Financial Statement Analysis CFA Level 1

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Explain the roles of financial reporting and financial statement analysis.

______ The role of financial reporting is described by the IASB in its Framework for the Preparation and Presentation of Financial Statements: The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. The role of financial statement analysis is to use the information in a companys financial statements, along with other relevant information, to make economic decisions. Examples of such decisions include whether to invest in the companys securities or recommend them to other investors, or whether to extend trade or bank credit to the company. Analysts use financial statement data to evaluate a companys past performance and current financial position in order to form opinions about the companys ability to earn profits and generate cash flow in the future.

Explain the role of key financial statements (4) in evaluating a companys performance and financial position.
______ 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. The balance sheet reports the firms financial position at a point in time. The balance sheet consists of assets, liabilities, and owners' equity. Transactions are measured so that the fundamental accounting equation holds: assets = liabilities + owners equity The cash flow statement reports the companys cash receipts and outflows. These cash flows are classified as either operating, investing, or financing. The statement of changes in owners equity reports the amounts and sources of changes in equity investors investment in the firm in a period of time.

Define financial statement notes, supplementary information, managements discussion and analysis (MD&A).
______ Financial statement notes (footnotes) include disclosures that offer further detail about the information summarized in the financial statements. Footnotes allow users to improve their assessments of the amount, timing, and uncertainty of the estimates reported in the financial statements. Supplementary schedules contain additional information. Examples include operating income or sales by region or business segment, reserves for an oil and gas company, and information about hedging activities and financial instruments. Managements Discussion and Analysis (MD&A) provides an assessment of the financial performance and condition of a company from the perspective of its management. For publicly held companies in the U.S., the MD&A is required to discuss results from operations, with a discussion of trends in sales and expenses, capital resources and liquidity, with a discussion of trends in cash flows, and a general business overview based on known trends.

What is the objective of audits of financial statements, the types of audit reports (3), and the importance of effective internal controls?
______ An audit is an independent review of an entitys financial statements. Public accountants conduct audits and examine the financial reports and supporting records. The objective of an audit is to enable the auditor to provide an opinion on fairness and reliability of financial statements. The auditors opinion gives evidence of an independent review of the financial statements that verifies that appropriate accounting principles were used, that standard auditing procedures were used to establish reasonable assurance that the statements contain no material errors, and that managements report on the companys internal controls has been reviewed. An unqualified opinion indicates that the auditor believes the statements are free from material omissions and errors. If the statements make any exceptions to the accounting principles, the auditor may issue a qualified opinion and explain these exceptions in the audit report. The

auditor can issue an adverse opinion if the statements are not presented fairly or are materially nonconforming with accounting standards. Under U.S. GAAP, the auditor must state an opinion on the companys internal controls, the processes by which the company ensures that it presents accurate financial statements. The auditor can provide this opinion separately or as the fourth element of the standard auditors opinion. Under the Sarbanes-Oxley Act, management is required to provide a report on the companys internal control system.

Sarbanes-Oxley Act: Management is required to ...

______ report on the companys internal control system.

Information sources other than annual financial statements and supplementary information that analysts use in financial statement analysis (5).
______ Besides the annual financial statements, an analyst should examine a company's: 1. Quarterly or semiannual reports: These reports update the major financial statements and footnotes, but may not be audited. 2. SEC filings: Include Form 8-K, used to report acquisitions and disposals of major assets or changes in management or corporate governance. Annual and quarterly financial statements are also filed (Forms 10-K and 10-Q). 3. Proxy statements (DEF-14A), which are issued to shareholders when there are matters that require a shareholder vote. Statements are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options. 4. Corporate reports and press releases, which are written by management and are often viewed as public relations or sales materials. Not all of the material is independently audited. 5. An analyst should also review information on the economy and the companys industry and compare the company to its competitors.

Steps in the financial statement analysis framework, 6

______ 1. State the objective and context: Determine what questions the analysis is meant to answer, the form it needs to be presented in, and resources available. 2. Gather data: Acquire the firms financial statements and other relevant data on its industry and the economy. Ask questions of the firm's management, suppliers, and customers, and visit firm sites. 3. Process the data: Make appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits (graphs, common-size balance sheets). 4. Analyze and interpret the data: Use data to answer questions stated in step 1. Decide what conclusions or recommendations the information supports. 5. Report the conclusions or recommendations: 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. 6. Update the analysis: Repeat these steps periodically and change the conclusions or recommendations when necessary.

Financial reporting: Describe the groups into which business activities are categorized (3), and classify business activities into the appropriate group.
______ 1. Operating activities are transactions that involve the firms everyday lines of production and trade. Sales and their related costs are typically a firms primary operating activities. Other examples of operating activities include paying taxes and buying short-term assets and taking on short-term liabilities to support the firms ordinary business. 2. Investing activities are the firms transactions to acquire or dispose of long-term assets. Purchases/sales of property, plant, equipment are investing activities, as are purchases and sales of securities issued by others. 3. Financing activities are transactions through which the firm raises or repays capital. These include issuing or repaying debt, issuing or repurchasing stock, and paying dividends to shareholders.

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The complete Study Notes cover the following topics for CFA Level 1 in ten volumes (450 pages): Alternative Investments (17 pages) Corporate Finance (28 pages) Derivatives (30 pages) Economics (73 pages) Equities (14 pages) Financial Statement Analysis (104 pages) Fixed Income (55 pages) Markets (16 pages) Portfolio Management (15 pages) Quantitative Concepts (105 pages) The entire collection of all volumes contains over 750 questions and answers about the CFA Level 1 curriculum. The Financial Analyst Study Notes are available for download immediately after verification of your purchase (pdf format, approx. 15 MB).

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