An+Overview+of+Financial+Statement+Analysis

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AN OVERVIEW OFFINANCIAL

STATEMENT ANALYSIS ACC5212 Financial Statement Analysis


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BASIC CONSIDERATIONSTo evaluate financial statements, you must:1. Be acquainted with business practices,2. Understand the purpose, nature, and limitations of

accounting,3. Be familiar with the terminology of business and

accounting,4. Have a working knowledge of the fundamentals of

finance, and5. Be acquainted with the tools of financial statement

analysis.


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Disclosure Notes

Summary ofSignificantAccounting Policies

Conveys valuable informationabout the companys choices fromamong various alternative

accounting methods.

Subsequent EventsA significant development thatoccurs after the companys fiscal

year-end but before the financialstatements are issued or available

to be issued.

Noteworthy Eventsand Transactions

Transactions or events that arepotentially important to evaluatinga companys financial statements,

e.g., related parties, errors andirregularities, and illegal acts.


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Management Discussion and Analysis

Provides a biased but

informed perspective ofa companysoperations, liquidity,

and capital resources.


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Managements Responsibilities

Preparing the financial

statements and otherinformation in the annualreport.

Maintaining and assessingthe companys internal controlprocedures.


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Auditors Report Expresses the auditors opinion

as to the fairness ofpresentation of the financial

statements in conformity withgenerally accepted accountingprinciples.


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Auditors Opinions

UnqualifiedIssued when the financial statementspresent fairly the financial position,results of operations, and cash flows

are in conformity with GAAP.

QualifiedIssued when there is an exception that

is not of sufficient seriousness toinvalidate the financial statements as a

whole.

AdverseIssued when the exceptions are so

serious that a qualified opinion is not justified.

DisclaimerIssued when insufficient information

has been gathered to express anopinion.


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Compensation of Directors and

Top ExecutivesProxy Statement Information Summary Compensation Table

Salary Bonus Stock Awards Option Awards Other Compensation

A proxy statement is sent each yearto all shareholders, usually in the

same mailing with the annual

report.


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Using Financial Statement Information

Comparative FinancialStatements

Allow financial statement users tocompare year-to-year financial

position, results of operations, andcash flows.

Horizontal Analysis

Expresses each item in thefinancial statements as a

percentage of that same item in thefinancial statements of another

year (base amount).

Vertical Analysis

Involves expressing each item inthe financial statements as a

percentage of an appropriatecorresponding total, or baseamount, within the same year.

Ratio AnalysisAllows analysts to control for sizedifferences over time and among

firms.


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Horizontal Analysis

Horizontal (or trend analysis ) enables comparison ofdata for a single company or single industry over a periodof time.

It indicates in which direction a company is headed. Trendpercentages are computed by taking a base year andassigning its figures as a value of 100. Figures generatedin subsequent years are expressed as percentages ofbase-year numbers.


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With 20x1 taken as the base year, its numbers are dividedinto those from subsequent years to yield comparativepercentages. For example, net sales in 20x1 ($775,000)is divided into 20x5s net -sales figure ($910,000).


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Trend percentages show horizontally the degree of increase or

decrease, but they do not indicate the reason for the changes. They do serve to indicate unfavorable developments that willrequire further investigation and analysis.

A significant change may have been caused by a change in theapplication of an accounting principle or by controllable internalconditions, such as a decrease in operating efficiency.


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Vertical Analysis

Vertical analysis involves the conversion of itemsappearing in statement columns into terms of percentagesof a base figure to show the relative significance of theitems and to facilitate comparison.

For example, individual items appearing on the incomestatement can be expressed as percentages of sales.

On the balance sheet, individual assets can be expressedin terms of their relationship to total assets.

Liabilities and shareholders equity accounts can beexpressed in terms of their relationship to total liabilitiesand shareholders equity.


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On the retained earnings statement, beginning retainedearnings is 100 percent.

Note: The percentages for the company in question canbe compared with industry norms.


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SUMMARY OF FINANCIAL RATIOS


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Ratios are based on accounting data . Ratios are not ends in themselves but help investors

provide answers to questions concerning specific issuesand insights into the operations of a business enterprise.


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Financial reporting should provide information to help

present and potential investors and creditors and otherusers in assessing the amounts, timing, and uncertainty ofprospective cash receipts from dividends or interest and

the proceeds from the sales, redemption, or maturity ofsecurities or loans. Since investors and creditors cashflows are related to enterprise cash flows, financialreporting should provide information to help investors,

creditors, and others assess the amounts, timing, anduncertainty of prospective net cash inflows to the relatedenterprise.


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HOW THE FINANCIAL STATEMENTSTIE TOGETHER


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QUALITATIVE CHARACTERISTICS OFACCOUNTING INFORMATION


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Constraints Materiality. Information is material if it can have an effect

on a decision made by users. One consequence ofmateriality is that GAAP need not be followed if an item isimmaterial. The threshold for materiality will dependprincipally on the relative dollar amount of the transaction.

Cost vs Benefit (cost effectiveness). Information is costeffective only if the perceived benefit of increaseddecision usefulness exceeds the anticipated costs of

providing that information.


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User-Specific Quality Understandability means that users must understand the

information and its significance. This is a user-specific quality because users will differ in

their ability to comprehend information. The overriding objective of financial reporting is to provide

comprehensible information to those who have areasonable understanding of business and economicactivities and are willing to study information.


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Primary Qualities Relevance. The capacity of information to make a

difference in a decision by helping users to formpredictions about the outcomes of past, present, andfuture events or to confirm or correct prior expectations.

Reliability. The quality of information that assures thatinformation is reasonably free from error and bias andfaithfully represents what it purports to represent.


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Relevance Predictive Value. The quality of information that helps

users to increase the likelihood of correctly forecasting theoutcome of past or present events.

Feedback Value. The quality of information that enablesusers to confirm or correct prior expectations.

Timeliness. Having information available to a decisionmaker before it loses its capacity to influence decisions.


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Reliability Verifiability. The ability through consensus among

measures to ensure that information represents what itpurports to represent or that the chosen method ofmeasurement has been used without error or bias.

Representational Faithfulness. Correspondence oragreement between a measure or description and thephenomenon that it purports to represent (sometimescalled validity).

Neutrality. Information presented should not to favorparticular groups or companies.


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Secondary Qualities Comparability. The quality of information that enables

users to identify similarities in and differences betweentwo sets of economic phenomena.

Consistency. Conformity from period to period withunchanging policies and procedures.


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