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FINANCIAL STATEMENT ANALYSIS:INTRODUCTION

Reading - 22

FINANCIAL REPORTING AND ANALYSIS

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Role of Financial reporting and FSA

• The role Financial reporting is to provide information about a company’s financial position and performance which can be used by external and internal parties related to the company.

• The role of Financial statement analysis is to use these financial statements to judge the past present and prospective financial position from the purpose of making investments and other financial decisions.

Financial statement users

Equity investors are interested in company’s

long term growth

Short term creditors are interested in

company’s liquidity because they always

want an early payback

Long term creditors Are always concerned in

the company’s earning power and long term

assets .

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Role of key Financial Statements : Income Statement

• The Income 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.

• Income Statement Format :-

Revenue from sale of goods and services

+ Other Income and expenses

- Operating Expenses

- Financing Costs

+ / - unusual or infrequent items

= Pretax earnings from Continuing operations

- Income Tax Expense

= Net Income from continuing operations

+ / - Income from discontinued operations

+ / - Extra ordinary Items

+ / - Cummulative effect of accounting changes

= Net Income

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Role of key Financial Statements : Income Statement . .

Revenues

• Inflows from delivering or producing goods or giving services.

Expenses

• Outflows from delivering or producing goods or giving services which are a part of operations.

Gains and losses

• Are increases or decreases in equity or net assets.

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Role of key Financial Statements : Balance Sheet Statement

• Balance Sheet provides the company’s financial position at a specific point in time .

Assets = Liabilities + Owners Equity

Assets• Resources which are controlled by the company.

Liabilities• Financial obligations that the company must fulfill in the future.

Equity Ownership

• Owners investments and finances provided by the owners of the company.

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Role of key Financial Statements : Cash Flow Statement

• It reports the cash receipts and cash outflows according to the Operating , Financing and Investing activities.

Operating Cash Flows

• Transactions that involve the normal business of the firm

Investing Cash Flows

• Activities resulting in sale or buying of property plant or equipment , securities and investments in other firms.

Financing Cash Flows

• Dividends paid to stockholders , issuance or retirement of firms debt.

• Issuance or retirement

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Statement of changes in Owners Equity

• It reports the amounts and sources of changes in equity from capital transactions with owners.

• It reports ownership interests in order of preference upon liquidation and dividends.

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Financial Statement Notes and Supplementary Schedules

• Financial Foot notes provide information about the accounting methods , assumptions and estimates used by the management to develop the data reported in the financial statements.– Additional disclosure is provided in areas such as income taxes

inventory methods , fixed assets , debt , pensions.

• Supplementary Schedules provide additional information about company’s assets and liabilities as supplementary data outside the financial statements.

Examples of such disclosures include :

– Operating income or sales by region or business segment

– Oil and gas reserves reported by the oil and gas companies.

– Impact of changing prices , sales revenue.

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Management ‘s Discussion and Analysis (MD&A)

• Requires the management to assess the company’s current financial condition , liquidity and planned capital expenditure for the next year.

– For publicly held companies in the United States the MD&A is required to discuss results from operations ,discussion of trends in sales and expenses ,capital resources and liquidity and a general business overview based on known trends.

– The MD&A section is not audited and it is for public companies only.

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Objectives of audits of Financial Statements and Auditors Reports

• An Audit is an independent review of an entity’s financial statements

– The objectivity revolves around the fairness and reliability of the financial statements.

• The Auditor is responsible for seeing that the financial statements issued comply with the Generally Accepted Accounting Principles(GAAP).

– The Auditor examines the company’s accounting and internal control systems.

– Auditors are supposed to be independent though they are hired by the government.

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Types of Audit Reports

Unqualified Opinion Report:

Company’s financial condition , position are fairly presented in the financial statements. It is in accordance with GAAP and free of misstatements.

Qualified Opinion Report :

It is issued when there are situations which are exceptions to the accounting principles like(GAAP).

Adverse Opinion Report :

It is issued when statements are not presented fairly or when they do not comply with the accounting standards.

Disclaimer of Opinion : It is issued when an auditor tried to audit a company but could not complete due to various reasons and does not issue an opinion.

Audit Reports

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Other Sources Of information Used by Analysts

Interim Reports

• These reports are generally unaudited .

• Publicly held companies must file form 10-Q(Interim Report) on a quarterly basis.

Proxy Statements

• It contains information regarding compensation , management Qualifications and stock options.

• These are issued to the shareholders and are filed with the SEC.

Corporate Reports and

Press Releases

• These are the public relations or the sales material written by the management.

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Financial Statement Analysis framework

• Define the purpose of the analysis , information presentation , time availability and budget.

Objective and context of the

Analysis

• Gathering company’s financial data and also information on the economy and industry to understand the environment in which the company operates.

Gather Data

• This involves calculation of ratios , preparing graphs ,performing statistical analyses and preparation of common size balance sheets.

Process the data

• Interpreting the output and using the data to answer the questions .

Analyze and interpret the data

• Prepare the report and communicate the conclusion and recommendation in the right format to the target audience.

Report the conclusions or

recommendations

• Changing the conclusions or recommendations when necessary by periodically repeating the above steps.

Update the Analysis