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Level I CFA: Financial Statement Analysis: An Introduction - YouTube

Channel: IFT

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introduction to financial statement

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analysis

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in this reading we'll talk about the

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roles of financial statement analysis

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then we will discuss the primary

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financial statements such as the balance

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sheet the income statement the cash flow

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statement

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as well as other information sources

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that are used by financial analysts

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and then we will discuss the financial

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statement analysis

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framework

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financial reports are one of the most

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important sources of

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information available to a financial

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analyst

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and therefore it is necessary that a

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financial analyst have a strong

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understanding of the information

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provided in a company's

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financial reports the associated notes

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and supplementary information

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rules of financial statement analysis

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let us understand the distinction

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between

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financial reporting and financial

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statement analysis

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with financial reporting companies

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provide information on performance

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financial position and changes in

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financial

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position the report on performance comes

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through

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a income statement the report on

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financial

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position is through the balance sheet

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and changes in

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financial position generally are through

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the statement of changes

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in stockholders equity

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the information that comes out of

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financial reporting

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is what feeds the financial statement

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analysis

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process and not only does financial

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statement analysis use

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the reports that come from here but

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other information

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is also necessary we'll talk about this

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in more detail

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later but essentially what the analyst

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needs to do

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is evaluate the past present

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and future performance of a

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company or subsidiary obviously the

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analyst

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studies the past and present performance

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through financial reports

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and then needs to assess the future

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performance and then make a investment

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decision

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which might either be a credit decision

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in terms of whether or not to lend to

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the company

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or whether or not to purchase shares in

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the company

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when we talk about performance there are

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several

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areas that we need to consider such as

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profits

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profitability which is a ratio

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of profits to either investment or

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profits to revenue

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we need to consider cash flows the

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liquidity of a company which is an

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indication of

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how able a company is to meet

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short-term obligations and solvency

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which is the ability of a company to

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meet

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long-term obligations these are areas

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that we will discuss

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in a lot more detail later in the course

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here are the four major financial

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statements

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the income statement balance sheet cash

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flow statement

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and statement of changes in owner's

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equity

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let us look at a simple version of the

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income statement over here

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later in the course there is a long

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reading on the income statement so

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obviously details will be covered there

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but very briefly the income statement is

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for a period

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in this particular case we are

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considering the year

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ending 31st december 2012.

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so this is the income statement for the

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entire 2012. we have a revenue number

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which is the total money that came in we

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subtract

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the expenses then subtract taxes

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and end up with the net income

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the income statement is also called the

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statement of operations

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it is also called the profit and loss

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statement or the

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pnl statement you also need to recognize

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the fact

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that there is a more comprehensive

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definition of

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income and that is covered in the

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statement of comprehensive income

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i will not cover comprehensive income at

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this stage

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i will cover it later when we discuss

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the

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income statement and balance sheet but

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just recognize that

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there is also a definition of income

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that goes beyond the regular net income

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here is a simplistic version of a

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balance sheet

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note that the balance sheet is depicted

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on a particular day

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here we are looking at a balance sheet

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as of 31st

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december 2012. this is

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also called the statement of financial

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position

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or the statement of financial condition

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it shows all the assets of the company

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both tangible and intangible assets

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the liabilities short term and long term

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and then stockholders equity

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this is the cash flow statement which is

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also for

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a given period this cash flow statement

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tells us

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what money has flowed in and what has

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flowed out

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the cash flow statement is divided into

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three parts

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operating activities investing

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activities and

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financing activities the financial

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statement notes and supplementary

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schedules provide a tremendous amount of

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additional information that is not

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explicitly available

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in the balance sheet income statement or

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cash flow statement

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and examples of what you will see in the

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notes

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and supplementary schedules is given

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right here

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if you have not done so before i would

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strongly encourage you

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to look at the financial statements of

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a few companies management discussion

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and analysis

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also called md a essentially

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provides a discussion and analysis

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regarding a company's

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future outlook and prospects this can be

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thought of as

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subjective information where management

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presenting its view and interpretation

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of the data

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that it has reported and then also

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describing

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the future outlook management should

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establish and maintain

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adequate internal control over financial

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reporting

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the objective is to provide reasonable

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assurance regarding the reliability of

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financial reporting essentially this

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means that

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when a company is preparing financial

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reports

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the company should put in place

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processes

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to ensure that the financial reports

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adequately reflect the economic

[411]

reality of the company

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once a company has prepared its

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financial reports

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and the reports have been audited

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internally or

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or have been through the appropriate

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internal

[425]

control process then the financial

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reports

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need to be audited what this means is

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that

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a independent accounting firm examines

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the financial statements and then

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expresses

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a opinion through a audit report the

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audit report

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needs to follow a particular format but

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what we need to recognize is

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that the audit report will give

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one of three opinions either a qualified

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unqualified or adverse opinion

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a unqualified opinion is what we would

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like to see

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this is where the accounting firm

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provides

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reasonable assurance that the financial

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statements are

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fairly presented a qualified opinion

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is where the accounting firm says

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that there are some misstatements or

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exceptions

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to accounting standards and uh

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adverse opinion is where the accounting

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firm is saying that the financial

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statements

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are materially misstated

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the audit report also includes a

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discussion of

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key audit matters key audit matters

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are defined as issues that the auditor

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considers to be most

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important such as those that have a high

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risk of misstatement

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involve significant management judgment

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or report the effects of significant

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transactions

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during the period now the term key audit

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matters is used in an international

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context

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in the u.s context the corresponding

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term is

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critical audit matters critical audit

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matters are defined as

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issues that involve especially

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challenging subjective or complex

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auditor judgment

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other sources of information include

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interim financial reports

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and proxy statements generally

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companies present interim reports every

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quarter and these contain the four key

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financial statements

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along with footnotes interim financial

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reports are generally not

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audited proxy statements are distributed

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to shareholders

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and describe matters that are to be put

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to a vote and an example would be voting

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for

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a new director the proxy statements also

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contain

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other useful information such as

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management and director compensation

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stock performance and potential

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conflicts of interest between

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management board and shareholders

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financial statement analysis framework

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this

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is perhaps the most testable part of the

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reading imagine you are a financial

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analyst

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what we are going to discuss here is the

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framework which is

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recommended by the cfa institute

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the first phase is to articulate the

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purpose

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and context based on your function

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client input and

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organizational guidelines just at a high

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level

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if you are a equity analyst looking for

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a long-term investment

[628]

your purpose will be very different from

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somebody else who is

[632]

a credit analyst looking to

[635]

make a short term debt based investment

[639]

so before you get into the details of

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your analysis

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you need to clearly articulate your

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purpose your objective

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and document what your objective is

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document the questions that need to be

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answered document the ultimate

[656]

content of the report so you need to be

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clear what your report will

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eventually contain you should also

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document the timeline

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and budget so this is phase one

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of your analysis

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in phase two you collect data the most

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important information is typically the

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financial statements or financial

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reports

[681]

you also collect other financial data

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industry and economic data

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you might have discussions with

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management suppliers

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customers and competitors so you collect

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this information

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and organize it your output here

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consists of

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the financial statements you've

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collected any financial tables that you

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create

[702]

and the questionnaires that you create

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through this process

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you then process the data and

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the output from this exercise would be

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adjusted financial statements

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common sized statements which we will

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discuss later

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ratios graphs and forecasts

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imagine that you are analyzing three

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different

[726]

auto companies in different parts of the

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world and they

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follow slightly different accounting

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standards which we will talk about in

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the next reading

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in order to compare these companies

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you need to make adjustments to the

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financial statements so that you can

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make

[743]

apples to apples comparison this is

[745]

called

[746]

processing the data once the data has

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been processed

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you analyze and interpret the data

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and come up with your analytical results

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and finally you develop and communicate

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your conclusions

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and recommendations if you are

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conducting

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a analysis for whether or not to make a

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long-term

[770]

equity investment your recommendation

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would be

[774]

whether to buy or not to buy in other

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words whether to make the investment

[779]

or not obviously your recommendation

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needs to be

[783]

justified so you create the report which

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answers the questions that you listed

[790]

in phase one

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given that you are making a long-term

[796]

investment decision

[797]

you should periodically follow up

[800]

because

[800]

circumstances change so every quarter

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as an example you might reconsider the

[807]

situation

[807]

and update recommendations or update

[810]

your recommendation

[812]

if necessary that's the end of this

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brief reading

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i will summarize the most important

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points first you need to understand the

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distinction between financial reporting

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and financial analysis financial

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reporting is about

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looking at existing and past data

[831]

related to a company and then reporting

[834]

against that information financial

[836]

analysis is a much broader field which

[838]

looks

[839]

at financial reports as well as other

[842]

information

[843]

to assess whether or not to make a

[846]

investment there are four key financial

[849]

statements

[850]

the income statement balance sheet cash

[853]

flow statement

[854]

and statement of changes in shareholder

[857]

equity

[858]

these four statements are backed up

[861]

by a tremendous amount of information in

[864]

the footnotes and supplementary

[867]

schedules

[868]

an audit report is important because

[871]

this represents

[872]

a independent third party's view

[875]

on the financial reports that have been

[878]

presented

[878]

by the company and finally you need to

[881]

be on top

[882]

of the financial statement analysis

[884]

framework that we just talked about

[886]

this perhaps is the most important item

[888]

from a

[889]

testability perspective

[893]

read the summary in the curriculum

[895]