1 financial analysis by binam ghimire. learning objectives 1. purpose of financial analysis 2....
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Financial Analysisby Binam Ghimire
Learning Objectives1. Purpose of financial analysis2. Various techniques of financial analysis 3. Understanding Creative Accounting, and 4. IFRS and auditing
Financial Analysis Financial Analysis as the name suggests is an
analysis of an organisation’s financial position
Why do we undertake financial analysis ? What information do we analyse ? What techniques do we use to undertake
financial analysis ?
Why undertake Financial Analysis ? Investors & Potential Investors - Share/Company valuation
Providers of Finance – Predicting financial distressAssessing creditworthiness
Authorities - Tax legislation Analysts/Investors/Potential Investors -
Forecasting future performance – share valuation/loan decisions
Internally ManagementDesigning profit sharing plansAiding management decisionsManagement performance evaluation
Examples of Documents used for Financial Analysis Published Financial Statements
The Balance Sheet or Statement of Financial Position (Session 4)
The Income Statement (Session 5)The Cash Flow Statement (Session 6)
Business Plans including Cash Forecasts Published Equity data (Session 10) e.g.:
Share PriceEPS; DPS
Analysts Reports
Techniques of Analysis
Common-Size Statements Trend Statements Financial Ratio Analysis including:
Basic Profitability, Liquidity & Gearing RatiosDu-Pont AnalysisCashflow Analysis
Altman “Z”Scores (Distress Analysis) Investment Ratios
These tend to rely on Published Financial Statements but what if they are prepared by Creative Accountants?
Creative Accounting
Creative Accounting is:the practice of showing users what they would
like to see rather than a true and fair value
Reasons for Creative Accounting Possible reasons for creative accounting could
include to:1. reduce taxation by reducing reported profits;2. attract new share capital or loan capital by showing a healthy (and non-volatile) financial position;3. achieve sales or profit targets (especially where performance bonuses are involved);4. report sufficient profit to pay a dividend or to meet investors’ expected level of return.
Methods of Creative Accounting
Overstatement of revenue ‘In-and-out trading’ Manipulation of expenses e.g. Depreciation Capitalization of expenses Concealment of losses or liabilities Revaluation of non-current assets Valuation of current assets e.g. Inventories Auditing
A Final Word of Caution
the Accounting Standards adopted, which will differ from company to company due to interpretation and country to country due to the standards adopted IAS or US GAPP
Management Bias – desire to show a good position, justify a bonus
The Need/Desire to Meet Lending Conditions Big Bath – in a bad year, why not have a really bad year Mergers & Acquisitions – the desire to avoid, encourage or
take part in, and the method of accounting for M & A Income Smoothing Tax Regime of the country
As a result analysts (you) need to be adversarial when analysing financial statements
The Case of ENRON
The story of Enron and a lesson in Creative Accounting is captured in the Oscar Nominated documentary film, “Enron: The Smartest Guys in the Room”,
An excellent film and well worth a watch.
IFRS and Audits
IFRS and Audits are methods used to ensure Financial Statements are reliable
What are they ?
IFRS
IFRS – International Financial Reporting Standards are:a single set of high quality, understandable
and enforceable global accounting standardsi.e. rules that organisations must follows when
preparing and reporting their financial statements
IFRS are developed and approved by the IASB – International Accounting Standards Board whose objective is…
The Objectives of the IASB (a) to develop, in the public interest, a single set of high
quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world's capital markets and other users make economic decisions;
(b) to promote the use and rigorous application of those standards; and
(c) in fulfilling the objectives associated with (a) and (b), to take account of, as appropriate, the special needs of small and medium-sized entities and emerging economies; and
(d) to bring about convergence of national accounting standards and International Accounting Standards and International Financial Reporting Standards to high quality solutions.
Auditing
An audit is an independent examination of the financial statements and procedures by a professional accountant who then expresses an opinion based on his/her examination.
It should not, merely, be regarded as a public service. Auditors seek to:maximise the revenue of the firm or
department they work forminimise costs maintain quality of financial proceduresminimise risk.
External & Internal Auditing Auditors are split into two principal categories –
External – appointed from outside the organisation
Internal – usually employees of the organisation
Internal ExternalObjectives To advise management on whether the
organisation has sound systems of internal controls to protect the organisation against loss
To provide an opinion on whether the financial statements provide a “true and fair view”
Legal Basis Generally not a legal requirement. However the latest corporate governance advice recommends that if a listed company does not have an internal audit department, it should regularly assess the need for one.
Usually a legal requirement for larger limited companies and most public bodies
Scope All areas of the organisation, operational and functional
Financial focus
Approach Increasingly risk basedAssess risksEvaluate the systems of controlsTest operations of systemsMake recommendations for improvement
Increasingly risk basedTest underlying transactions that form the basis of the financial statements
Responsibilities
To advise and make recommendations on internal controls and corporate governance
To form an opinion on whether the financial statements provide a “true and fair view”
Summary Why do we undertake financial analysis ? What information do we analyse ? What techniques do we use to undertake
financial analysis ? What is Creative Accounting What is the role of IFRS and Auditing ?
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