CHAPTER 1
FINANCIAL STATEMENT ANALYSIS: AN
INTRODUCTION
FINANCIAL REPORTING AND FINANCIAL
STATEMENT ANALYSIS
Financial Reporting
Financial Statement Analysis
• Providing financial
information about an
entity to enable users to
make decisions
• Financial information
includes financial
statements and other
types of reports
• Using financial information
to assess prior
performance and likely
future performance to
make decisions
• Typical decision: capital
allocation
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FINANCIAL REPORTING
WHAT THE COMPANY REPORTED (EXCERPT)
Apple Reports Second Quarter Results
Record March Quarter Sales of iPhones, iPads and Macs
Net Profit Increases 94% Year-over-Year
CUPERTINO, California—April 24, 2012—Apple® today announced financial results for
its fiscal 2012 second quarter ended March 31, 2012. The Company posted quarterly
revenue of $39.2 billion and quarterly net profit of $11.6 billion, or $12.30 per diluted
share. These results compare to revenue of $24.7 billion and net profit of $6.0 billion, or
$6.40 per diluted share, in the year-ago quarter. Gross margin was 47.4 percent compared to
41.4 percent in the year-ago quarter. International sales accounted for 64 percent of the
quarter’s revenue.
Excerpt from Apple’s earnings announcement (2Q2012)
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FINANCIAL ANALYSIS
ANALYSTS’ RESPONSE (EXCERPT)
On April 24, 2012, Apple (AAPL) reported results that blew
past everyone's expectations, including our expectations.
Apple reported quarterly revenue of $39.2B and quarterly
profit of $11.6B, or $12.30 EPS. This surpassed the $10.07
consensus estimates from the analyst community. Apple
saw growth due to strong sales growth from all of its
product lines. Revenue enjoyed a mammoth 59% increase
versus Q2 2011 and EPS grew by over 92%. EPS Growth
was also aided by a higher gross margin, which was aided
by lower commodity input costs associated with Apple's
products.
Saibus Research , Seeking Alpha (25 April 2012)
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FINANCIAL STATEMENTS
• Statement of Financial Position
• Statement of Comprehensive Income
• Statement of Changes in Equity
• Statement of Cash Flows
• Notes
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FINANCIAL STATEMENTS
STATEMENT OF FINANCIAL POSITION
Statement of Financial Position (the Balance Sheet)
 Assets = Liabilities + Owners’ equity
 Assets − Liabilities = Owners’ equity
 Point in Time
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Assets of Lindt &
Sprüngli Group
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Liabilities and Equity of Lindt & Sprüngli Group
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FINANCIAL STATEMENTS:
STATEMENT OF COMPREHENSIVE INCOME
 Also known as the income statement, statement of earnings, or profit
and loss statement
 Comprehensive income: All items that affect owners’ equity but are not
the result of transactions with shareholders
 Comprehensive income = Net income + Other comprehensive income
 Presentation permitted
 Single statement of comprehensive income
 Two consecutive statements
 Net Income = Income – Expenses
 Period of time
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Lindt & Sprüngli Group
Income Statement
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Lindt & Sprüngli Group
Statement of Comprehensive Income
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FINANCIAL STATEMENTS:
STATEMENT OF CHANGES IN EQUITY
 Also known as statement of changes in owners’ equity or
statement of shareholders’ equity
 Period of time
 Beginning equity + Changes in equity = Ending equity
 Basic components of owners’ equity are paid-in capital and
retained earnings.
 Beginning common stock + Issuances – Repurchases =
Ending common stock
 Beginning retained earnings + Net Income – Dividends =
Ending retained earnings
 Beginning AOCI + OCI = Ending AOCI
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Lindt & Sprüngli Group
Statement of Changes in Equity
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FINANCIAL STATEMENTS
STATEMENT OF CASH FLOWS
 Period of time
 Beginning Cash + Changes in cash = Ending cash
 Changes in cash from
 Operating
 Investing
 Financing
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Portions omitted
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ACCOMPANYING NOTES
• The notes (also sometimes referred to as footnotes) that accompany
the four financial statements are required and form an integral part of
the statements.
• Notes include information on
- Significant accounting choices (policies, methods, and estimates).
- Explanatory detail about line items on the face of the financial
statements.
- Other disclosures, such as commitments and contingencies.
• Based on notes disclosures, analysts can understand whether
accounting choices are similar for the companies being compared. If
the policies differ, an analyst can often make necessary adjustments so
that the financial statement data used are more comparable.
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EXAMPLE OF DISCLOSURE OF
ACCOUNTING PRINCIPLES IN NOTES
Property, plant, and equipment — Property, plant, and equipment are valued at
historical cost, less the accumulated depreciation. The assets are depreciated using the
straight-line method over the period of their expected useful economic life.
Historical cost includes all costs associated with the acquisition. Subsequent costs
increasing the value of an asset are, depending on the case, either recorded in the book
value of the asset or as a separate asset, to the extent that it can be assumed that it is
likely that the Group will benefit from it in the future and that its costs can be calculated
in a reliable manner. All other repair or maintenance costs are reflected in the income
statement in the year of their occurrence.
Land is not depreciated. Depreciation on other assets is calculated using the
straight-line method to write down their cost to their residual values. The following
useful lives have been applied:
− Buildings (incl. installations): 5 – 40 years
− Machinery: 10 – 15 years
− Other fixed assets: 3 – 8 years
Profits and losses from disposals are recorded in the income statement.
Excerpt from Lindt & Sprüngli Group, Annual Report (2011)
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EXAMPLE OF DISCLOSURE OF LINE ITEM
DETAIL IN NOTES
Excerpt from Lindt & Sprüngli Group, Annual Report (2011)
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EXAMPLE OF DISCLOSURE IN NOTES
Excerpt from Lindt & Sprüngli Group, Annual Report (2011)
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MANAGEMENT COMMENTARY OR MD&A
• Management commentary
- Is a narrative report that provides a context within which to interpret
the financial position, financial performance, and cash flows of an
entity.
- Provides explanations of the amounts in the financial statements.
- Provides information on a company’s prospects.
- Provides management with an opportunity to explain its objectives
and its strategies for achieving those objectives.
- Encompasses reporting that jurisdictions may describe as
management’s discussion and analysis (MD&A), operating and
financial review (OFR), or management’s report.
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CONTENTS OF MANAGEMENT COMMENTARY
The IFRS practice statement Management Commentary states that the
management commentary should include information that is essential to an
understanding of:
1) the nature of the business;
2) management’s objectives and its strategies for meeting those objectives;
3) the entity’s most significant resources, risks, and relationships;
4) the results of operations and prospects; and
5) the critical performance measures and indicators that management uses to
evaluate the entity’s performance against stated objectives.
In the United States, the SEC requires listed companies to provide an MD&A and
specifies the content. 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.
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EXAMPLE OF MD&A EXPLANATION OF
AMOUNTS IN FINANCIAL STATEMENTS
Net Sales
2011 compared with 2010
Net sales increased 7.2% in 2011 compared with 2010 due to net price
realization and sales volume increases in the U.S. and for our international
businesses. Net price realization contributed approximately 3.5% to the net sales
increase primarily due to the impact of list price increases, offset somewhat by
higher promotional rates. Sales volume increased net sales by approximately
3.4% due primarily to sales of new products in the U.S. The favorable impact of
foreign currency exchange rates increased net sales by approximately 0.3%.
Excerpt from Hershey’s MD&A, Annual Report (2011)
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EXAMPLE OF MD&A INFORMATION ON THE
COMPANY’S PROSPECTS
OUTLOOK
The outlook section contains a number of forward-looking statements, all of which are
based on current expectations. Actual results may differ materially.....
Excluding the Brookside acquisition, we expect volume to be slightly up for the full year
2012, resulting in net sales growth of about 5% to 7%, including the impact of foreign
currency exchange rates….
We expect reported gross margin to increase approximately 90 basis points in 2012….
We expect full-year adjusted earnings per share-diluted, including the adjustment for
non-service related pension expenses, to increase 9% to 11%....
Cash Flows from Investing Activities
…We anticipate total capital expenditures, including capitalized software, of
approximately $280 million to $295 million in 2012…
Excerpt from Hershey’s MD&A, Annual Report (2011)
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AUDITOR’S REPORTS
• Financial statements presented in companies’ annual reports are
generally required to be audited (examined) by an independent
accounting firm in accordance with specified auditing standards.
• An audit report is a written opinion on the financial statements
prepared by the independent auditor.
• Objectives of the independent auditor in conducting an audit:
- To obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement (whether
due to fraud or error), enabling the auditor to opine on whether the
statements are prepared in accordance with applicable financial
reporting framework
- To report on the financial statements
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TYPES OF AUDITOR’S REPORTS
• Unqualified audit opinion: “Clean” opinion. States that the financial statements
give a “true and fair view” (international) or are “fairly presented” (international
and U.S.) in accordance with applicable accounting standards. This opinion is
the one that analysts would like to see in a financial report.
• Other types of opinions:
- Qualified audit opinion: 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.
- Adverse audit opinion: Issued when an auditor determines that the financial
statements materially depart from accounting standards and are not fairly
presented. Generally, an analyst would not bother analyzing these
statements.
- Disclaimer of opinion: Issued when the auditors are unable to issue an
opinion for some reason, such as a scope limitation.
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INTERNAL CONTROL SYSTEM
• The internal control system is the company’s internal
system that is designed, among other things, to ensure that
the company’s process for generating financial reports is
sound.
• Some countries (e.g., the United States) require an
additional audit opinion on the company’s internal control
systems.
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INFORMATION SOURCES BESIDES
ANNUAL FINANCIAL STATEMENTS
• Annual report or proxy statement: Management compensation and governance
information
• Interim reports: (Unaudited) financial statements with updated information on a
company’s performance and financial position since the last annual period
• Press releases, particularly earnings announcements, and conference calls
• Presentations to analysts
• External data sources for information on
- the economy
- the industry
- the company and peer (comparable) companies
• Regulatory context, where applicable
• Direct experience of the company’s products and services
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STEPS IN FINANCIAL STATEMENT ANALYSIS
Phase
1. Articulate the Purpose and Context of the Analysis
2. Collect Data
3. Process Data
4. Analyze/Interpret the Processed Data
5. Develop and Communicate Conclusions and Recommendations
6. Follow-Up
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ARTICULATE THE PURPOSE AND
CONTEXT OF ANALYSIS
• Purpose of analysis: evaluate the historical performance of a company
(trend and cross sectional), prepare a forecast of future performance,
value a company’s equity or debt securities, prepare rating or
recommendation
• Define the context
- Intended audience
- End product
- Time frame
- Resources and resource constraints
• Based on purpose and context, formulate questions to be answered
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COLLECT DATA, PROCESS DATA,
ANALYZE DATA
• Collect data required to answer questions.
• Use analytical tools to process data:
- Ratio analysis
- Common-size financial statements
• Analyze data:
- Use financial ratios to assess a company’s profitability, liquidity,
leverage, and efficiency relative to its own past (trend analysis) and
relative to peer/benchmark companies.
- Synthesize all available information to develop expectations about a
company’s likely future performance.
- Develop forecasts and use as input to valuation.
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DEVELOP AND COMMUNICATE
CONCLUSIONS/RECOMMENDATIONS
• Communicate the conclusion or recommendation in an appropriate
format.
• Appropriate format will vary by analytical task, by institution, and/or by
audience.
• An equity analyst’s report would typically include the following
components:
- Summary and investment conclusion
- Earnings projections
- Valuation
- Business summary
- Risk, industry, and competitive analysis
- Historical performance
- Forecasts
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FOLLOW-UP
• If an equity investment is made or a credit rating is
assigned, periodic review is required to determine whether
the original conclusions and recommendations are still
valid.
• Follow-up may involve repeating all the previous steps in
the process on a periodic basis.
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SUMMARY
-
Financial statements include
- statement of financial position (balance sheet);
- statement of comprehensive income;
- statement of changes in equity;
- statement of cash flows; and
- notes.
- Analysts use various information sources in financial statement
analysis besides annual financial statements.
- For example, MD&A, earnings announcements, external data
sources, and direct experience.
- Steps in financial analysis:
- articulate purpose and context,
- collect data,
- process data,
- analyze data,
- develop and communicate conclusions and recommendations, and
- follow-up.
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