Chapter 1
FINANCIAL STATEMENT ANALYSIS:
AN INTRODUCTION
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Presenter’s title
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CONTENTS
1. Introduction
2. Roles of Financial Reporting and Financial Statement Analysis
3. Primary Financial Statements and Other Information Sources
4. Financial Statement Analysis Framework
5. Summary
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FINANCIAL REPORTING
AND FINANCIAL STATEMENT ANALYSIS
Financial Reporting
Financial Statement Analysis
• Providing financial
information about an entity to
enable users to make
decisions
• Using financial information to
assess prior performance and
likely future performance to
make decisions
• Financial information includes
financial statements and
other types of reports
• Typical decision: capital
allocation
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FINANCIAL REPORTING
WHAT THE COMPANY REPORTED (EXCERPT)
Apple Reports Second Quarter Results
Revenue Grows 16 Percent and EPS Grows 30 Percent to New March Quarter
Records
CUPERTINO, California—May 1, 2018—Apple today announced financial results for
its fiscal 2018 second quarter ended March 31, 2018. The Company posted quarterly
revenue of $61.1 billion, an increase of 16 percent from the year-ago quarter, and
quarterly earnings per diluted share of $2.7, up 30 percent. International sales accounted
for 65 percent of the quarter’s revenue.
“We’re thrilled to report our best March quarter ever, with strong revenue growth in
iPhone, Services and Wearables,” said Tim Cook, Apple’s CEO. Customers chose iPhone
X more than any other iPhone each week in the March quarter, just as they did following
its launch in the December quarter.”
Excerpt from Apple’s earnings announcement (2Q2018)
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FINANCIAL STATEMENTS
• Statement of Financial Position
• Statement of Comprehensive Income
• Statement of Changes in Equity
• Statement of Cash Flows
• Notes
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STATEMENT OF FINANCIAL POSITION
Statement of Financial Position (the Balance Sheet):
• Assets = Liabilities + Owners’ equity
• Assets − Liabilities = Owners’ equity
• Point in Time
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CONSOLIDATED INCOME STATEMENT: HERSHEY
Total assets
Total liabilities and shareholders’ equity
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$ 7,703,020
$ 5,553,726
$ 7,703,020
$ 5,553,726
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ASSETS: LINDT & SPRÜNGLI GROUP
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LIABILITIES: 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:
1. Single statement of comprehensive income
2. Two consecutive statements
 Net Income = Income – Expenses
 Period of time.
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CONSOLIDATED STATEMENTS OF INCOME: HERSHEY
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CONSOLIDATED INCOME STATEMENT: LINDT &
SPRÜNGLI GROUP
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STATEMENT OF COMPREHENSIVE INCOME:
LINDT & SPRÜNGLI GROUP
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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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CONSOLIDATED STATEMENTS OF
SHAREHOLDERS’ EQUITY: HERSHEY
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STATEMENT OF CHANGES IN EQUITY: LINDT &
SPRÜNGLI GROUP
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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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Other
37,278
THE HERSHEY COMPANY
CONSOLIDATED
STATEMENTS OF CASH8,585
FLOWS
Accounts receivable—trade, net
(in thousands)
Inventories
(12,746)
77,291
51,375
Changes in assets and liabilities, net of business acquisitions and divestitures:
CONSOLIDATED STATEMENTS OF CASH FLOWS:
HERSHEY
(6,881)
21,096
Prepaid
and31,
other current assets
For the years
endedexpenses
December
Accounts payable and accrued liabilities
Operating Activities
Accrued income taxes
Net income including noncontrolling interest
Contributions to pension and other benefit plans
Adjustments to reconcile net income to net cash provided by operating activities:
Other assets and liabilities
Depreciation and amortization
Net cash provided by operating activities
Stock-based compensation expense
I nvesting Activities
Deferred income taxes
Capital additions (including software)
Impairment of long-lived and intangible assets (see Notes 3 and 7)
Proceeds from sales of property , plant and equipment and other long-lived assets
Write-down of equity investments
Proceeds from sales of businesses, net of cash and cash equivalents divested
Gain on settlement of SGM liability (see Note 2)
Equity investments in tax credit qualifying partnerships
Other
Business acquisitions, net of cash and cash equivalents acquired
Changes in assets and liabilities, net of business acquisitions and divestitures:
Net cash used in investing activities
Accounts receivable—trade, net
Financing Activities
Inventories
Net increase (decrease) in short-term debt
Prepaid expenses and other current assets
Long-term borrowings
Accounts payable and accrued liabilities
Repayment of long-term debt
Accrued income taxes
Repayment of tax receivable obligation
Contributions to pension and other benefit plans
Payment of SGM liability (see Note 2)
Other assets and liabilities
Cash dividends paid
Net cash provided by operating activities
Repurchase of common stock
I nvesting
Activities
Exercise
of stock options
(39,899)
2018
(100,252)
$
Portions omitted
Capital
additions
(including
software)
Net cash
provided
by (used
in) financing
activities
Proceeds
from
sales
of
property
,
plant
and equipment
Effect of exchange rate changes on cash and cash
equivalentsand other long-lived assets
Proceeds
from
sales
of
businesses,
net
of
cash
and cash equivalents divested
Increase (decrease) in cash and cash equivalents
Equity
tax creditof
qualifying
Cash and
cashinvestments
equivalents,inbeginning
period partnerships
Business
acquisitions,end
netofofperiod
cash and cash equivalents acquired
Cash and
cash equivalents,
Net cash used in
investinge activities
Supplemental
Disclosur
Financing
Activities
Interest paid
Repayment of long-term debt
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$
(42,955)
2016
(63,467)
(71,027)
756,537
(56,433)
49,761
261,853
1,249,515
51,061
$
(937)
720,044
(41,697)
16,443
301,837
1,013,428
54,785
18,582
(257,675)
208,712
7,609
66,209
—
—
(78,598)
77,291
—
(38,097)
(269,476)
4,204
3,651
43,482
—
(26,650)
(44,255)
51,375
(285,374)
(1,502,894)
8,585
(328,664)
(6,881)
(595,454)
21,096
(71,404)
(81,426)
18,214
954
(52,960)
—
(71,027)
—
(56,433)
—
49,761
(526,272)
1,249,515
(300,312)
13,965
275,607
(42,955)
792,953
(63,467)
(500,000)
(937)
—
(41,697)
(35,762)
16,443
(499,475)
1,013,428
(592,550)
63,323
(328,601)
116,108
49,759
(5,388)
167,048
207,819
(52,641)
380,179
(1,338,459)
587,998 $
(1,502,894)
63,288
(257,675)
(843,768)
7,609
6,129
83,212—
(78,598)
296,967
380,179— $
94,831
(269,476)
(464,396)
132,486 $
645,805
118,842
101,874 $
(81,426)
351,832
1,199,845
(910,844)
See Notes to Consolidated Financial Statements.
Repayment of tax receivable obligation
$
13,965
18,214
2017
(52,960)
36,255
(328,601)
57,729
49,759
50,329
167,048
—
(52,641)
37,278
(1,338,459)
(12,746)
645,805
(39,899)
1,199,845
(100,252)
(910,844)
75,568
(72,000)
(25,864)
—
(2,471)
(562,521)
1,599,993
(247,500)
$
Net
increase
Income
taxes
paid (decrease) in short-term debt
Long-term borrowings
75,568
1,171,051
(25,864)
(2,471)
295,144
1,599,993
49,286
(71,404)
(72,000)
(328,664)
3,651
(3,140)
(49,562)—
(44,255)
346,529
(285,374)
296,967
(595,454)
90,951
275,607
425,539
954
792,953
—
(500,000)
—
—
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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 accumulated depreciation. The assets are depreciated using the
straight-line method over the period of their expected useful economic life. Depreciation
on assets is calculated using the straight-line method to reduce the carrying amount to the
expected residual value. The following useful lives have been applied: - Buildings (incl.
installations) 5-40 years – Machinery 10-15 years – Other fixed assets 3-8 years Land is
not depreciated. Profits and losses from disposals are recorded in the income statement.
Excerpt from Lindt & Sprüngli Group, Annual Report (2018)
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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
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
2018 compared with 2017
Net sales increased 3.7% in 2018 compared with 2017, reflecting a benefit from the
recent Amplify and Pirate Brands acquisitions of 3.6% and a volume increase of
1.3%, partially offset by unfavorable price realization of 1.0% and an unfavorable
impact from foreign currency exchange rates of 0.2%. Excluding the unfavorable
impact from foreign currency exchange rates, our net sales increased 3.9%.
Consolidated volumes increased due to the acquisitions of Amplify and Pirate
Brands, as well as solid performance in select international markets, which more
than offset the volume reduction resulting from the sale of SGM in July 2018. The
net increase in volume was partially offset by unfavorable net price realization,
which was primarily attributed to incremental trade promotional expense in the
North America segment in support of 2018 programming.
Excerpt from Hershey’s MD&A, Annual Report (2018)
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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.
- Key Audit Matters and Critical Audit Matters are included in the report for certain
entities.
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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 (e.g., 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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