analysis of financial statements l2

8/13/2019 Analysis of Financial Statements L2

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Framework For FinancialStatement Analysis

Lec 2By:Saif UllahPhD Finance Scholar+92 321 6633271, [email protected]

mailto:[email protected]

mailto:[email protected]



Objective of Financial Reporting

One purpose of Financial Statements is tohelp investors and creditors make moreinformed economic decisions.

Because economic events and accountingrecognition of these events diverge across thedimensions of timing , recognition , andmeasurement , financial statement analysis isrequired



Objective of Financial Reporting

Timing : - Economic events and the accounting entriesfor those events may take place at different times.Recognition : - Many economic events do not receiveaccounting recognition. For example, many financialcommitments enforced by signed contracts are notrecognized on the financial statements.Measurement : - Accounting rules permiteconomic events to be reported in different ways bydifferent financial statements. For example, one firmmay use the First in First Out (FIFO), Last in First out(LIFO), Specific unit Method.



Foundation of Accrual Accounting

The Financial Reporting system depends on datastemming from accounting events ortransactions and selected economic events. Thefollowing principles are the foundations ofaccrual accounting:

Recognition Principle

Matching PrincipleHistorical Cost Principle



Qualities of Accounting Information

Financial Statement information should facilitatecomparison of firms using alternative reporting methodsand be useful for decision making. It should have thefollowing characteristics:

Relevance – information that could affect a decisionTimelines – information should be updateReliability – information can be measured accuratelyand they ware what they report to be.Consistency – same principles over timeComparability – information should allow comparisonMateriality – only important information should beincluded



Basic Financial Statements

Balance SheetIncome StatementStatement of Comprehensive Income

The Statement of Cash FlowsThe Statement of Stakeholder’s EquityFinancial FootnotesSupplementary SchedulesThe Management Discussion and AnalysisProxy Statements




The Balance SheetThe Balance Sheet reports financial position

AssetsLiabilities

Equity

Assets = Liabilities + Shareholder’s Equity




The income StatementThe income statement reports o the performanceof the firm and explain, some, but not all, of thechanges in assets, liabilities, and equity of thefirm between two balance sheet dates.

Elements of Income Statement are:

RevenuesExpenses

Gain and losses




The Statement of comprehensive IncomeIt reports the change in equity from transactionand from non-owner sources.

It includes all changes in equity during a periodexcept those resulting from investments byowners and distributions to owners.The purpose of the statement of comprehensiveincome is to help distinguish income fromcontinuing operations from changes in carryingamounts of assets and liabilities.




The Statement of Cash FlowsThe statement of cash flow reports the cash receipts andoutflows. These are defined as follows:

Investing cash flows are those resulting from

acquisition or sale of property, plant, and equipment ofa subsidiary or segment and purchase or sale ofinvestments in other firms.Financing Cash Flows are those resulting from issuanceor retirement of debt and equity securities and

dividends paid to stakeholdersCash from operations include the cash effects of alltransactions that are neither investing nor financing asdefined above.




Financial FootnotesInclude disclosures that help explain the informationsummarized in the financial statements:

Provide information about accounting methods and the

assumptions and estimates used by management.Are audited, whereas other disclosures, such assupplementary schedules, are not audited. provide additional information on such items as fixedassets, inventory, income taxes, pensions, debt,contingencies and commitments, marketable securities,significant customers, sales to related parties, export sales.Often contains disclosers relating to contingent losses.




Supplementary SchedulesContain additional information. Examples are:

Operating income or sales by region or businesssegment

Reserves for an oil and gas company

Information about hedging activities and financialinstrument




The management discussion and AnalysisThis portion of financial disclosure provides anassessment of the financial performance and condition ofa company from the perspective of the company.

Results from operations, with a discussion of trends insales and expensesCapital resources and liquidity, with a discussion of trendsin cash flowsA general business overview based on known trendsLiquidity, capital resources, and transactions or events withliquidity implicationsDiscontinued operations, extraordinary items, and otherunusual or infrequent events




Proxy StatementsProxy statements are issued to shareholderswhen there are matters that require ashareholder vote. These statements are a goodsource of information about the election ofboard members, compensation, managementqualifications, and the issuance of stock options.



Role of Auditor

An audit is an independent review of anentity’s financial statements. The auditorprovides an opinion on the fairness and

reliability of financial reports.The auditor examines the company’s accounting and internal control systems,confirms assets and liabilities, and generallytries to be confident that there are nomaterial errors in the financial statements.



Auditor’s Opinion

The standard auditor’s opinion contains three parts:Whereas the financial statements are prepared bymanagement and are its responsibility, the auditor hasperformed an independent review.

Generally accepted auditing standards were followed, thusproviding reasonable assurance that the financialstatements contain no material errors.The auditor is satisfied that the statements were preparedin accordance with GAAP and that the accountingprinciples chosen and estimates made are reasonable. Theauditor’s report must also contain an additionalexplanation when accounting methods have not been usedconsistently between periods.



Auditors opinion

An unqualified opinion indicates that theauditor believes the statements are free frommaterial omissions and errors.

A qualified opinion may be issued if theauditor has concerns about omissions anderrors.



Auditor’s Opinion

The auditor’s opinion will also contain anexplanatory paragraph when a material loss isprobable but the amount cannot bereasonable estimated. These “uncertainties” may relate to the going concern assumption,the valuation or realization of assets, or to

litigation. This type of disclosure may be asignal of serious problems and call for closerexamination by the analyst.

analysis of financial statements l2

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