Reading 29

FINANCIAL STATEMENT ANALYSIS: AN INTRODUCTION

I. Financial Reporting and FS Analysis

1. Financial Reporting: The way companies show their financial performance to investors, creditors & other
parties by preparing/ presenting FS.
2. Financial Statement Analysis: use the information in the company’s FS, along with other information, to
make economic decisions.
3. Financing Activities

II. Key roles of FS

1. Income Statement: financial performance over a period of time.
• Revenues
• Expenses
• Gains/ Losses
2. Balance Sheet: Firm’s financial position at a point of time.
• Assets
• Liabilities
• Shareholders’ Equity
• ASSETS = LIABILITIES + OWNERS’ EQUITY
3. Cash Flow Statement: reports cash receipts and payments
• Operating Cash Flows
• Investing Cash Flows
• Financing Cash Flows
4. Statement of changes in owner’s equity: reports the amount and sources of changes in equity investors’
investment over a period of time.

III. FS notes, Supplementary information & Management’s

discussion/ analysis
1. Financial Statement Notes: further details about information in the FS
• Accounting methods, assumptions, estimates
• Audited
• Acquisitions/ Disposals, legal actions, employee benefit plans, contingencies &
commitments, significant customers, sales to related parties, segments of the firm.
2. Supplementary Schedules: additional information
• Operating income by region/ segments
• Reserves for an oil/ gas company
• Hedging activities & financial instruments
• NOT Audited
3. Management’s Discussion & Analysis: assessment of financial performance from the management’s
perspective
• Results form operations (trends in sales/ expenses)
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 • Capital resources and liquidity
• General business overview
• Accounting Policies
• Effects of current trends
• Discontinued operations, extraordinary items, other unusual/ infrequent events.
• Disclosures in interim FS
• Disclosures of segments need for CF or its contribution to revenues or profit

IV. Audits
1. Audit: independent review of the company’s FS (accounting and internal control systems).
2. Standard auditor’s opinion states that:
• FS prepared by management and that the auditor performed an independent review is
management’s responsibility.
• General accepted auditing standards were followed, thus providing reasonable assurance
that FS contain no material errors.
• Auditor is satisfied with the FS, principles & estimates are reasonable.
• ONLY IN GAAP: auditor must state its opinion for the internal controls
3. Unqualified, qualified, adverse opinion & disclaimer of opinion:
• Unqualified opinion: the auditor believes the statement if free from material omissions and errors
• Qualified opinion: the auditor explains any exceptions to accounting principles in the audit report
• Adverse opinion: the auditor believes the statements are not fairly presented or are materially
nonconforming with accounting standards.
• Disclaimer of opinion: the auditor is unable to issue an opinion.
4. Internal Controls:
• Statement that the management is responsible for implementing/ maintaining effective internal
controls.
• Description of how management evaluates internal control systems (framework)
• Statement that the firm’s auditors have assessed management’s report on internal controls
• Statement that the FS are presented fairly

V. Other information sources

1. Interim (Quarterly or Semiannual) reports:
• Not Audited
2. SEC fillings (available from EDGAR)
• 8-K: acquisitions/ disposals form or changes in management/ corporate governance
• 10-K: annual FS
• 10-Q: quarterly FS
3. Proxy Statements: for shareholders’ vote
• Compensation schemes
• Stock performance
• Conflicts of interest
4. Corporate reports and Press releases: public releases or sales material

VI. Steps of Financial Analysis

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1. State the objectives (purpose) and context of the analysis
2. Gather data
3. Process the data
4. Analyse and interpret the data
5. Report the conclusions or recommendations (analysis report)
6. Update the analysis