International Financial Statement Analysis Chapter One

Why is cash flow not a complete measure of performance?

because as seen in chapter one, a company may be oligated to make future cash transactions as a result of a transactions that results in positive cash flow at the current time

How does flexibility create challenges for analyst?

because the use of different policies and methods and estimates reduces the ability to compare one company to the next.

What are examples of specific economic decisions analysts have in mind when evaluating reports?

1. Evaluate equity investment for inclusion in a port. 2. evaluate a merger or acquisition 3. evaluate a subsidiary or operating div. of parent company. 4. deciding whether to make a venture capital or other private equity investment 5. Determining the creditworthiness of a company in order to decided whether to extend a loan 6. extending credit to a customer 7. examine compliance with debt covenants or other contractual arrangements 8. valuing a security for making an investment recommendation to another 9. Forecasting future net income and cash flow

What is the top-down approach to determining the industry analysis for a given company?

1. gain an understanding of the macroeconomic environment, such as prospects for growth in the economy and inflation. analyze the prospects of the industry in which the subject company operates based on the expected macroeconmic environ. 3. determine the prospects for the company in the expected industry and macroeconomic environments

What are the five content elements for "decision useful management commentary"?

1. nature of business 2. managements objectives and strategies 3. significant resources, risks, and relationships 4. results of operations 5. critical performance measures

When a parent company owns ____ of the voting shares of a subsidiary company, it is presumed to control the subsidiary and thus needs _____

50% presents consolidated income statements

Net income "bottom line" net earnings net profit etc...

= revenue + other income - expenses = income -expenses

What is depreciation?

A cost allocation method Various methods to depreciate and item. Two companies may use two different methods this hinders an analysts ability to compare the two companies to one another.

Balance Sheet Equation

Assets = Liabilities + Equity

What questions can an analyst answer using the balance sheet?

Has the company's liquidity improves from last year? Is the company solvent? What is the companies financial position in the industry?

The indirect method approach for statement of cash flows?

Begins with profit before Tax -actual income tax payments then adjusts this amount for the effects of non-cash transactions, accurals and defferals, and transactions of an investing and financing nature

IFRS permit more flexibility that ______ in classifying dividend and interest receipts and payments within these categories.

US GAAP

Are financial statements infallible?

NO.

What is operating income referred to as?

Earnings before interest and taxes

What else do the notes to fin. statements contain information about?

Financial instruments and risks rising from financial instruments Commitments and contingencies Legal proceedings Related-party transactions Subsequent events (events that occure after the balance sheet date) business acquistions and disposals operating segments performance

What does a complete set of financial statements include?

Income Statement/ Statement of comprehensive income Statement of Financial Position (Balance Sheet) (at a given point in time) statement of changes in equity statement of cash flows accompanying notes and footnotes

Examples of Non-Current assets

Intangible assets PPE Leasing and rental assets Investment Property Equity accounted invest other equity investments Financial services receivables Other financial receivables and fin. assets Noncurrent tax receivables Deferred tax assets

What is the IFRS?

International Financial Reporting Standards

The Audit Report

Introductory --> describes the financial statements that were audited and the responsibilities of both management and the independent auditor Scope --> describes the nature of the audit process and the auditors expression about reasonable assurance on the fairness of the financial statements opinion --> expresses the auditor's opinion on fairness of the statements

Examples of Current Assets

Inventories Trade receivables Financial services receivables other receivables and financial assets Current Tax receivables Marketable securities Cash and cash equivalents Assets held for sale

What questions arise from the income statement?

Is the change in revenue related to an increase in units sold, an increase in prices, or some combination? If the company has mutliple business segments, how are the segment's revenue and profits changing? How does the company compare with other companies in the industry?

MD&A

Management discusses a variety of issues of concern, including the nature of the business, past results, and future outlook Recommended by International Organization of Securities Commissions and required by the regulatory authorities such as SEC or the UK financial services authority

Is information included in the MD&A audited?

No. information in this section is typically unaudited.

Ideally, and analyst would like to see that the primary flow of cash is from ______ instead of ______ and ______

Operating instead of investments and financing

What are the classification categories on the statement of cash flows?

Operating, investing and financing

What are the basic components of owners equity?

Paid-in capital retained earnings

What is profit?

Profit --> The difference between prices at which goods and services are sold to customers and the expense of those goods/services also includes other income (investment income, income from selling a car etc...) minus expense of this income

Gross Profit =

Sales Revenue - Cost of Goods Sold

True or False: Both IFRS and US GAAP allow some flexibility in choosing among alternative policies and methods when accounting for certain items?

TRUE

What is Financial analysis?

The process of examining a company's performance in the context of its industry and economic environment in order to arrive at a decision or recommendation

What does the flexibility aim to do?

aims to meed the divergent needs of many businesses for reporting a variety of economic transactions. allows companies to select the policies and methods most appropriate for their business and allow them to demonstrate the MOST fair economic conditions.

What can an examination of performance of a company include?

an assessment of a company's profitability (ability to earn profit from goods and services) the ability to generate positive cash flow

What did the IASB issue in terms of MD&A

an exposure draft or proposed framework for the preparation

The footnotes/supplementary schedules?

are required and are an integral part of the financial statements give more information that aids in understanding the four main statements. disclose the basis of preparation for the financial statments disclose information about the accounting principles, methods and estimates used to prepare statements.

how are income statments reported?

as a consolidated basis they include the income and expenses of subsidiary companies under the control of the parent (reporting) company

The Statement of Cash Flows

cash flow is vital to a company's longterm succuess. discloses the sources and uses of cash for a company

What is cash flows from investing?

cash flows from activities associated with the acquisition and disposal of long-term assets, such as property and equipment.

What is the formula for the change in net cash flow during the fiscal year?

change in net cash flow during the fiscal year = net cash from ops. + net cash from inv. + net cash from fin.

What does the IFRS require?

companies to present classified balance sheets that show current and non-current assets and liabilities as seperate classifications Usually presented on the balance sheet from least to most liquid

why is cash flow so important?

company needs cash to pay employees, suppliers, and others to continue ops.

what is an investor in equity securities concerned about?

company's ability to pay dividends and the likelihood the share price will increase.

What is the goal of financial analysis?

evaluate company's ability to earn a return on its capital at least to equal the cost of capital to profitably grow its operations to generate enough cash to meet obligations and pursure opps.

how is the financial position of a company assessed?

comparing the amnt of asssets in relation to the liabilities and equity

Audit reports maybe required by ________

contractual arrangement law regulation

Retained Earnings

cumulative amount of the company's profits that have been retained into the company

The direct method approach for statement of cash flows?

discloses major classes of gross cash receipts and gross cash payments. Ex. Cash paid to suppliers and employees Cash received from customers

What information is typically included when an analyst sets out to analyze a company?

economic info industry info comparable peer companies

Where does the information come from?

economic statistics industry reports trade publications and databases Comapany reports, press releases, coference calls, and webcasts

How to Canada, USA, and Australia format their balance sheets?

from most liquid to least liquid

Other income includes?

gains, which may or may not arise in ordinary activities of a business

Why is the statement of cash flows useful?

helps creditors, investors and others evaluate the company's liquidity, solvency, and financial flexibility

What is other Comprehensive income?

includes all items that impact owners equity but are not the result of the transactions with shareowners. some of this items are included in the calc. of net income and some are included in other comprehensive income.

In general, the financial statments of a company are required to be examined by an __________

independent accounting firm in accordance with specified auditing standards the auditor then provides an audit report

Phase one: Articulate the Purpose and Context of the analysis

info --> The nature of the analysts function such as evaluating debt/equity or issuing credit communication with client/supervisor on needs/concerns institutional guidelines related to developing specific work product output --> purpose of objectives a list of specific questions to be answered by analysis nature/content of report to be provided timetable and budgeted resources for completion

What does fundamental analysis begin with?

information in the financial reports

Phase two: collect input data

input : financial statements/questionnaires and industry/economic data discussions with management, suppliers, customers and competitors company site visits output: organized financial statements financial data tables complete questionnaires

What does comparability help with?

it helps distinguish difference between companies that are NOT a result of using different accounting principles, methods and estimates

If the parent does not own 100% of the subsidiary, what is necessary?

it is necessary for the parent to present an allocation of net income to the minority of interests

What does the additional information include?

letter from a chairman Management discussion and analysis external auditor report a governance report

The SEC requires ______ companies to provide an MD&A and specifies content.

listed management must highlight any favorable or unfavorable trends and identify significant events and uncertainties that affect the company's liquidity, capital resources and results of operations.

What does a company who generates positive cash flow have?

more felxibility in funding needed investments and taking advantage of attractive bus. opps.

expenses > revenues

net loss

Example of paid- in capital?

new issuance of stock

Does the independent auditor provide absolute assurance?

no the auditor provides reasonable assurance that the statements are fairly represented

what are minority interests also called?

non-controlling interests. referring to the remaining shares of the subsidiary that are not owned by the parent

What else is included in equity?

non-controlling or minority interests and reserves that represent accumulated other comprehensive income items are included in equity

Where is the share of consolidated net income attributable minority interests shown?

on the bottom of the income statement along with the net income attributable to shareholders of parent company

In the US under the Sarbanes Oxley Act, auditors must also express an ______

opinion on the company's internal system of controls

Under IFRS, when _______ is presented in two statesments, _________ begins with ______or ______ from the income statement and then presents the components of ________

other comprehensive the statement of other comprehensive income profit loss other comprehensive income

What is the most common decrease in equity?

payment of dividends

Who uses financial reports?

people outside the company (investors, creditors, analysts etc..)

The Balance Sheet/ Statement of Financial Position

presents a company's current financial position by comparing the amnt of asssets to amnt of liabilities and equity

What is the Income Statement?

presents information on the financial results of a company's business activities over a period of time. communicates how much revenues was generated and the expenses incurred

What are interim reports?

provide updated information on a company's performance and the financial position since the last annual report

What do the decisions/rec pertain to?

providing capital to companies whether to invest in company's debt or equity securitites and at what price

Expenses

reflect outflows. depletions of assets and incurrences of liabilities that decreas equity includes items such as Cost of Goods Sold, administrative expenses, and income tax expense.

In many jurisdictions some or all additional information is regulated by ______ or _______

regulators or accounting standards board

Earnings per share

represent net income attributable to the class of shareholders divided by the number of shares outstanding during the period

Owners equity

represents the excess of assets over liabilities amnt attributable to owners and shareholders the owner's residual claim (interest) in the company's assets deducting the liabilities

Example of a decrease in equity?

repurchase of stock

What are cash flows from financing activities?

those cash flows from activities related to obtaining or repaying capital to be used in business.

What is the most common increase in equity?

retained earnings

Statement of Changes in Equity

serves to report changes in the owners investment in the business overtime.

Phase five: Develop and communicate conclusions and recommendations

sources: analytical results and previous reports institutional guidelines for published reports output: analytical report answering questions posed in phase 1. Recommendation regarding the purpose of the analysis, such as whether to make an investment or grant credit.

Phase three: process data

sources: data from phase two output: adjusted financial statements common size statements ratios and graphs forecasts analytical results

Phase six: follow up

sources: info, gathered by periodically repeating the above steps to determine whether changed have occured output: updated reports and recommendations

Phase four: analyze/interpret the processed data

sources: input data as well as processed data info: analytical results

What are proxy statements?

statements distributed to shareholders about matters that are to be put to a vote at the company's annual meeting.

What does the cash flow state. present?

the ability of the company to generate cash via its operations, investments, and financing.

What is financial flexibility?

the ability of the company to react and adapt to financial adversaries and opportunities.

what is solvency?

the ability to meet long term obligations

what is liquidity?

the ability to meet short term obligations

Revenue refer to..?

the amounts charged for the delivery of goods and services in the ordinary activities of a business

What is an investor in debt securities concerned about?

the company's ability to pay interest and repay the principle lent

What does the indirect method emphasize?

the different perspectives of the income statement and cash flow statement on the income statment, income is recorded when earned NOT NECESSARILY when received. Expenses are recorded when incurred, NOT NECESSARILY when paid.

MD&A must also provide information about __________

the effects of inflation, changing prices, and other information that may cause the futuring operating/financial results to change. must provide off the balance sheet information

diluted shares?

the number of shares that would hypothetically be outstanding if potentially diluted claims on common shares (stock options, convertible bonds) were to be exercised

What is an earning announcement?

the senior executives describe the companys performance and answer questions

Where does the US permit people to present components of other comprehensice income?

the statement of changes in equity

What is the internal system of control?

the system that is designed to ensure that the company's process for generating financial reports is sound. Management is in charge of implementing, maintaing and reporting on the internal system of controls

What is Cash Flows from Operating?

those cash flows not classified as investing or financing generally involve the cash effects of trans. that enter into the determination of net income and comprise the day-to-day operations of the company

What are the objectives of an auditor according to international standards?

to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement making sure fraud does not occur to report the financial statements and communicate as required by ISA in accordance with the auditors findings

What is the role of financial analysis?

to use financial reports prepared by companies, combined with other information, to evaluate the past, current and potential performance and financial position of a company for the purpose of making investments, credit, and other economic decisions

Opinion categories

unqualified (clean) --> financial statements give "true and fair view" or are fairly represented qualified --> audit opinion is one in which there is some scope limitation or exception to accounting standards. adverse --> opinion issued when an auditor determine that the financial statement materially depart from accounting standards and are not fairly represented. disclaimer of opinion --> occurs when, from some reason, such as a scope limitation, the auditors are unable to issue an opinion

How is basic eps calcualted?

using the weighted average of shares outstanding from the past two periods

When can comparability happen?

when different companies information is measured and reported in a similar manner over time.