← Chapter One Export Options Alphabetize Word-Def Delimiter Tab Comma Custom Def-Word Delimiter New Line Semicolon Custom Data Copy and paste the text below. It is read-only. Select All Role of financial reporting: Provide information about performance, financial position, changes in financial position (firm resources versus claims against the firm) for a wide range of users. Role of financial statement analysis Take financial reports by companies evaluate the past, current and prospective performance and financial condition and use that information to make investment, credit and better economic decisions. Examples of Financial statement analysis Evaluating an equity investment, forecasting net income and cash flow -Evaluate a merger or acquisition candidate -Deciding whether to make a venture capital or private equity investment. -Determining credit worthiness of a company, assign debt ratings & compliance with debt covenants The role of the financial analyst -external approach vs. internal analysis -publicly traded firms vs. private firms -financial statements that adhere to US GAAP vs. IAS -Dependence upon general purpose external financial reports provided by management The role of corporate managers: -responsible for form and content -selection of various accounting methods -compilation of accounting data -preparation of the financial statements -issuance financial statements 5 principal financial statements -balance sheet -income statement -statement of comprehensive income -statement of cash flows -statement of stockholders equity (footnotes, MD&A, external audit report) What does income statement do? Summarizes events over a period of time measuring revenues, expenses, and gains/losses what does the balance sheet do? "snap shot" at a point in time listing firm resources (assets), liabilities (future costs), and residual interest owner's equity. what does the cash flow statement do? Reconciles beginning and ending cash balance with CFD, CFI and CFF for a period of time. what does the statement of changes in owners equity do? Reports amounts and sources of changes in investor's equity over the period In an ideal world financial statements would be: -comparable across companies -analysts could focus on the bottom line- earnings -the statements would always fully reflect the economic position of the firm Alternatively financial statements are not comparable: -diverge in the recognition and timing of certain events -recognition of revenues and expenses, value of assets on the balance sheet, ect. -Many economic events are not recognized at all Classes of user -Investors (debt and equity) -Government (taxes/regulators) -Others (public, special interest groups, workforce0 Equity investors Interested in identifying firms with long term earnings power, growth opportunities, ability to pay dividends, earnings and return on capital. Short term creditors Interested in liquidity of the business and financial position Long term creditors Interested in long term asset position, earnings power and solvency General Principals of Financial Reporting System -Accounting events don't equal economic reality 1. Timing (Economic events and accounting entries may take place in different periods, ex: changes in market value of PP&E and land) 2. Recognition (Many economic events do not receive recognition, ex: contingencies, off balance sheet financing arrangements (operating leases)). 3. Measurement (certain items may be reported by different methods, ex: inventory) Under Sarbanes-Oxley, management must report on: 1. it's responsibility of management to establish and maintain adequate internal controls 2. Identify management's framework for evaluating internal controls 3. Assessment of effectiveness of internal controls over the period. 4. Statement of auditor's attestation report on managements assessment 5. Certify that financial statements are fairly presented About The Audit Report Audit: Independent review of company's financial statements -Reasonable assurance that financial statements are free of material errors. Audit Opinion: -Unqualified: "clean" opinion -Qualified: exceptions to accounting principles -Adverse: Statements not presented fairly -Must provide opinion on company's internal controls under U.S. GAAP Audit Report Cont. 1. Responsibility of management to prepare accounts 2. Independence of auditors 3. Properly prepared in accordance with relevant GAAP 4. Free from material misstatement 5. Accounting principles and estimates chose are reasonable. 6. opinion on internal control systems Footnotes -Audited information about accounting methods, assumptions, management estimates Supplementary schedules Business acquisitions and sales, commitments and contingencies, legal issues, related party transactions, customer concentration, segment and quarterly date. Management discussion and analysis (MD&A) Must highlight favorable and unfavorable business trends, results from operations, trends in sales and expenses (inflation), capita resources and liquidity, cash flow trends, business overview, material events and uncertainties. Financial statement analysis framework 1. Purpose and context of analysis: who, what, when and why of analysis 2. Collect data- historical, macro assessment, industry evaluation 3. Process data- Read and evaluate the data, make adjustments, prepare common size statements 4. Analyze/interpret data: interpret the data 5. Conclusions and recommendations 6. Update analysis periodically Supplementary Sources of Information 1. quarterly, semiannual reports: updates of major financial statements and footnotes; ex: SEC filings 2. Proxy statements: issued when shareholder vote is required, contain information on board elections, management compensation, stock options 3. Corporate reprots, press releases: written by management 4. Economic, industry data: from trade journals, reporting services, government agencies Income Statement "The Bottom Line" is Net Income -Revenues: inflows from a firm's primary operations -Expenses: Cost of producing goods and services sold over the period -Gains/losses: increases/decreases in equity or net assets from peripheral or incidental transactions -EPS/diluted EPS -analyst focus = profitability growth Statement of Cash Flows Classifies how a firm generates cash flows based on 3 categories: -Operating based on a firms primary operating activities and day to day business operations -Investing cash flows derived from purchasing and disposing of long term assets -Financing cash flows related to obtaining or repaying capital to shareholders and long term creditors Balance Sheet -Static statement of financial position Assets: firms economic resources they own Liabilities: Future economic costs or what they owe Owners equity: Residual interest in assets after deducting liabilities Analysts focus: Liquidity- meet short term obligations Solvency- long term obligations financial position vs. industry Cash Flow Statement (analyst focus) -liquidity -Sources and uses of cash -Solvency -Financial flexibility Statement of changes in owners (shareholders) equity -Amounts and sources of changes in investors equity over the period -AKA statement of retained earnings -Stock issuance and repurchase -Certain adjustments to equity from events not recorded on the income statement -"other comprehensive income"