#analyst-notes #cfa-level-1 #fra-introduction #has-images #reading-22-financial-statement-analysis-intro #study-session-7Financial statements are the most important outcome of the accounting system. They communicate financial information gathered and processed in the company's accounting system to parties outside the business.
The four principal financial statements are:
These four financial statements, augmented by footnotes and supplementary data, are interrelated. In addition, there are other sources of financial information, such as management discussion and analysis, auditor's reports, etc.
The income statement summarizes revenues earned and expenses incurred, and thus measures the success of business operations for a given period of time. It explains some but not all of the changes in the assets, liabilities, and equity of the company between two consecutive balance sheet dates.
The income statement lists income and expenses as they are directly related to the company's recurring income. The format of the income statement is not specified by U.S. GAAP and actual format varies across companies. The following is a generic sample:
The goal of income statement analysis is to derive an effective measure of future earnings and cash flows. Analysts need data with predictive ability, hence income from continuing (recurring) operations is considered to be the best indicator of future earnings. As operating expenses do not include financing costs such as interest expenses, operating income (EBIT) is independent of the company's capital structure.
In the typical income statement this means segregating the results of normal, recurring operations from the effects of nonrecurring or extraordinary items to improve the forecasting of future earnings and cash flows. The idea here is that recurring income is persistent. If an item in the unusual or infrequent component of income from continuing operations is deemed not to be persistent, then recurring (pre-tax) income from continuing operations should be adjusted.
The net income figure is used to prepare the statement of retained earnings.
A balance sheet provides a "snapshot" of a company's financial condition. Think of the balance sheet as a photo of the business at a specific point in time. It reports major classes and amounts of assets, liabilities, stockholders' equity, and their interrelationships as of a specific date.
Cash Flow Statement
The primary purpose of the cash flow statement is to provide information about a company's cash receipts and cash payments during a period. It reports the cash receipts and cash outflows classified according to operating, investment, and financing activities.
The cash flow statement is useful because it provides answers to the following simple yet important questions:
The statement's value is that it helps users evaluate liquidity, solvency, and financial flexibility.
The details of income statements, balance sheets and cash flow statements will be covered in Study Session 8.
Statement of Changes in Owners' Equity
This statement reports the amounts and sources of changes in equity from capital transactions with owners. It reports ownership interests in order of preference upon liquidation and dividends. For example, the first item listed gets paid off first after creditors in the event of liquidation.