Introduction to Financial Statement Analysis quiz

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 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.

The independent audit report provides reasonable assurance that the financial statements are fairly presented, meaning that there is a high probability that the audited financial statements are free from material error, fraud, or illegal acts that have a direct effect on the financial statements.

The balance sheet reports a company’s Financial position as of a specific date. The income statement, cash flow statement, and statement of changes in owners’ equity show the company’s performance during a specific period .

The footnotes are an integral part of the audited financial statements in a firm's annual report and are included in the audit opinion .

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 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 .

A company’s revenues and expenses are presented on the income statement, which is used to evaluate a company’s financial results (or profitability) from business activities over a period of time. A company’s financial position is best evaluated by using the balance sheet. A company’s sources of cash flow are best evaluated using the cash flow statement.

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 .

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.

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 .

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

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 .

An unqualified opinion is a “clean” opinion and indicates that the financial statements present the company’s performance and financial position fairly in accordance with a specified set of accounting standards .

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 standard auditor's report contains three parts :

1. The financial statements are prepared by management and are their responsibility and the auditor has performed an independent review.
2. The audit was conducted using generally accepted auditing standards, which provides reasonable assurance that there are no material errors in the financial statements .
3. The auditor is satisfied the statements were prepared in accordance with accepted accounting principles, and the principles chosen and estimates are reasonable .

Under U.S. GAAP, the auditor is required to state an opinion on the company's internal controls. The auditor may add this opinion as a fourth element of the auditor's report or provide it separately .

Financial statement analysis refers to the use of information from a company's financial statements along with other information to make economic decisions regarding that company. Financial reporting refers to the reports and presentations that a company uses to show its financial performance to investors, creditors, and other interested parties. Financial reporting is a requirement for companies that are listed on public exchanges .

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 .

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.

Interim reports are provided semi-annually or quarterly, depending on applicable regulatory requirements.

(are audited) is incorrect. Interim reports are not audited.

(include a full set of financial statements and notes) is incorrect. Interim reports generally present the four basic financial statements and condensed notes.

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. Examples of such decisions include whether to invest in the company's securities or recommend them to other investors, or whether to extend trade or bank credit to the company. Although the financial statements might provide indirect evidence about the management skill of the company's executives, that is  not generally considered the role of financial statement analysis .

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.

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 .

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 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.

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

Interim reports, either quarterly or semi-annual, contain updated information on a company’s performance and financial position since the last annual report.

(management discussion and analysis) is incorrect . The MD&A is part of the annual report and is not an update since the last annual report .

(proxy statements) is incorrect . Proxy statements contain information about matters that will be put to a vote at shareholders’ meetings .

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.

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