financial statements. While the income statement, balance sheet, and statement of
cash flows are covered in detail in subsequent readings, candidates should pay special
attention here to the other sources of information for financial analysis. The nature of
the audit report is important, as is the information that is contained in the footnotes to
financial statements, proxy statements, Management’s Discussion and Analysis, and
the supplementary schedules. A useful framework enumerating the steps in financial
statement analysis is presented.
LOS 21.a: Describe the roles of financial reporting and financial statement analysis.
CFA
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Study Session 6
Program Curriculum, Volume 3, page 6
Financial reporting refers to the way companies show their financial performance to
investors, creditors, and other interested parties by preparing and presenting financial
statements. According to the IASB Conceptual Framework for Financial Reporting 2010:
“The objective of general purpose financial reporting is to provide
financial information about the reporting entity that is useful to
existing and potential investors, lenders, and other creditors in making
decisions about providing resources to the entity. Those decisions
involve buying, selling or holding equity and debt instruments, and
providing or settling loans and other forms of credit.”
The role of financial statement analysis is to use the information in a company’s
financial statements, along with other relevant information, to make economic
decisions. Examples of such decisions include whether to invest in the company’s
securities or recommend them to investors and whether to extend trade or bank credit
to the company. Analysts use financial statement data to evaluate a company’s past
performance and current financial position in order to form opinions about the
company’s ability to earn profits and generate cash flow in the future.
Professor’s Note: This topic review deals with financial analysis for external users. Management
also performs financial analysis in making everyday decisions. However, management may rely
on internal financial information that is likely maintained in a different format and unavailable to
external users.
LOS 21.b: Describe the roles of the statement of financial position, statement of
comprehensive income, statement of changes in equity, and statement of cash flows
in evaluating a company’s performance and financial position.
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Program Curriculum, Volume 3, page 11
The balance sheet (also known as the statement of financial position or statement of
financial condition) reports the firm’s financial position at a point in time. The balance
sheet consists of three elements:
1. Assets are the resources controlled by the firm.
2. Liabilities are amounts owed to lenders and other creditors.
3. Owners’ equity is the residual interest in the net assets of an entity that
remains after deducting its liabilities.
Transactions are measured so that the fundamental accounting equation holds:
assets = liabilities + owners’ equity
The statement of comprehensive income reports all changes in equity except for
shareholder transactions (e.g., issuing stock, repurchasing stock, and paying dividends).
The income statement (also known as the statement of operations or the profit and
loss statement) reports on the financial performance of the firm over a period of time.
The elements of the income statement include revenues, expenses, and gains and
losses.
Revenues are inflows from delivering or producing goods, rendering services, or
other activities that constitute the entity’s ongoing major or central operations.
Expenses are outflows from delivering or producing goods or services that
constitute the entity’s ongoing major or central operations.
Other income includes gains that may or may not arise in the ordinary course of
business.
The income statement can be combined with “other comprehensive income” and
presented as a single statement of comprehensive income. Alternatively, the income
statement and the statement of comprehensive income can be presented separately.
The statement of changes in equity reports the amounts and sources of changes in
equity investors’ investment in the firm over a period of time.
The statement of cash flows reports the company’s cash receipts and payments. These
cash flows are classified as follows:
Operating cash flows include the cash effects of transactions that involve the
normal business of the firm.
Investing cash flows are those resulting from the acquisition or sale of property,
plant, and equipment; of a subsidiary or segment; of securities; and of
investments in other firms.
Financing cash flows are those resulting from issuance or retirement of the
firm’s debt and equity securities and include dividends paid to stockholders.
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