Introduction to Financial Statement Analysis

Every equity valuation, credit decision and peer comparison starts with a company's financial reports, so you need to know what they contain, who sets the rules behind them and how far you can trust them. This module covers the purpose of financial reporting, the primary statements and how they link, the filings, notes and commentary that surround them, the auditor's report, the role of standard setters and regulators, and a step-by-step framework for carrying out an analysis.

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What you will learn

1. Explain the objective of general-purpose financial reporting and how financial statement analysis supports investment and credit decisions.

The objective of general-purpose financial reporting is to give investors and creditors information useful for deciding whether to provide resources to the entity.
Financial statement analysis uses past performance and current position to assess future earnings power, cash generation and risk.
Equity analysts emphasize profitability and growth; credit analysts emphasize cash flow, leverage and downside protection.
Net income and operating cash flow can diverge sharply; both must be examined.
Reported figures reflect management's policy choices and estimates, so analysis requires judgment and, often, adjustments.

2. Describe the primary financial statements and explain how they link to one another.

Balance sheet = a point in time; income statement, comprehensive income, changes in equity and cash flows = a period of time.
Assets = liabilities + equity at every reporting date.
Ending retained earnings = beginning retained earnings + net income - dividends declared.
Total comprehensive income = net income + OCI; both increase equity, but only net income passes through the income statement.
Change in cash = CFO + CFI + CFF (plus any exchange-rate effect), and it ties to the balance sheet cash figure.

3. Describe the information found in regulatory filings, financial statement notes, management commentary and other sources that analysts use beyond annual and interim reports.

US filings: 10-K (annual), 10-Q (quarterly, unaudited), 8-K (material events), proxy statement (governance and pay); 20-F and 6-K for foreign private issuers.
Notes disclose policies, estimates, segments, debt, contingencies and related parties, and are part of the audited statements.
MD&A or management commentary covers results, liquidity, trends and critical estimates; it is unaudited.
Non-GAAP measures must be reconciled to the nearest IFRS or US GAAP measure.
Earnings calls, rating reports, industry and economic data supplement company filings.

4. Interpret the auditor's report, including the types of audit opinion, key or critical audit matters, going-concern disclosures and reporting on internal control.

An audit provides reasonable, not absolute, assurance and cannot rule out all fraud.
Material but not pervasive misstatement: qualified. Material and pervasive misstatement: adverse.
Unable to obtain sufficient evidence with possibly pervasive effects: disclaimer of opinion.
KAMs (ISA) and CAMs (PCAOB) flag the areas of greatest audit judgment; they do not modify the opinion.
Going-concern uncertainty, material weaknesses, auditor changes and late filings are red flags.

5. Describe the roles of accounting standard setters and securities regulators, and explain why differences between IFRS and US GAAP matter for analysis.

The IASB (IFRS) and FASB (US GAAP) set standards; regulators such as the SEC and national authorities enforce them.
Fundamental qualitative characteristics: relevance and faithful representation; enhancing: comparability, verifiability, timeliness, understandability.
Key remaining differences include LIFO, inventory write-down reversals, development costs and cash flow classification of interest and dividends.
Foreign private issuers may file IFRS statements, as issued by the IASB, with the SEC without reconciling to US GAAP.
New standards can break trend comparisons; read transition disclosures and restate where needed.

6. Apply the steps of the financial statement analysis framework and identify the output of each step.

Six steps: purpose and context, collect data, process data, analyze and interpret, conclude and communicate, follow up.
Common-size statements, ratios and forecasts are outputs of processing; explaining them is interpretation.
The purpose of the analysis determines which data and techniques matter.
Analysis is iterative and requires periodic follow-up.

Module at a glance

Financial reporting aims to give investors and creditors information useful for resource-allocation decisions.
The balance sheet is a snapshot; the income, comprehensive income, equity and cash flow statements cover a period and link to it.
Notes are audited and essential; MD&A and non-GAAP measures are management's view and must be read critically.
Audit opinions: unmodified, qualified (material, not pervasive), adverse (material and pervasive), disclaimer (no evidence).
Standard setters write the rules, regulators enforce them, and IFRS versus US GAAP differences must be adjusted for.
Follow the six-step framework: purpose, collect, process, interpret, conclude, follow up.

This free module has 6 lessons, 15 practice questions with full explanations.

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