CFA

FSA
CF A

CF A

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 R22 CF A

CF A
Financial Statement Analysis: An Introduction

2-50
 FASBUS.GAAP

IASBIFRS

make economic decisions

CF A
()
CF A

Financial position Financial performance Change in financial position

The balance sheet The income statement The cash flow statement

Revenue Operating cash flows

Assets
Expense Investing cash flows
=liabilities+owners equity
Net income Financing cash flows

3-50

Statement of comprehensive income

CF A

Reports all change in equity expect for shareholder transactions

CF A

IFRS US.GAAP

Income statement OCI

single statement of comprehensive IFRS
income OCI

4-50
 Other relevant information
Providing information about accounting methods,
assumptions, and estimates
Financial statement Providing additional information about business acquisitions
notes(Footnotes) or disposal, legal actions, employee benefit plans, significant
customers, sales to related parties, and segment of the firm
Are audited
CF A
Supplementary
Operating income or sales by region or business segment
Reserves for an oil and gas company
schedules
CF A
Information about hedging activities and financial instruments

Providing an assessment of the financial performance and
condition of a company from the perspective of its management
Managements Results from operations, with a discussion of trends in sales and
Discussion and expense
Analysis(MDA) Capital resource and liquidity, with a discussion of trends in
cash flow
A general business overview based on known trends
Material events and uncertainties that may affect future

5-50
Quarterly or The most updated information on the major financial
semiannual reports statements and footnotes
Form 8-K
Acquisitions or disposals of major assets
Change in its ,management
Securities and
Change in corporate governance
Exchange Commission
(SEC) filings
Form 10-K
CF A
Annual financial statements
Form 10-Q

CF A
Quarterly financial statements

Issues to shareholders when there are matters that require a

shareholder vote
Proxy statements Providing information about the board members,
managements, compensation and the issuance of stock options.
Corporate reports and
Public relations
press releases
Other necessary
Information on economic conditions, industry and competitors.
information

6-50

Autid

Unqualified (clean) opinion Free from material errors, fraud, or illegal acts

CF A

If statements make any exceptions to the accounting
Qualified opinion

principles, can issue qualified opinion and explain

A
the exceptions

CF If not presented fairly or not materially conforming

Adverse opinion
Disclaimer of opinion
with accounting standards.
If the auditor is unable to express an opinion(e.g.,in
the case of a scope limitation ), disclaimer of opinion
is issued.

Internal control system

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 R23 CF A

CF A
Financial Reporting Mechanics

8-50

Balance Sheet
Cash equivalents
Accounts receivables
Inventory
Financial assets
Prepaid expenses
Asset PP E
CF A


Investment in affiliates
Deferred tax assets

A
Intangible assent

CFAccounts payables

Financial liabilities
Unearned revenue
Income taxes payable
Liabilities
Long-term debt
Deferred tax liabilities
Capital
Owners equity Additional paid-in capital
Retained earnings
OCI

9-50
Income Statement
Sales
Revenue Gains
Investment income
COGS
SGA
Depreciation
CF A
Expenses

Amortization
Tax expense

CF A
Interest expense

Losses
Double-entry accounting
Assets= liabilities + owners equity
Owners equity = Contributed Capital + Retained earnings
Ending retained earnings = Beginning retained earnings + Net income - Dividend
Net income = Revenue - Expense

10-50
Accrual accounting
Cash received in advance Unearned revenue
Cash paid in advance Prepaid expense
Cash received in arrears Accrued revenue
Cash paid in arrears Accrued revenue

CF A
Assets
Liabilit Reve Expe Equi

CF A ies nue nse ty

revenue A liability
Unearned No revenue recognized

Accrued Revenue recognition

revenue An asset
Prepaid No expense recognized Cash
expenses An asset Prepaid exp
Accrued Expense recognition

expenses A liability
11-50
 Valuation adjustments

CF A
historical cost

Asset
C F A


current market valuesOCIEquity

12-50
 R24 CF A

CF A
Financial Reporting Standards

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FASBUS.GAAP
Standard-setting bodies
IASBIFRS
SECUS10K,10Q.8K
Regularly authorities
FSAUK
Qualitative Objective
CF A
Reporting
Characteristics
Relevance
Comparability

CFA
Elements
Faithful Verifiability

IASB
representation Timeliness
conceptual
Understandability Constraint
framework
Performance Financial Position Cost(cost/benefit
Income Assets considerations)
Expenses Liabilities Underlying
Capital maintenance Equity assumption
adjustments Accrual basis
Past cash flows Going concern
14-50
 IASB general requirements
General Features Structure and Content
Fair presentation Classified balance sheet
Going concern Minimum specified information on face
Accrual basis Minimum specified note disclosure
Materiality and aggregation Comparative information

No offsetting
CF A

Frequency of reporting

Comparative information

A
Consistency of presentation

CF

Required Financial Statements

Statement of financial position(B/S)
Statement of comprehensive income (Single statement or income statement +
Statement of comprehensive income)
Statement of changes in equity
Statement of cash flows
Notes, summarizing accounting policies and disclosing other items
In certain cases, Statement of financial position from earliest comparative period

15-50
 Coherent financial reporting framework

Transparency Valuation
Comprehensiveness Standard setting

Consistency measurement

CF A

IASBFASB

IASB
CF A FASB

Lists income and expense as elements
related to performance
Defines it as a resource from which a
future economic benefit is expected to
flow
Allow the upward valuation
Includes revenues, expenses, gains, losses,
and comprehensive income
Defines an assets as a future economic
benefit
Does not allow the upward valuation of
most assets

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 R25 CF A

CF A
Understanding the I/S

17-50
 I/S
Net revenues from Sales of goods and services
Operating -Cost of goods sold/Cost of service provided
components Gross profit
-Other operating Expenses(SGA)
+Other Income and revenues
Non-operating
F A
Recurring income before interest and taxes from Continuing operations
C
components
The best indicator
-Financing Costs

Recurring (pretax) income from continuing operations
of future earnings
CF A

+/- Unusual or Infrequent Items
Pretax income from Continuing Operations
-Income Tax Expense
The line Net Income from Continuing Operations
Blow the line +/- Income from Discontinued Operations (net of tax)
+/- Extraordinary Items (net of tax)

Net income=(revenues ordinary expense) + (other income other expense) + (gains-losses)

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1.Revenue
Revenues are the amounts reported from the sale of goods and services in
the normal course of business

Revenue less adjustments for estimated returns and allowance is known as
net revenue.
RevenueDelivery method
CF A
Sale of goods
Services rendered

CF A

transferred.
The risk reward of ownership is

There in no continuing control or

management over the goods sold.
IFRS
Revenue can be reliably measured.
There is a probable flow of
economic benefits.
The cost can be reliably measured.
The amount of revenue can be reliably
measured.
There is a probable of economic
benefits.
The stage of completion can be
measured.
The cost incurred and cost completion
can be reliably measured.

19-50
RevenueDelivery method

Realized or realizable and earned.

There is evidence of an arrangement between the buyer
CF A

and seller.
US.GAAP
The product has been delivered or the service has been

CF A
rendered.

The price is determined or determinable.
The seller is reasonably sure of collecting money.

20-50
RevenueLong term contract
Condition Methods
Projects of long-term
contract. GAAP
Reliable estimates of the Percentage-of-completion method
revenues, costs and
LT contract completion time. IFRS
CF A

Projects of long-term
GAAP Completed contract method
projects.
CF A Revenue is recognized to the

Outcome of the project

cannot be reliably IFRS
extent of contract costs.
Costs are expenses when incurred.
Profits are recognized only at
estimated.
completion
F/S Items POC Completed Contract
CFS Cash flows Same Same

I/S Income Volatility Less

Reverse
Net come Greater
21-50
RevenueInstallment contract
A firm finances a sale and payments are expected to be received over an extended period
Profit is recognized as cash is collected
Profit is equal to cash collected during
Collectability cannot Installment sales
the multiplied by the total expected
be reasonably method(POC
profit as a percentage of sales
estimated. )
GAAP
CF A
Used in limited circumstances, eg, sale

Cost recovery
of estate or other firm assets
Sales are recognized when cash is
Collectability is
F A
method (Similar
C
received
highly uncertain
to the completed Profit is recognized only when cash
contract method) collected exceeds costs incurred.
The discounted present value of the installment payments is
Outcome can be recognized at the time of sale.
reliably estimated The difference between the installment payments and
IFRS discounted present value is recognized as interest over time
Outcome cannot be Revenue recognition under IFRS is similar to cost recovery
reliably estimated method

22-50
RevenueBarter transactions( round-trip transaction)
U.S.GAAP
Can be recognized at fair value only if the firm
has historically received cash payments for
such goods and services and can use this
historical experience to determine fair value.
Otherwise, the revenue is recorded at the
CF A
IFRS
Revenue must be based on the fair
value of revenue from similar non-
barter transactions with unrelated
parties.

carrying value of the asset surrendered.
RevenueGross and Net Reporting of Revenue

C F A
Gross revenue Net revenue

The selling firm reports sales revenue and cost of
goods sold separately.Profit is the same, sales are
Only the difference in sales and cost
is reported.
higher using gross revenue reporting.
U.S.GAAP gross revenue
Be the primary obligor under the contract.
Bear the inventory risk and credit risk.
Be able to choose its supplier.
Have reasonable latitude to establish the price.
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2. Expense

Expenses are the amounts incurred to generate revenue and include cost of goods
sold, operating expenses, interest, and taxes.
CF A

Expenses are grouped together by their nature or function.

CF A

Matching principle Expenses are recognized in the same period as the revenue

24-50
3. Non-Recurring items
Reported above the line and presented on a pretax basis
Unusual or
G/L from the sale of assets or part of a business
Above the infrequent
Impairments , write-offs, write-downs, and restructuring
line items
costs.
Presented on net of tax
CF A
Extraordinary
items
Loss from expropriation of assets;
Gains or losses from early retirement of debt;

CF A
Uninsured losses from natural disasters

Discontinued Presented on net of tax
operations income/loss
Below the Change in accounting principle might be
line Accounting retrospective;
changes Change in accounting estimate prospective and not a
below line item.

25-50
4. EPS

Basic EPS Basic EPS=

A
New issue,
repurchase
Weighted by time (days or months)

CF

CF A
Not weighted by time, adjust the number of common share before

Stock dividend/split
the stock dividend or split
Diluted EPS=

.

+
+ (1)
Diluted EPS =+
.. + .
+ .

26-50
4. Comprehensive income

Net income

CF A

Foreign currency translation gains and (losses)
Adjustment for minimum pension liabilities

A
Comprehensive income
F
Unrealized g/l form cash flow hedging

C
OCI
derivatives
Unrealized g/l available for sale securities

Gross profit margin= Net profit margin=

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 R26 CF A

CF A
Understanding the B/S

28-50
Stockholders paid-in-capital
Capital Common excess of par i.e. premium
Additional paid-in-capital Capital in excess of par i.e. premium
Stock has been reacquired by issuing firm but
Treasury not yet retired
CF A
Retained earnings
Non voting rights, no dividend
Net Income - Dividend

CF A Foreign currency translation gains and losses.

Accumulated other comprehensive
Adjustments for minimum pension liability.
Unrealized gains and losses from cash hedging
income derivatives.
Unrealized gains losses from available-for-sale
securities.
Minority interest/Non-controlling
Group accounting
interest

30-50
 Financial asset
Held-to-Maturity Available-for-sale Trading Securities
B/S Amortized cost Fair value Fair value

A
I/S
interest I/S I/S
CF
Dividend debt I/S I/S

CF A
Realized
G/l I/S I/S I/S

Fair B/SOCI I/S
Unrealized G/L
value

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 R27 CF A

CF A
Understanding the C/F

32-50
 Information about a companys cash receipts and payments
during an accounting period.
Information about a companys operating, investing , and
CF/S
financing activities.
An understanding of the impact of accrual accounting events
CF A

on cash flows

CF A
I/S
Operating cash flow + Investing cash flow + Financing
CF/S
cash flow
B/S =Change in cash balance for the current year +
Beginning cash balance
= Ending cash balance

33-50


CF Inflows Outflows

Cash collected from customers Cash paid to employees and suppliers

Sale proceeds from trading Acquisition of trading securities

A
CFO securities Interest paid
Interest received
CF
Cash paid for other expenses

Dividend received

Purchase trading

CF A
Sale proceeds from fixed assets

CFI
Sale proceeds from debt
equity investments
Acquisition of fixed assets
Acquisition of debtequity investments
Principal received from loans Loans made to others
made to others

Principal paid on debt

Principal amounts of debt issued
CFF Payments to reacquire stock
Proceeds from issuing stocks
Dividends paid to shareholders

34-50
IFRS vs US.GAAP
Items U.S.GAAP IFRS
Interest received CFO CFO or CFI
Interest paid CFO CFO or CFF
Dividends received CFO CFO or CFI
Dividends paid CFF
CF ACFO or CFF
Taxes paid CFO
CFO ,CFI or CFF

A
Bank overdrafts CFF Cash equivalents

CF
Encourage direct method,
but allows indirect method.
If direct method presented,
Encourage direct method
But permits either method
IFRS permits more flexibility in
Disclosure footnotes must provide
reporting
indirect method.
CFA
CFO CFI CFF
Direct Method Indirect Method Direct Method Direct Method
35-50
 CFO
Indirect method Direct method
Cash received Opening A/R + net sales Closing A/R =Net
Net income
from customers sales - A/R
Opening A/P + COGS Closing A/P =- COGS +
A/P + Depreciation included in COGS (COGS
A
+Non cash expenses or - Cash paid to
losses suppliers
Inventory)
CF
= Opening Inventory + purchase Closing

Opening wage payables + wage expense
+Non cash revenues or
F A
- Cash paid to
C Closing wage payables = wage expense +

gains employees

wage payables
+/- Non operating items - Interests paid
- Increase in non-cash Opening tax payables + income tax expense
operating asset - Tax paid Closing tax payables = - income tax expense +
accounts(Inventory, A/R) tax payables
+Increase in operating
= CFO
liability accounts (A/P)
= CFO
36-50
 CFI
Pay attention to the movement of fixed assets.
Cash used in purchase
Book Value = Carrying value = Purchase cost AD Impairment
of fixed assets
BV end = BV Begin + Purchase Disposal BV - Depreciation
Proceeds received
CF A
Gain or loss = proceeds received disposal NBV

from sale of fixed Gain or loss resulting from disposal of PPE or other long term
assets

assets are NOT presented in the CFI, but in gain or loss.

CF A CFF

Review long-term
Increases supply cash and decrease use cash.
debt and stock

Dividend paid = - Dividend declared + dividend payables

Dividend paid
Opening R/E + Net Income Dividend declared = Ending R/E

37-50
 CF/S ratio
Performance ratios Coverage ratio
CFO/Revenue CFO/Total debt
CFO/Average total assets CFO/Cash paid for long- term assets

A
CFO/Average total equity CFO/Cash long- term debt repayment
CFO/Operating income CFO/dividend paid
CF
(CFO Preferred dividends ) / Weighted
CFO/ Cash outflows from investing and

CF A
average number of common shares financing activities

(CFO + interest paid + taxes paid) / interest paid

Free Cash Flow

Free cash flow to firm (FCFF)
Free cash flow to equity (FCFE)
FCFF = NI + NCC + [ Int *(1 tax rate) ] FC Inv WC Inv
FCFE = CFO FC Inv + Net borrowing
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 R28 CF A

CF A
Financial Analysis Techniques

39-50
 Ratio analysis
Common size analysis
Stack column graph
Graphical analysis
Line graph
Regression analysis
Ratio analysis
1. Activity ratio
CF A
Inventory
Inventory turnover
A/R

Receivables turnover
A/P
Payables turnover
= COGS/ average inventory
CF A = Net revenue / average A/R = Purchase / average A/P

period

Average inventory processing Average receivables
= 365 / inventory turnover
collection period
= 365 / receivables turnover
Average payment period
= 365 / payables turnover

Operating cycle = collection period + inventory period

Cash conversion cycle
= collection period + inventory period payment period.liquidity ratio
Total asset turnover Net revenue / average total assets
Fixed asset turnover Net revenue / average next fixed asset
Working capital turnover Net revenue / average WC
40-50
2. Liquidity ratios (A firms ability to pay short term debt)
Current ratio Current assets / Current liabilities
[cash + marketable securities + receivable ] / Current liabilities
Quick ratio
=[current asset inventories ] / Current liabilities
Cash ratio [ cash + marketable securities ] / Current liabilities
(cash + marketable securities + receivables ) / average daily
Defensive interval
expenditures
CF A
Cash conversion
cycle
Days of sales outstanding + days of inventory on hand number of
days of payable

CF A
3. Solvency Ratios (A firms ability to pay long-term debt)

Debt to equity ratio D/E
Debt to capital D/(D+E)
Leverage
Debt- to assets D/A
Financial leverage A/E
Interest coverage EBIT/ Interest
Coverage (EBIT + lease payment)/( Interest + lease
Fixed charge coverage
payments)
41-50
4. Profitability Ratios (A firms ability to generate profits)
Gross profit margin Gross profits / net revenue
Profit / Net Operating profit margin EBIT / net revenue
revenue Pretax margin EBT / net revenue
Net profit margin NI / net revenue

A
ROA [NI + interest (1-t)] /average total assets
Operating return on assets
CF
EBIT / average total assets

Return on total capital (ROTC) EBIT / average total capital

A
Profit / Capital
ROE
CF NI / average total equity

Return in common equity
(NI Preferred Dividend) / average
common equity

ROE Dupont analysis

ROE=

ROE=

42-50
5. Valuation ratios
rationEquity P/E P/CF P/B P/S
Equity Net income per employee
analysis Growth in same-store sales

Sales per square foot
Interest coverage ratio
C
EBIT / Interest
F A
Credit Return in capital

EBIT / average total capital
analysis
F A
Debt to asset ratio
C
D/A

Z- score
CV sales
Z = 1.2A+1.4B+3.3C+0.6D+1.0E
Sales / mean sales
Business Operating income / mean operating
CV operating income
risk income
NI / mean NI
CV net income

43-50
 R29 CF A

CF A
Inventories

44-50


COGS = beginning inventory + purchases ending inventory (BASE )

Capitalizing B/S
A
Expensing I/S
CF
Purchase cost less trade discounts and
rebates.
Abnormal waste of materials, labor, or
overhead.

CF A
Conversion costs including labor and Storage costs (unless required as part of
overhead.

Other costs necessary to bring the
production).
Administrative overhead.
inventory to its present location and Selling costs
condition.

45-50


Inventory cost flow method

Specific identification
GOGS I/S
FIFO
Inventory B/S
LIFO IFRS

CF A

Weighted average cost

CF A


Inventory COGS
Periodic perpetual system
FIFO and specific identification
InventoryCOGS
Periodic or perpetual system
LIFO and weighted average cost

46-50
LIFO FIFO
LIFO FIFOLIFO
COGS Higher Lower
Taxes Lower Higher
EBIT&EAT Lower Higher

CF A
Inventory balances
Cash flows
Lower

HigherTax
Higher
Lower

CF A
CF

Net and gross margins Lower Higher
Current ratios Lower Higher
Inventory turnover Higher Lower
D/A and D/E HigherINVA; Lower
COGSNIE

47-50


Cost vs NRV (which is lower) NRV=sales price-selling

IFRS
cost

CF A
US GAAP
Cost vs Market (which is lower)

CF A
NRV-normal profit margin<replacement cost<NRV

Retrospectively

LIFO Prospectively

48-50
 R30Long-Lived Assets
Capitalize or expense
Expense I/SCFO

Capitalize B/SCFI I/S

C F A
Depreciation Impairment
Interest Capitalizing R&D Cost
Leases

CF A
Yes
Current assetsInventoryCOGS
Tangible
depreciation
B/S Non- assets
current
Spending assets Intangible
Amortization
Expenditure assets

No
I/S I/S
49-50
 51CFA

CFA CFA

CF A

CF A

CFA

50-50