29 Introduction to Financial Statement Analysis

Financial Statement Analysis and Reporting

• Financial reporting involves companies presenting their financial performance to investors, creditors, and other parties through financial statements, detailing changes in financial position.
• Financial statement analysis uses financial statement data along with other information to inform economic decisions, such as investment recommendations.
• Analysts utilize financial statement data to assess a company's past performance, current financial standing, and future ability to generate profits and cash flow.

IFRS and Management Commentary

• IFRS recommends that management's commentary should cover key relationships, resources, risks, nature of business, management objectives, past performance, and performance measures.
• Securities regulators may mandate certain disclosures in management's commentary for publicly traded firms, but accounting standards do not.

Financial Statement Footnotes

• Footnotes contain information on contingent losses, assumptions, and estimates by management.
• Footnotes do not include a discussion of past performance and future outlook; this is found in management's commentary.

MD&A for Publicly Traded U.S. Firms

• For publicly traded U.S. firms, the Management Discussion and Analysis (MD&A) must discuss results of operations, capital resources, liquidity, and a general business overview based on known trends.
• Discussion of unusual or infrequent items may be included but is not required.

Financial Reporting vs. Financial Statement Analysis

• Financial reporting demonstrates how companies present their financial performance.
• Financial analysis involves using the presented information to make economic decisions.
• Financial statements provide information about an entity's financial position, performance, and changes, serving a wide range of users.
• Financial statement analysis assesses past performance to predict future cash generation and profitability.

Independent Auditor Responsibilities

• Independent auditors conduct reviews of financial statements prepared by company management.
• Auditors confirm assets, liabilities, and other statement items, and issue an opinion on fairness and reliability.
• Auditors do not prepare or accept responsibility for the financial statements.

IASB and Financial Reporting

• The International Accounting Standards Board (IASB) describes the role of financial reporting, financial statements provide insight into financial position, performance, and changes to benefit various users for decision-making.
• Using financial statements to make economic decisions is financial analysis.

Financial Statement Analysis Defined

• Financial statement analysis uses data from a company's reports and other sources to make informed decisions about the company.
• Financial reporting are how a company presents its financial performance to external parties.

Financial Statement Analysis Framework

• The financial statement analysis framework involves 6 steps:
  • State the objective and context.
  • Gather data.
  • Process the data.
  • Analyze and interpret the data.
  • Report the conclusions or recommendations.
  • Update the analysis.

Auditor's Report and GAAP

• An auditor's report would not include an explanatory paragraph for statements verifying financial information in accordance with GAAP.
• Explanatory paragraphs are generally added for uncertainties like going concern issues or litigation.

Audited Data in Annual Reports

• Footnotes to the annual financial statements typically contain audited data.
• Management's commentary and interim financial statements filed with the SEC may not always be audited.

Suspicious Financial Transactions

• Analysts should be skeptical of new financial transactions affecting earnings when management does not explain the business purpose.
• The absence of accounting standards or governing regulations should raise concerns for analysts.

Financial Statement Analysis Framework: Data Processing

• In processing data, appropriate adjustments are made to the financial statements and ratios are calculated.

Proxy Statements

• Proxy statements are filed with the SEC and available on EDGAR.
• Proxy statements hold information about board members, compensation, and other management details.

Internal Controls

• Internal controls directly impact financial reporting quality.
• Company management ensures the effectiveness of internal controls
• Auditors give opinions on the effectiveness of internal controls under U.S. GAAP

EDGAR Availability

• Corporate press releases are less likely to be available on EDGAR.
• SEC filings, including Form 10-Q and Form 10-K, are available on EDGAR.

Role of Financial Statement Analysis

• The main role is making economic decisions, financial statement analysis informs investment choices and credit decisions.
• Assessing management's skills is generally not considered the primary role.

Standard Auditor's Report

• A standard auditor's report assures that financial statements do not contain material errors.
• Auditor reports states that the financial statements are the responsibilities of the management of the business.
• The report provides reasonable assurance based on accepted accounting principles.

Financial Statement Data Processing

• Processing the data includes making necessary adjustments and preparing exhibits.
• Acquiring the company’s financial statements falls under gathering data, rather than processing it.

Objective Information in Company Analysis

• Corporate press releases are less objective.
• Analysts use government data and proxy statements for company's analysis.

Financial Statement Notes

• Financial statement notes (footnotes) are audited and may contain contingent losses information.
• Management's assessment of operating performance is usually separate

Financial Statement Analysis Framework: Analyzing and Interpreting Data

• In financial statement analysis, analysts use the data to address the analysis's goals and determine the supportable conclusions or recommendations.