Introduction to Financial Statement Analysis quiz

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

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

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 .

This statement describes the role of an auditor, rather than the role of an analyst. The other responses describe the role of financial statement analysis .

The notes provide information that is essential to understanding the information provided in the primary statements.

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 .

The notes disclose information about the accounting policies, methods, and estimates used to prepare the financial statements.

(a discussion of significant trends, events, and uncertainties that affect the operating results) is incorrect. The management commentary (or MDA), which is not part of the notes to financial statements, includes a discussion of significant trends, events, and uncertainties that affect the operating results.

(an auditor’s opinion as to the fair presentation of the financial statements) is incorrect. The Auditor’s Report, which is not part of the notes to financial statements, includes the auditor’s opinion as to the fair presentation of the financial statements.

Financial reporting refers to the way companies show their financial performance to investors, creditors, and other interested parties by preparing and presenting financial statements, including information about changes in a company's financial position. The role of financial statement analysis is to use the information in a company's financial statements, along with other relevant information, to make economic decisions, such as whether to invest in the company's securities or recommend them to other investors. Analysts use financial statement data to evaluate a company's past performance and current financial position in order to form opinions about the company's ability to earn profits and generate cash flow in the future .

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.

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 .

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

These are components of management commentary.

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.

The financial statement analysis framework consists of six steps :

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

2. Gather data. Acquire the company's financial statements and other relevant data onits 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 thefirst step. Decide what conclusions or recommendations the information supports.

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

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

The financial statement analysis framework consists of six steps :

1. State the objective and context.
2. Gather data.
3. Process the data.
4. Analyze and interpret the data.
5. Report the conclusions or recommendations.
6. Update the analysis.

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

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.

The role of financial statement analysis is to use the information in a company's financialstatements, along with other relevant information, to make economic decisions. Examplesof such decisions include whether to invest in the company's securities or recommendthem to other investors, or whether to extend trade or bank credit to the company.Although the financial statements might provide indirect evidence about the managementskill of the company's executives, that is  not generally considered the role of financialstatement analysis .

 

The financial statement analysis framework consists of six steps :

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

2. Gather data. Acquire the company's financial statements and other relevant data onits 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 thefirst step. Decide what conclusions or recommendations the information supports.

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

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

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

The statements that the financial information was prepared according to GAAP should beincluded 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 theauditors' report.

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

Discussion of a firm's past performance and future outlook is most likely to be found inmanagement's commentary.

The basic components of owners’ equity are paid-in capital and retained earnings. In the paid-in capital account, an example of an increase in owners’ equity is a new equity issuance. Cash dividends reduce retained earnings and owners’ equity. Share repurchases reduce paid-in capital and owners’ equity.

(Share repurchase ) is incorrect because for the paid-in capital account an example of a decrease in owners’ equity is the repurchase of previously issued shares.

(Cash dividend) is incorrect because a cash dividend payment is the most common cause of a decrease in owners’ equity.

Information about management and director compensation is not found in the auditor’s report. Disclosure of management compensation is required in the proxy statement, and some aspects of management compensation are disclosed in the notes to the financial statements.

 A qualified audit opinion is one in which there is some scope limitation or exception to accounting standards. Exceptions are described in the audit report with additional explanatory paragraphs so that the analyst can determine the importance of the exception.

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.

Revenues for a reporting period are presented on a company's income statement. They can be, but are not required to be, classified as operating and nonoperating revenues. Cash from operating activities is presented on the company's statement of cash flows, but this is not necessarily equal to operating revenues because revenue might be recognized in a different period than cash is collected. The balance sheet displays a company's financial position at a fixed point in time .

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

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.