Financial Statement Analysis Flashcards
Role of Financial Statement Analysis
> Using information in a company’s financial statements to make economic decisions.
Evaluating a company’s past performance and current financial position to form opinions about a firm’s ability to make profits and generate cash flows.
Balance Sheet (aka the statement of financial position or statement of financial condition)
Reports the firm’s financial position at a point in time. The balance sheet consists of three elements:
> Assets (resources controlled by the firm)
> Liabilities (amounts owed to lenders and other creditors)
> Owners’ equity (also shareholders’ equity, shareholders’ funds, or net assets) - (the residual interest in the net assets of an entity that remains after deducting its liabilities from its assets).
Accounting equation
Assets = Liabilites + Equity
Capital Structure of a firm:
The proportions of liabilities and equity used to finance a company
The statement of comprehensive income
Comprehensive income represents the changes to owners’ equity that originate from non-owner sources and traditional income. This includes:
- adjustments made to the prices of securities held for sale by the firm and/or derivatives used to hedge such positions, foreign currency exchange rate changes, and adjustments to pension liabilities.
Comprehensive income and how it is accounted for will usually appear in the footnotes to a company’s financial statements.
The income statement (also known as the statement of operations or the profit and loss statement)
reports on the financial performance of the firm over a period of time. The elements of the income statement include revenues, expenses, and gains and losses.
The statement of changes in equity
reports the amounts and sources of changes in equity investors’ investment in the firm over a period of time.
The statement of cash flows
reports the company’s cash receipts and payments
Three types of cash flows:
> Operating cash flows include the cash effects of transactions that involve the normal business of the firm.
Investing cash flows are those resulting from the acquisition or sale of property, plant, and equipment; of a subsidiary or segment; of securities; and of investments in other firms.
Financing cash flows are those resulting from issuance or retirement of the firm’s debt and equity securities and include dividends paid to stockholders.
What is the significance of the accruals process:
Earnings do not equal cash.
As revenues/expenses are recorded when a transaction occurs, not when payment is received or made.
Retained earnings
Earnings that are reinvested in the company and not distributed to shareholders
Financial statement notes
include disclosures that provide further details about the information summarized in the financial statements. Footnotes allow users to improve their assessments of the amount, timing, and uncertainty of the estimates reported in the financial statements.
Management’s commentary (Management’s Discussion and Analysis (MD&A))
Discusses the nature of the business, the management’s objectives, the company’s past performance, the performance measures used, and the company’s key relationships, resources, and risks.
Analysts must be aware that some parts of management’s commentary may be unaudited.
unqualified / unmodified / clean opinion
indicates that the auditor believes the statements are free from material omissions and errors.
qualified opinion
indicated the statements make exceptions to the accounting principles and an explanation is given.
adverse opinion
if the statements are not presented fairly or are materially nonconforming with accounting standards
disclaimer of opinion
If the auditor is unable to express an opinion (e.g., in the case of a scope limitation)
modified opinion
Any opinion other than unqualified
Proxy statements
issued to shareholders when there are matters that require a shareholder vote.
‘Goring Concern’ assumption
The assumption that the company will continue operating for the foreseeable future.
Internal controls
The processes by which the company ensures that it presents accurate financial statements and to prevent fraud.
Which audit opinion do shareholders want on the financial statements
Unqualified opinion
How are auditors appointed?
By the shareholders to review the financial statements of the company
Where are the Securities and Exchange Commission (SEC) filings available from and what do they contain?
EDGAR (Electronic Data Gathering, Analysis and Retrieval System)
Form 8-K: which a company must file to report events such as acquisitions and disposals of major assets or changes in its management or corporate governance.
Forms 10-K and 10-Q: annual and quarterly financial statements