.
Operating Activities
Equity, Cash Flow, and Notes Analysis
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IBM had a substantially better year in 2003 compared with 2002. Cash flow from
operating activities was significantly higher. Below is a discussion of the 2003line items:

Income from Continuing Operations –42% increase; divestiture of
Microelectronics, $1.2B, and acquisition of PwCC, $433M, in 2002. Netting this
out of income, the real increase is approximately 12%

Depreciation – no significant changes; the nature of the product requires that
depreciation be continually review due to technological innovations

Amortization of Software – no significant changes

Deferred Income Taxes – there was 1780% increase, indicating that 2003 was a
substantially better year than 2002. As stated by Doehring (2001), deferred
income taxes are used to moderate earnings by increasing the tax liability in good
years and decreasing the tax liability in bad years

Net gain on asset sales and other –20% decrease; fewer dispositions

Other than temporary declines in securities and other investments – no significant
changes

Noncash portion of special actions – $1350 reported in 2002 PwCC acquisition;
no such transactions in 2003

Receivables – 51% reduction; company effectively turning receivables into cash
and clearing off uncollectible accounts

Inventories – 63% decline in inventories; shorter cycle times for deliverables

Pension – 67% decrease in pension assets; one time voluntary funding in
December 2002 of $3,963 million

Other Assets – 600% decrease; non-core business activity
Equity, Cash Flow, and Notes Analysis

Accounts Payable – 1221% increase; outsourcing and increased foreign currency
exchange rates

Other Liabilities – 80% decrease; decreased non-core business activity
Operating activities were the main contributing factors to higher cash flows in 2003.
Increased sales and prior cost cutting activities were the primary reasons.
Investing Activities
Investing activities had a smaller impact on IBM’s cash flow in 2003. Much of the
activity was attributable to 2002 transactions. Below is a discussion of these statement
items.

Payments for plant, rental machines and other property – 7.5% decrease

Proceeds from disposition of plant, rental machines and other property – 34%
increase; difference between estimated and actual values of 2002 dispositions
related to the acquisitions of PwCC and Rational

Investment in software – no significant change

Purchases of marketable securities and other investments – 309% decrease

Proceeds from disposition of marketable securities and other investments – large
increase, 493%

Divestiture of businesses – 92% decrease; no significant divestitures in 2003,
mostly offsets from 2002
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Equity, Cash Flow, and Notes Analysis

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Acquisition of businesses - 41% decrease, fewer acquisitions in 2003, mostly
offsets from 2002 transactions
Investing activities contributed little to IBM’s cash flow changes. This was due to
reduced acquisition and divesture activity compared with 2002.
Financing
Financing activity had the second largest impact on cash flow. Most of this activity
was due to debt settlement, stock repurchases, and dividend payouts.

Proceeds from new debt – 79% decrease; lower margins from IBM’s Global Financial
Services

Short-term borrowings/(repayments) less than 90 days —net – 119% increase;
accelerated debt payments

Preferred stock transactions —net – outstanding shares retired July 3,2001; 1995
decision

Common stock transactions —net – no significant changes

Cash dividends paid – no significant changes
Cash Flow Summary
Equity, Cash Flow, and Notes Analysis
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Cash flow has increased significantly in 2003. As displayed above, there is an
approximate increase of $1.9 billion. While there are underlying factors for such a
dramatic increase, we can see from the CCD for the two years, solid liquidity and a
substantial increase in the ratio:
Cash current debt coverage (CCD) is a ratio that can be used to measure a
company's ability to repay its current debt. CCD is calculated as follows:
(Cash flow from operations – cash dividends) / Current interest-bearing debt
(Weiss, 2000).
2003: (14,569 – 1085)/2350 = 5.74
2002: (13,788 – 1005)/2639 = 4.84
As would be expected, IBM has very good liquidity. The increase from 2002 to 2003
indicates that this aspect is improving.
Management Discussions and Notes
The statements discussed above can only provide limited information. Certainly
valuable, the information is limited in scope and description. In order to appreciate the
meaning, one needs to review the management discussion and explanatory notes. The
management discussion provides valuable insight regarding the way management handles
the data. For instance, on page 66 of IBM’s 2003 annual report we discover that
Equity, Cash Flow, and Notes Analysis
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depreciation is variable due to technological advances. This is a key point since assets
can be deemed valueless in short and unpredictable periods of time.
Even more important than the management discussion are the explanatory notes.
The notes provide reasons to the numbers. Without them, the huge line item shifts may
be cause for great concern. But as we see with IBM, 2002 was a year with a great deal of
restructuring and subsequently, 2003 was a year that exploited the benefits of positive
sales and stability. Simply looking at the numbers is not enough; the notes are a critical
component of a financial statement.
Summary
Both the Statement of Stockholders’ Equity and Statement of Cash Flow reflect a strong
growth over 2002. IBM generated $89.1 billion in revenues with strong cash flows;
including investments of over $5.1 billion in research and development. Over all, $5.4
billion was returned to the stockholders, thus making this company attractive to investors.
IBM’s strong leadership team and continued profitable growth makes this company a
wise investment.
Equity, Cash Flow, and Notes Analysis
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References
Anonymous (2004, April 5). Largest U.S. Corporations. Fortune 149(7) p. F-1. Retrieved
on January 30, 2005 from EBCOhost
Doehring, T. A. (2001). Understanding the effects of deferred income taxes on your
operation. Retrieved January 31, 2005 from
http://www.centrec.com/Articles/FinAnalysisFarmRanches/DeferredTaxes.pdf
Christy, J. H. (2004, November 29). The Classic Approach. Forbes 174(11). p. 86.
Retrieved
January 27, 2005 from EBCOhost.
IBM (2003) 2002 Annual Report Retrived January 27, 2005 from
http://www.ibm.com/annualreport/2002/index_home.htm
IBM (2004) 2003 Annual Report. Retrived January 27, 2005 from
http://www.ibm.com/annualreport/
Ohlson,J.A. (1995). Earnings, Book Values, and Dividends in Equity Valuation.
Contemporary Accounting Research. 11(2) p. 2. Retrieved from EBCOhost on
January 27, 2005
Weiss, P. (2000). Calculating cash flows. Retreived January 31, 2005 from
http://www.fool.com/research/2000/features000707.htm
Williams, J. R., Haka, S. F., Bettner, M. S., & Meigs, R. F. (2002). Financial and
Managerial Accounting: The Basis for Business Decisions, (12th ed). New York:
McGraw Hill Companies. Retrieved January 30, 2005 from
Equity, Cash Flow, and Notes Analysis
http://highered.mcgrawhill.com/sites/0072396881/student_view0/chapter13/chapter_summary.html
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