Reading 16: Introduction to Financial Statement Analysis

Question 1

Describe the roles of financial reporting to financial statement analysis.

Answer 1

• The role of financial reporting is to provide a variety of users with useful information about a company’s performance & financial position.
• The role of financial statement analysis is to use data from financial statements to support economic decisions.

Question 2

Describe the roles of (i) the statement of financial positions, (ii) statement of comprehensive income, (iii) statement of change in equity, and (iv) statement of cash flow in evaluating a company’s performace and financial position.

Answer 2

• The statement of financial position (balance sheet) shows assets, liabilities and owner’s equity at a point in time.
• The statement of comprehensive income shows the results of a firm’s business activities. Revenues, the cost of generating those revenues, and the resulting profit or loss are presented on the income statement.
• The statement of changes in equity reports the amount and resources of changes in the equity owner’s investment in the firm.
• The statement of cash flows shows the sources and uses of cash over a period.

Question 3

Describe the importance of financial statement notes and supplementary information—including disclosures of accounting policies, methods and estimates—and management commentary.

Answer 3

• Important information about accounting methods, estimates and assumptions is disclose in the footnotes to the financial statement and supplementary schedules.
• These disclosures also contains information about segment results, commitments and contingencies, legal proceedings, acquisitions or divestitures, issuance of stock options and details of employee benefit plans.
• Managenemnt’s commentary (Management’s Discussion and Analysis) contains and overview of the company and important information about business trends, future capital needs, liquidity, significants events and significant choices of accounting methods requiring management judgment.

Question 4

Describe the (1) objectives of audits in financial statement, (2) the types of audit reports, and (3) the importance of effective internal controls.

Answer 4

• The objective of audits of financial statements is to provide an opinion on the statements’ fairness and reliability.
• The auditor’s opinion gives evidence of an independent review of the financial statements that verifies that (i) appropiate accounting principles were use, (ii) that standard audition procedures were use to establish reasonable assurance that the statement contains no material errors, and (iii) that management’s report on the company’s internal control has been reviewed.
• An auditor can issue:
  
  • An unqualified (clear) opinion if the statements are free from material omissions and errors.
  • A qualified opinion that notes any exception to accounting principles.
  • An adverse opinion if the statement are not presented fairly in the auditor’s opinion, or a disclaimer of opinion if the auditor is unable to express an opinion.
• A company’s management is responsible for maintaining an effective internal control system to ensure the accuracy of its financial statements.

Question 5

Identify and describe information sources that analyst use in financial statement analysis besides annual financial statement and supplementary information.

Answer 5

Along with the annual financial statements, important sources for analyst include a company’s quarterly and semiannual, proxy statemetns, press releases, and earning guidance, as well as information on the industry and peer companies from external sources.

Question 6

Describe the steps in the financial statement analysis framework.

Answer 6

The framework for financial analysis has six steps.

1. State the objective of the analysis.
2. Gather data.
3. Process data.
4. Analyze and interpret the data.
5. Report the conclusions or recommendations
6. Update the analysis.