R15: Intro to Financial Statement Analysis Flashcards
What is the role of financial statement reporting?
To provide information about a company’s financial performance, financial position, and changes in financial position.
What is the role of financial statement analysis?
To assess a company’s past performance and evaluate its future potential using financial reports and other relevant company information.
Assessments are performed prior to making an investing decision, offering any credit facilities, or making other economic decisions related to the company
A company’s performance can be examined through…
Profitability and Cash Flow
Profitability Definition
the ability to generate profits from core business activities
Cash Flow Definition
the ability to generate cash receipts in excess of cash payments
A forecast of the expected amount of future cash flows is important in determining…
the company’s ability to meet its obligations.
Liquidity
a company’s ability to meet its short-term obligations
Solvency
a company’s ability to meet its long-term obligations.
Companies prepare financial statements to…
report their operating performance to investors and creditors
The income statement is also known as…
- the statement of operations
- profit and loss statement
The income statement provides operating information relating to a company’s business activities…
over a period of time (the accounting period)
The income statement presents..
revenues earned by a company and corresponding costs
Net Income
difference between a company’s total revenue and total costs
Net Income = Revenue - Expenses
Income statements are useful in evaluating a company’s
profitability
Balance sheet is also known as
statement of financial position
The balance sheet shows
a company’s assets, liabilities, and equity at a point in time.
The interrelationships between these three components of the balance sheet are presented in the basic accounting equation:
Assets = Liabilities + Owners’ Equity
Assets
productive resources that a company owns
Liabilities
amounts that the company owes other entities
Owner’s Equity
shareholders’ residual claim on the company’s assets after deducting liabilities
Owners’ Equity = Assets - Liabilities
The information contained in balance sheets is used to assess a company’s financial position and to
evaluate its ability to meet short-term and long-term obligations.
A cash flow statement reports..
various sources of cash receipts and cash payments
The cash flow statement segments the sources and uses of cash into the following activities
operating, investing, and financing
Operating activities
day-to-day core business activities of a company.
Investing activities
the acquisition or disposal of long-term assets.
Financing activities
the injection or repayment of capital
Cash flow statements reflect
a company’s ability to generate cash from its core business activities
It is desirable that a company generates most of its cash from..
operating activities, as opposed to investing and financing activities.
Statement of Changes in Owners’ Equity
reports any changes in owners’ investment in the business. It is useful in understanding changes in the financial position of a company.
Financial notes are an important part of financial statements because
they provide detailed explanatory information
Areas of financial notes
- Accounting policies, methods, and estimates
- Business acquisitions and disposals
- Commitments and contingencies
- Legal proceedings
- Subsequent events
- Related-party transactions
- Business and geographic segments
- Financial instruments and risks arising from them
Footnotes contain important details about
accounting methods, estimates, and assumptions
that have been used by the company in preparing its financial statements.
Are footnotes audited?
YES
Is MD&A required under GAAP?
YES
The management discussion and analysis section highlights..
- important trends and events that affect a company’s liquidity, capital resources, and operations.
- prospects for the upcoming year with respect to inflation, future goals, material events, and uncertainties.
Is the MD&A section audited?
NO
Typically according to IFRS what should be included in the MD&A?
- The nature of the business
- Management objectives and strategies
- The company’s significant resources, risks, and relationships
- Results of operations
- Critical performance measures
Financial statements in a company’s annual report must be…
audited
They must be examined by an independent accounting firm (or audit practitioner), which then states its opinion on the financial statements.
Audits are required by contractual arrangement, law, or regulation.
Objective of audits
- To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and
- To report on the financial statements, and communicate as required by the ISAs (international standards for auditing), in accordance with the auditor’s findings.
Types of auditor’s opinions:
Unqualified
Qualified
Adverse
Disclaimer
Unqualified Opinion
the financial statements have been presented fairly in accordance with applicable accounting standards.
Qualified Opinion
the financial statements have been presented fairly, but do contain exception(s) to the accounting standards.
The audit report provides further details and explanations relating to the exception(s)
Adverse Opinion
that the financial statements have not been presented fairly and significantly deviate from acceptable accounting standards.
Disclaimer of Opinion
issued when the auditor, for whatever reason, is not able to issue an opinion on the financial statements.
Internal controls definition
seeks to ensure the reliability of processes used by the company in preparing its financial statements.
In the United States, management is responsible for
- the effectiveness of internal control
- to evaluate the effectiveness of internal control
- to support the evaluation
- to provide a report on internal control
Interim Reports
prepared either semiannually or quarterly.
contain the four financial statements and footnotes, but are not audited.
Proxy statements are distributed to shareholders when
there are matters that require a shareholder vote.
Proxy statements provide info on
- management and director compensation
- company stock performance
- potential conflicts of interest between management, the board of directors, and shareholders.
Press releases, in addition to a company’s website and conference calls, provide
current information about the company.
External sources provide information about
- the economy, the industry that the company operates in, and the company’s competitors.
- Such information is useful as it allows the analyst to place the company’s performance in perspective.
- Examples of external sources include trade journals and government agencies.
of steps in the financial analysis framework?
6
Step 1 in financial analysis framework
Define the purpose and context of the analysis
In cases where the task is well-defined, the purpose is governed by institutional norms. However, there are also analytical tasks that require the analyst’s discretion in defining the purpose. The definition of the purpose determines the approach, tools, data sources, and the format used to present results. In this preliminary stage, the analyst is also required to define the context of the analysis, which requires understanding the audience, the time frame, and the resources available for completion of the tas
Step 2 in financial analysis framework
Collect data
The analyst acquires the necessary information to answer the questions that were defined in the previous stage. For instance, a task with the purpose of analyzing the historical performance of a company could be carried out by understanding the financial statements alone. However, a more thorough analysis that requires understanding a company’s financial performance and position relative to the industry would require collecting industry data as well.
Step 3 in financial analysis framework
Process data
The financial information collected is converted into ratios, growth rates, common-size financial statements, charts, and regressions.
Step 4 in financial analysis framework
Analyze/interpret the processed data
The data is interpreted and a recommendation is reached.
Step 5 in financial analysis framework
Develop and communicate conclusions
An appropriate format for the presentation of analysis is determined. The presentation format is sometimes determined by regulatory authorities or professional standards.
Step 6 in financial analysis framework
Follow up
Financial statement analysis does not end with the preparation of a recommendation report. When equity analysis is performed or a credit rating is assigned, periodic reviews are required to determine whether previously drawn conclusions remain valid.
