Introduction to Financial Statement Analysis quiz

When performing financial statement analysis, analysts should review all company sources of information as well as information from external sources regarding the economy, the industry, the company, and peer (comparable) companies .

The balance sheet portrays the company’s financial position on a specified date. The income statement and statement of cash flows present different aspects of performance during the period.

The statements that the financial information was prepared according to GAAP should be included in the regular part of the auditors' report and not as an explanatory paragraph. The other information would be contained in explanatory paragraphs added to the auditors' report.

Management's perspective on the company's results is provided in the Management's Discussion and Analysis supplement to the financial statements. Financial statement notes (footnotes) provide information about matters such as the company's accounting methods and assumptions, contingencies, and acquisitions and disposals. Footnotes to the financial statements are audited .

For publicly traded U.S. firms, the MD&A portion of the financial disclosure is required to discuss results of operations, capital resources and liquidity and a general business overview based on known trends. A discussion of unusual or infrequent items may be included in the MD&A, but is not required .

Financial reporting refers to the way companies show their financial performance to investors, creditors, and other interested parties by preparing and presenting financial statements. The objective of financial statements, not analysis, is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. The role of financial statement analysis, not reporting, is to use the information in a company's financial statements, along with other relevant information, to assess a company's past performance in order to draw conclusions about the company's ability to generate cash and profits in the future.

Preparing common-size financial statements is part of the process data step.

(Collect data) is incorrect. The financial statements are obtained in the collect data step, but not converted into common-size statements until the process step.

(Analyze/interpret data) is incorrect. Preparing common-size financial statements is part of the process data stage, after which the analyst will analyze/interpret the processed data.

Interim reports are typically provided semiannually or quarterly and present the four basic financial statements and condensed notes. They are not audited. Unqualified is a type of audit opinion .

The financial statement analysis framework consists of six steps :

1. State the objective and context. Determine what questions the analysis is meant to answer, the form in which it needs to be presented, and what resources and how much time are available to perform the analysis.

2. Gather data. Acquire the company's financial statements and other relevant data on its industry and the economy. Ask questions of the company's management, suppliers, and customers, and visit company sites.

3. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.

4. Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports. 

5. Report the conclusions or recommendations. Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.

6. Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.

The follow-up phase involves gathering information and repeating the analysis to determine whether it is necessary to update reports and recommendations.

For a publicly traded firm in the United States, the auditor must express an opinion as to whether the company’s internal control system is in accordance with the Public Accounting Oversight Board, under the Sarbanes–Oxley Act. The opinion is given either in a final paragraph in the auditor’s report or as a separate opinion.

(state that the financial statements are prepared according to generally accepted accounting principles) is incorrect. The statements are those prepared by management, not the auditor. The auditor is expressing an opinion as to whether the statements are fairly presented and free from material error.

(ensure that the financial statements are free from error, fraud, or illegal acts) is incorrect. The auditor only provides reasonable assurance that the statements are free from material error.

This is the role of financial reporting. The role of financial statement analysis is to evaluate the financial reports.

The statement of cash flows describes a firm's inflows and outflows of cash during a reporting period from operating, investing, and financing activities. Financing transactions such as issuance of debt or stock are shown on the statement of cash flows. The statement of financial position (balance sheet) presents the firm's assets, liabilities, and equity at a point in time. The statement of comprehensive income (income statement) does not directly reflect a firm's financing transactions. Cash  raised is not included in a firm's revenues and dividends paid and debt principal repaid are not included in its expenses .

The role of financial reporting is to provide information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users in making economic decisions.

(the audit report) is incorrect. Audit reports express an opinion about the fair presentation of the financial statements.

(financial statement analysis) is incorrect. The role of financial statement analysis is to take the financial reports and evaluate the past, current, and prospective performance and financial position of a company for the purpose of making investment, credit, and other economic decisions .

Proxy statements are issued to shareholders when there are matters that require a shareholder vote. These statements, which are also filed with the SEC and available from EDGAR, are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options.

Ratios are an output of the process data step but are an input into the analyze/interpret data step .

Securities and Exchange Commission (SEC) filings are available from EDGAR (Electronic Data Gathering, Analysis, and Retrieval System, www.sec.gov). Companies' annual and quarterly financial statements are also filed with the SEC (Form 10-K and Form 10-Q, respectively) .

Proxy statements contain information related to matters that come before shareholders for a vote, such as elections of board members .

The primary role of financial statement analysis is to use financial reports prepared by companies to evaluate their past, current, and potential performance and financial position for the purpose of making investment, credit, and other economic decisions.

Profitability is the performance aspect measured by the income statement. The balance sheet portrays the financial position. The statement of cash flows presents a different aspect of performance.

Owners’ equity is the owners’ residual interest in (i.e., residual claim on) the company’s assets after deducting its liabilities, which is information presented on the balance sheet .

In general, analysts seek to examine the past and current performance and financial position of a company in order to form expectations about its future performance and financial position.

To be in compliance with Sarbanes–Oxley, it is mandatory that management’s Report to Shareholders discuss internal financial controls and their effectiveness, as well as the company’s auditor’s opinion of these internal controls.

(The suitability of management and director compensation agreements) is incorrect. Information on management and director compensation agreements will be found in the proxy statement and/or notes to the financial statements.

(The accuracy of estimates and assumptions used in preparing the financial statements) is incorrect. Estimates and assumptions used in preparing financial statements are found in the notes to the financial statements.

Corporate reports and press releases are written by management and are often viewed as public relations or sales materials. An analyst should review information on the economy and the company's industry and compare the company to its competitors. This information can be acquired from sources such as trade journals, statistical reporting services, and government agencies. Securities and Exchange Commission (SEC) filings include Form 8-K, which a company must file to report events such as acquisitions and disposals of major assets or changes in its management or corporate governance and proxy statements, which are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options.

The balance sheet represents information at a specific point in time. The income  statement represents information over a period of time .

Auditors make an independent review of financial statements, which are prepared by company management and are management's responsibility. It is the responsibility of auditors to confirm the assets, liabilities, and other items included in the statements and then issue an opinion concerning their fairness and reliability.

The notes disclose choices in accounting policies, methods, and estimates .

Information about accounting methods and estimates is contained in the footnotes to the financial statements .

The role of financial reporting is described by the International Accounting Standards Board (IASB) in its "Framework for the Preparation and Presentation of Financial Statements" :

The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions .

Using the information in a company's financial statements to make economic decisions is financial analysis, not financial reporting .

The financial statement analysis framework consists of six steps :

1. State the objective and context. Determine what questions the analysis is meant to answer, the form in which it needs to be presented, and what resources and how much time are available to perform the analysis.

2. Gather data. Acquire the company's financial statements and other relevant data on its industry and the economy. Ask questions of the company's management, suppliers, and customers, and visit company sites.

3. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.

4. Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports. 

5. Report the conclusions or recommendations. Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.

6. Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.