READING 27 INTRODUCTION TO FINANCIAL STATEMENT ANALYSIS Flashcards
Sets out a generic set of steps for analysts to apply to a multitude of objectives when analyzing debt issues, equity securities, and corporate actions.
The financial statement analysis framework
Financial statements analysis framework consists of:
- State the objective and context
- Gather data
- Process the data
- Analyze the data
- Report the conclusion
- Update the analysis
Determine what questions the analysis seeks to answer, the form in which this information needs to be presented, and what resources and how much time are available to perform the analysis.
- State the objective and context
Acquire the company’s financial statements and other relevant data on its industry and the economy. Ask questions of the company’s management, suppliers, and customers, and visit company sites.
- Gather data
Make any appropriate adjustments to the financial statements. Calculate ratios and perform statistical analysis. Prepare exhibits such as graphs and common-size balance sheets.
- Process the data
Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports.
- Analyze the data
Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.
- Report the conclusion
Repeat these steps periodically and change the conclusions or recommendations when necessary.
- Update the analysis
Refers to the way companies show their financial performance to investors, creditors, and other interested parties by preparing and presenting financial statements.
Financial Reporting
The role of … is to use the information in a company’s financial statements, along with other relevant information, to make economic decisions.
Examples of such decisions include whether to invest in the company’s securities or recommend them to investors, whether to extend trade or bank credit to the company and assigning credit ratings to a company’s debt.
Financial Statement Analysis
Analysts use financial statement data to evaluate a company’s … performance and … financial position to form opinions about the company’s ability to earn profits and generate cash low in the future.
Analysts use financial statement data to evaluate a company’s past performance and current financial position to form opinions about the company’s ability to earn profits and generate cash low in the future.
Professional organizations of accountants and auditors that establish financial reporting standards.
Standard-setting bodies
Government agencies that have the legal authority to enforce compliance with financial reporting standards.
Regulatory Authorities
What are the two primary standard setting bodies?
- Financial Accounting Standard Board (FASB)
- International Accounting Standard Board (IASB)
In the United States, the FASB sets forth the U.S. …
Outside the United States, the IASB establishes the …
Other national standard-setting bodies exist as well. Some of the older IASB standards are referred to as the …
In the United States, the FASB sets forth the U.S. General Accepted Accounting Principles (GAAP).
Outside the United States, the IASB establishes the International Financial Reporting Standards (IFRS).
Other national standard-setting bodies exist as well. Some of the older IASB standards are referred to as the International Accounting Standards (IAS)
What are the regulatory authorities that are established by the national governments in the US and the UK?
Securities and Exchange Commission (SEC) in the United States
Financial Conduct Authority in the United Kingdom
Most national authorities belong to?
International organization of Securities and Commission (IOSCO)
True or false
the members of IOSCO regulate more than 50% of the world’s financial markets.
IOSCO is not a regulatory body, but its members work together to improve cross-border cooperation and make national regulations and enforcement more uniform around the world.
False
the members of IOSCO regulate more than 95% of the world’s financial markets.
IOSCO is not a regulatory body, but its members work together to improve cross-border cooperation and make national regulations and enforcement more uniform around the world.
The IOSCO Objectives and Principles of Securities Regulation are based on three main objectives:
- Protect the investors
- Ensure the market is fair
- Reduce systemic risk
True or false
The Financial Conduct Authority has the responsibility of enforcing the Sarbanes-Oxley Act of 2002.
False
The SEC has the responsibility of enforcing the Sarbanes-Oxley Act of 2002.
An act that prohibits a company’s external auditor from providing certain additional paid services to the company, to avoid the conflict of interest involved, and to promote auditor independence.
Sarbanes-Oxley Act of 2002.
Statements that are issued to shareholders when there are matters that require a shareholder vote.
These statements, which are also filed with the SEC, are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options.
Proxy Statement
True or false
In the European Union (EU), each member state has its own securities regulations, but all countries in the EU are required to report using IFRS.
True
Statements that include disclosures that provide further details about the information summarized in the financial statements.
Financial statements note (footnotes)
Statements that do the following:
They discuss the basis of presentation such as the fiscal period covered by the statements, whether IFRS or U.S. GAAP is adhered to, and the inclusion of consolidated entities.
They provide information about accounting methods, assumptions, and estimates used by management.
They provide additional information on information included in the primary financial statements and items such as business acquisitions or disposals, legal actions, employee benefit plans, contingencies and commitments, significant customers, related party transactions, position and performance of segments of the firm, and significant post balance sheet events.
They are audited along with the primary financial statements
Financial statements notes (footnotes)
SEC Required Filings
This is the registration statement filed before the sale of new securities to the public. The statement includes disclosures about the securities offered, audited financial statements (plus interim accounts, if the statement is filled more than three months after year-end), risk assessment, underwriter identification, and the estimated amount and use of the offering proceeds.
Form S-1
SEC Required Filings
This is the required annual filing that includes information about the business, risks, and its management, audited financial statements and disclosures, and disclosures about legal matters involving the firm. information required in the form is similar to that which a firm typically provides in its annual report to shareholders. However, a firm’s annual report is not a substitute for the required filling.
Form 10-K
SEC Required Filings
U.S. firms are required to file this form quarterly, with updated interim financial statements (unlike form 10-K, these statements do not have to be audited) and disclosures about certain events significant legal proceedings or changes in accounting policy. Non-U.S. companies are typically required to file the equivalent form 6-K semi-annually
Form 10-Q
SEC Required Filings
When a company prepares a proxy statement for its shareholders before the annual meeting or other shareholder vote, it also files the statement with the SEC as the form
Form DEF-14A
SEC Required Filings
Companies must file this form to disclose material events including significant asset acquisitions and disposals, changes in management or corporate performance, or matters related to its accountants, its financial statements, or the markets in which its securities trade
Form 8-K
SEC Required Filings
A company can issue securities to certain qualified buyers without registering the securities with the SEC, but it must notify the SEC that it intends to do so
Form 144
SEC Required Fillings
involve the beneficial ownership of securities by a company’s officers and directors. Analysts can use these filings to learn about purchases and sales of company securities by corporate insiders
Forms 3,4, and 5
A portion of a larger company that accounts for more than 10% of the company’s revenues, assets, or income.
A business segment (operating segment)
True or false
An operating segment should be distinguishable from the company’s other lines of business in terms of the risk and return characteristics of the segment. Segments reported should account for a minimum of 50% of the firm’s external sales.
False
An operating segment should be distinguishable from the company’s other lines of business in terms of the risk and return characteristics of the segment. Segments reported should account for a minimum of 75% of the firm’s external sales.
What should be disclosed for each segment within the financial statements notes?
- Revenue
- A measure of profits or losses
- A measure of assets and liabilities
- Interest
- Acquisitions
- D&A
- Other non-cash expense
- Income tax expense
- Share of equity- accounted investments results
Segments that are identified when they meet the size criterion given previously and the geographic unit has a business environment that is different from that of other segments or the remainder of the company’s business
Geographic segment
Address the nature of the business, 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 it may be unaudited
Management commentary
What does the management commentary discuss?
- Effects of inflation and changing prices
- Impact of off-balance sheet obligations and contractual obligations
- Accounting policies
- Forward-looking expenditures
An independent review of an entity’s financial statements.
Audit
The standard auditor’s opinion contains three parts and states the following
- The financial statements are prepared by management, and the auditor performed an independent review
- Generally accepted auditing standards were followed
- The auditor is satisfied that the statements were prepared in accordance with accepted accounting principles and that the principles chosen and estimates made are reasonable.
The auditor believes the statements are free from material omissions and errors.
Unqualified opinion
If the statements make any exceptions to the accounting principles, the auditor may issue a?
Qualified opinion
The statements are not presented fairly or are materially nonconforming with accounting standards.
Adverse opinion
If the auditor is unable to express an opinion
Disclaimer of opinion
Processes by which the company ensures that it presents accurate financial statements.
Internal controls
An audit report must also contain a section communicating … or … which highlights accounting choices that are of greatest significance to users of financial statements.
An audit report must also contain a section communicating Key Audit Matters (Internationa) or Critical Audit Matters (U.S.) which highlights accounting choices that are of greatest significance to users of financial statements.
Who is U.S. GAAP developed by?
FASB
Who is IFRS developed by?
IASB
What is U.S. based on?
Rules
What is IFRS based on?
Principles
Inventory valuation for U.S. GAAP
FIFO, LIFO, and weighted average
Inventory valuation for IFRS
LIFO prohibited
Product development costs for U.S. GAAP
Expensed
Product development costs for FIRS
Capitalized
Interest paid for U.S GAAP
CFO
Interest paid for IFRS
CFO or CFF
Reversal of inventory write-downs for U.S. GAAP
Prohibited
Reversal of inventory write-downs for IFRS
Allowed
As well as regulated information provided by issuers in filings and financial statements, an analyst can also use additional information sources:
- issuer sources
- Public third-party sources
- Proprietary third-party sources
- Proprietary primary research
What kind of additional sources are these examples?
- Earnings calls. Targeted at investors, analysts, and members of the media, earnings calls include presentations by the company’s management and the opportunity for question-and-answer sessions.
- Ad hoc presentations and events that are similar in format to an earnings call
- Press releases focusing on major events relevant to the company
- Communications with management, investor relations, and company personnel
Issuer sources
What kind of additional sources are these examples?
- Free industry reports, whitepapers, and trade journals
- Government agency-produced economic and industry statistics
- Generalized and industry-specific media sources
- Social media
Public third party
What kind of additional sources are these examples?
- Analyst reports
- Reports from data platforms such as Bloomberg, Wind, and FactSet
- Reports from industry-specific agencies and consultancies
Proprietary third-party sources
What kind of additional sources are these examples?
- Studies commissioned by the analyst
- Hands-on experience with the company’s products or services
- Data and advice of technical specialists employed by the analyst
Proprietary primary research
