INRODUCTION TO FINANCIAL STATEMENT ANALYSIS

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INRODUCTION TO FINANCIAL STATEMENT ANALYSIS

• Chapter 1

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CHAPTER 1 OBJECTIVES

• Understand the decision emphasis of financial
  statement analysis and why a comprehensive
  approach is needed to meet this objective.
• Indicate who uses financial statements and how
  they use them to make decisions.

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CHAPTER 1 OBJECTIVES (CONT.)

• Show the importance of generally accepted
  accounting principles (GAAP) to analysis, which
  organizations determine GAAP, why GAAP differs
  among countries, and the benefits of harmonizing
  GAAP.
• Determine the various concepts of capital
  maintenance and attributes of asset measurement.

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CHAPTER 1 OBJECTIVES (CONT.)

• Articulate the benefits and limitations of the
  nominal dollar capital maintenance concept and
  historical cost valuation in financial reporting
  and analysis.
• Explain how inconsistent terminology, data
  volume, transaction complexity, information
  variability, and financial statement limitations
  can affect financial statement analysis.

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OVERALL PERSPECTIVE

• Analysisseparation of something into its parts
  to study its nature, proportion, function, and
  interrelationship
• Analytical processprovides insights about how
  the entirety operates, where it came from, and
  where it is going

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OVERALL PERSPECTIVE (CONT.)

• Financial statement analysis
• Art and science of examining corporate financial
  statements
• Financial statementscorporate monetary
  disclosures

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OVERALL PERSPECTIVE (CONT.)

• Objective of this book Students will
• Learn how to analyze financial statements
• Critically evaluate corporate disclosures and
  related information

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COMPREHENSIVE ANALYSIS

• Business environmentan analyst must understand
  the context in which a company does business
•  
• Components of business environment
• Overall economy
• Legal environment
• Political climate
• Cultural context

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COMPREHENSIVE ANALYSIS (CONT.)

• Data sources
• amount and variety of information sources needed
  to conduct analysis
• Qualities of data sources
• Timing-current versus historical
• Potential bias-objective versus subjective
• Type-quantitative versus qualitative

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CATEGORIES OF ANALYSTS

• Equity investorsowners who seek to maximize
  return on investment, subject to a given risk
  level
• Credit granterslenders who seek payment of
  principal and interest in a timely manner
• Corporate managersowners agents who seek
  information to plan and control their entitys
  operations

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CATEGORIES OF ANALYSTS (CONT.)

• Merger and acquisitions specialistsprofessionals
  who, for a fee, realign corporations to maximize
  shareholder value
• Internal and external auditorsindependent
  evaluators who attest to the fairness of
  managerial representations (external auditors)
  and corporate employees who seek to improve
  business operations (internal auditors)

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CATEGORIES OF ANALYSTS (CONT.)

• Regulatorsrepresentatives of government entities
  who judge an entitys compliance with existing
  laws and regulatory requirements
• Corporate employeesindividuals, or their
  collective bargaining agents, who seek to
  maximize compensation for their services

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REPORTING STANDARDS

• Authoritative pronouncements that when taken
  together with accepted financial reporting
  conventions compose generally accepted accounting
  principles (GAAP)

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REPORTING STANDARDS (CONT.)

• Collaborative partnership
• Securities and Exchange Commission
  (SEC)quasi-governmental agency that has the
  legal authority to set reporting standards
• Financial Accounting Standards Board
  (FASB)private U.S. standard setting body that
  determines most authoritative pronouncements

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REPORTING STANDARDS (CONT.)

• Financial reporting standards consist of
• Corporate financial statements
• Notes to the financial statements
• Supplemental financial statement disclosures

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REPORTING STANDARDS (CONT.)

• International dimension
• Countries determine national generally accepted
  accounting principles
• Differences in business formation, development,
  and activity produce various national standards
• GAAP is classified into models, such as the Anglo
  American and European Models of accounting or
  financial reporting

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REPORTING STANDARDS (CONT.)

• International Accounting Standards Committee
  (IASC)collaborative effort by the accounting
  bodies of many nations to reduce financial
  reporting alternatives and harmonize accounting
  standards lacks enforcement power of national
  bodies, such as the FASB

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DISCLOSURE CHALLENGES

• Desirable qualitative characteristics of
  financial reporting
• Relevant information matters to analysts by
  helping them predict the future
• Reliable information can be verified and is
  unbiased

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DISCLOSURE CHALLENGES (CONT.)

• Capital maintenance selection
• Amount of investment that must be recovered
  through revenues before income is earned
  alternative concepts exist that result in
  different degrees of relevance and reliability in
  the financial statements

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DISCLOSURE CHALLENGES (CONT.)

• Nominal dollar concept of capital
  maintenancerecognizes income after recovering
  the number of dollars invested in the asset sold
  ignores overall inflation rate or price changes
  for specific goods underlies the current system
  of financial reporting in the U.S. and most
  countries

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DISCLOSURE CHALLENGES (CONT.)

• General purchasing power concept of capital
  maintenanceincome results when an entity
  recovers more revenues than the general
  purchasing power equivalent of its investment
  not GAAP

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DISCLOSURE CHALLENGES (CONT.)

• Physical capital concept of capital
  maintenanceincome results when an entity
  recovers more revenues than the current cost of
  its investment not GAAP

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DISCLOSURE CHALLENGES (CONT.)

• Historical costprinciple that governs asset
  measurement used with the nominal dollar concept
  of capital maintenance to compose financial
  reporting system

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DISCLOSURE CHALLENGES (CONT.)

• Information complexitiesobstacles that hinder
  financial statement disclosures and analysis
• Inconsistent terminology and financial statement
  formats vary among companies and over time
• Numerous information sources provide substantive
  amounts of data

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DISCLOSURE CHALLENGES (CONT.)

• Information complexities (cont.)
• Transaction complexities reflect the increasingly
  complicated ways in which business is conducted
• Data sources vary greatly with respect to their
  relevance and reliability
• Financial statements report only selected events
  in constant monetary units and on the basis of
  historical cost