Financial Statement Analysis quiz

The balance sheet portrays the company’s financial position on a specified date. The income statement and statement of cash flows present different aspects of performance during the period.

In general, analysts seek to examine the past and current performance and financial position of a company in order to form expectations about its future performance and financial position.

The primary role of financial statement analysis is to use financial reports prepared by companies to evaluate their past, current, and potential performance and financial position for the purpose of making investment, credit, and other economic decisions.

The financial statement analysis framework consists of six steps. Step 2: "Gather data" includes acquiring the company's financial statements and other relevant data on its industry and the economy. Step 3. "Process the data" includes activities such as making any appropriate adjustments to the financial statements and preparing exhibits such as graphs and common-size balance sheets.

Corporate reports and press releases are written by management and are often viewed as public relations or sales materials. An analyst should review information on the economy and the company's industry and compare the company to its competitors. This information can be acquired from sources such as trade journals, statistical reporting services, and government agencies. Securities and Exchange Commission (SEC) filings include Form 8-K, which a company must file to report events such as acquisitions and disposals of major assets or changes in its management or corporate governance and proxy statements, which are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options.

Financial statement analysis refers to the use of information from a company's financial statements along with other information to make economic decisions regarding that company. Financial reporting refers to the reports and presentations that a company uses to show its financial performance to investors, creditors, and other interested parties. Financial reporting is a requirement for companies that are listed on public exchanges .

The standard auditor's report contains three parts :

1. The financial statements are prepared by management and are their responsibility and the auditor has performed an independent review.
2. The audit was conducted using generally accepted auditing standards, which provides reasonable assurance that there are no material errors in the financial statements .
3. The auditor is satisfied the statements were prepared in accordance with accepted accounting principles, and the principles chosen and estimates are reasonable .

Under U.S. GAAP, the auditor is required to state an opinion on the company's internal controls. The auditor may add this opinion as a fourth element of the auditor's report or provide it separately .

Interim reports, either quarterly or semi-annual, contain updated information on a company’s performance and financial position since the last annual report.

(management discussion and analysis) is incorrect . The MD&A is part of the annual report and is not an update since the last annual report .

(proxy statements) is incorrect . Proxy statements contain information about matters that will be put to a vote at shareholders’ meetings .

The notes provide information that is essential to understanding the information provided in the primary statements.

The role of financial reporting is described by the International Accounting Standards Board (IASB) in its "Framework for the Preparation and Presentation of Financial Statements" :

The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions .

Using the information in a company's financial statements to make economic decisions is financial analysis, not financial reporting .

Profitability is the performance aspect measured by the income statement. The balance sheet portrays the financial position. The statement of cash flows presents a different aspect of performance.

Information about management and director compensation is not found in the auditor’s report. Disclosure of management compensation is required in the proxy statement, and some aspects of management compensation are disclosed in the notes to the financial statements.

Proxy statements contain information related to matters that come before shareholders for a vote, such as elections of board members .

Revenues for a reporting period are presented on a company's income statement. They can be, but are not required to be, classified as operating and nonoperating revenues. Cash from operating activities is presented on the company's statement of cash flows, but this is not necessarily equal to operating revenues because revenue might be recognized in a different period than cash is collected. The balance sheet displays a company's financial position at a fixed point in time .

The financial statement analysis framework consists of six steps :

1. State the objective and context. Determine what questions the analysis is meant to answer, the form in which it needs to be presented, and what resources and how much time are available to perform the analysis.

2. Gather data. Acquire the company's financial statements and other relevant data on its industry and the economy. Ask questions of the company's management, suppliers, and customers, and visit company sites.

3. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.

4. Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports. 

5. Report the conclusions or recommendations. Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.

6. Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.

The balance sheet reports a company's financial position at a point in time. In contrast, the income statement and the cash flow statement report a company's financial performance over a reporting period .

For publicly traded U.S. firms, the MD&A portion of the financial disclosure is required to discuss results of operations, capital resources and liquidity and a general business overview based on known trends. A discussion of unusual or infrequent items may be included in the MD&A, but is not required .

The balance sheet reports a company’s Financial position as of a specific date. The income statement, cash flow statement, and statement of changes in owners’ equity show the company’s performance during a specific period .

This is the role of financial reporting. The role of financial statement analysis is to evaluate the financial reports.

IFRS recommends that management commentary address the company's key relationships, resources, and risks, as well as the nature of the business, management's
objectives, the company's past performance, and the performance measures used. Securities regulators may impose requirements for publicly traded firms to address
certain topics in management's commentary, but accounting standards do not .

An unqualified opinion is a “clean” opinion and indicates that the financial statements present the company’s performance and financial position fairly in accordance with a specified set of accounting standards .

Owners’ equity is the owners’ residual interest in (i.e., residual claim on) the company’s assets after deducting its liabilities, which is information presented on the balance sheet .

Auditors make an independent review of financial statements, which are prepared by company management and are management's responsibility. It is the responsibility of auditors to confirm the assets, liabilities, and other items included in the statements and then issue an opinion concerning their fairness and reliability.

Securities and Exchange Commission (SEC) filings are available from EDGAR (Electronic Data Gathering, Analysis, and Retrieval System, www.sec.gov). Companies' annual and quarterly financial statements are also filed with the SEC (Form 10-K and Form 10-Q, respectively) .

Preparing common-size financial statements is part of the process data step.

(Collect data) is incorrect. The financial statements are obtained in the collect data step, but not converted into common-size statements until the process step.

(Analyze/interpret data) is incorrect. Preparing common-size financial statements is part of the process data stage, after which the analyst will analyze/interpret the processed data.

For a publicly traded firm in the United States, the auditor must express an opinion as to whether the company’s internal control system is in accordance with the Public Accounting Oversight Board, under the Sarbanes–Oxley Act. The opinion is given either in a final paragraph in the auditor’s report or as a separate opinion.

(state that the financial statements are prepared according to generally accepted accounting principles) is incorrect. The statements are those prepared by management, not the auditor. The auditor is expressing an opinion as to whether the statements are fairly presented and free from material error.

(ensure that the financial statements are free from error, fraud, or illegal acts) is incorrect. The auditor only provides reasonable assurance that the statements are free from material error.

The follow-up phase involves gathering information and repeating the analysis to determine whether it is necessary to update reports and recommendations.

The footnotes are an integral part of the audited financial statements in a firm's annual report and are included in the audit opinion .

This statement describes the role of an auditor, rather than the role of an analyst. The other responses describe the role of financial statement analysis .

Information about accounting methods and estimates is contained in the footnotes to the financial statements .

A company’s revenues and expenses are presented on the income statement, which is used to evaluate a company’s financial results (or profitability) from business activities over a period of time. A company’s financial position is best evaluated by using the balance sheet. A company’s sources of cash flow are best evaluated using the cash flow statement.

The balance sheet represents information at a specific point in time. The income  statement represents information over a period of time .

Ratios are an output of the process data step but are an input into the analyze/interpret data step .

Weak internal controls provide an opportunity for low-quality or even fraudulent financial reporting. A firm's management, not its board of directors, is responsible for ensuring the effectiveness of a firm's internal controls. Under U.S. GAAP, auditors are required to state an opinion on a firm's internal controls.

Management's perspective on the company's results is provided in the Management's Discussion and Analysis supplement to the financial statements. Financial statement notes (footnotes) provide information about matters such as the company's accounting methods and assumptions, contingencies, and acquisitions and disposals. Footnotes to the financial statements are audited .

Determining the suitability of an investment for a client is not one of the six steps in the Financial statement analysis framework. The analyst would only perform this function if he also had an advisory relationship with the client. Stating the objective and processing the data are two of the six steps in the framework. The others are gathering the data, analyzing the data, updating the analysis, and reporting the conclusions .

These are components of management commentary.

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 other investors, or whether to extend trade or bank credit to the company. Although the financial statements might provide indirect evidence about the management skill of the company's executives, that is  not generally considered the role of financial statement analysis .

Proxy statements are issued to shareholders when there are matters that require a shareholder vote. These statements, which are also filed with the SEC and available from EDGAR, are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options.

The financial statement analysis framework consists of six steps :

1. State the objective and context.
2. Gather data.
3. Process the data.
4. Analyze and interpret the data.
5. Report the conclusions or recommendations.
6. Update the analysis.

The financial statement analysis framework consists of six steps :

1. State the objective and context. Determine what questions the analysis is meant to answer, the form in which it needs to be presented, and what resources and how much time are available to perform the analysis.

2. Gather data. Acquire the company's financial statements and other relevant data on its industry and the economy. Ask questions of the company's management, suppliers, and customers, and visit company sites.

3. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.

4. Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports. 

5. Report the conclusions or recommendations. Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.

6. Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.

Financial reporting refers to the way companies show their financial performance to investors, creditors, and other interested parties by preparing and presenting financial statements. The objective of financial statements, not analysis, is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. The role of financial statement analysis, not reporting, is to use the information in a company's financial statements, along with other relevant information, to assess a company's past performance in order to draw conclusions about the company's ability to generate cash and profits in the future.

 A qualified audit opinion is 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.

Interim reports are typically provided semiannually or quarterly and present the four basic financial statements and condensed notes. They are not audited. Unqualified is a type of audit opinion .

When performing financial statement analysis, analysts should review all company sources of information as well as information from external sources regarding the economy, the industry, the company, and peer (comparable) companies .

Assessment of performance includes analysis of profitability and cash flow generating ability. The relationship between assets and liabilities is used to assess a company’s financial position, not its performance.

(profitability) is incorrect. Assessment of performance includes analysis of profitability.

(cash flow generating ability) is incorrect. Assessment of performance includes analysis of cash flow generating ability.

auditor will issue a qualified opinion if the financial statements make any exceptions to applicable accounting standards and will explain the effect of these exceptions in the auditor’s report .

The role of financial reporting is to provide information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users in making economic decisions.

(the audit report) is incorrect. Audit reports express an opinion about the fair presentation of the financial statements.

(financial statement analysis) is incorrect. The role of financial statement analysis is to take the financial reports and evaluate the past, current, and prospective performance and financial position of a company for the purpose of making investment, credit, and other economic decisions .

 A company’s profitability is best evaluated using the income statement. The income statement presents information on the financial results of a company’s business activities over a period of time by communicating how much revenue was generated and the expenses incurred to generate that revenue .

Interim reports are provided semi-annually or quarterly, depending on applicable regulatory requirements.

(are audited) is incorrect. Interim reports are not audited.

(include a full set of financial statements and notes) is incorrect. Interim reports generally present the four basic financial statements and condensed notes.

The notes disclose choices in accounting policies, methods, and estimates .

Discussion of a firm's past performance and future outlook is most likely to be found in management's commentary.

The basic components of owners’ equity are paid-in capital and retained earnings. In the paid-in capital account, an example of an increase in owners’ equity is a new equity issuance. Cash dividends reduce retained earnings and owners’ equity. Share repurchases reduce paid-in capital and owners’ equity.

(Share repurchase ) is incorrect because for the paid-in capital account an example of a decrease in owners’ equity is the repurchase of previously issued shares.

(Cash dividend) is incorrect because a cash dividend payment is the most common cause of a decrease in owners’ equity.

Financial reporting refers to the way companies show their financial performance to investors, creditors, and other interested parties by preparing and presenting financial statements, including information about changes in a company's financial position. 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, such as whether to invest in the company's securities or recommend them to other investors. 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 .

Companies should disclose in management commentary any critical accounting policies that require management to make subjective judgements that may have a significant impact on reported financial results. These subjective judgements should be carefully reviewed because they may materially alter an analyst’s conclusions about the future performance or financial position of a company

(future revenue projections must be disclosed) is incorrect because companies are not required to disclose future revenue projections in the management’s discussion and analysis section of financial statements, but should highlight any favorable or unfavorable trends or uncertainties that may impact future performance or financial position.

(management commentary is typically unaudited) is incorrect because although management commentary is typically unaudited, it is not a reason why management commentary is of importance to analysts. Rather, analysts should be aware that management commentary is unaudited and interpret accordingly.

The statements that the financial information was prepared according to GAAP should be included in the regular part of the auditors' report and not as an explanatory paragraph. The other information would be contained in explanatory paragraphs added to the auditors' report.

To be in compliance with Sarbanes–Oxley, it is mandatory that management’s Report to Shareholders discuss internal financial controls and their effectiveness, as well as the company’s auditor’s opinion of these internal controls.

(The suitability of management and director compensation agreements) is incorrect. Information on management and director compensation agreements will be found in the proxy statement and/or notes to the financial statements.

(The accuracy of estimates and assumptions used in preparing the financial statements) is incorrect. Estimates and assumptions used in preparing financial statements are found in the notes to the financial statements.

The independent audit report provides reasonable assurance that the financial statements are fairly presented, meaning that there is a high probability that the audited financial statements are free from material error, fraud, or illegal acts that have a direct effect on the financial statements.

The statement of cash flows describes a firm's inflows and outflows of cash during a reporting period from operating, investing, and financing activities. Financing transactions such as issuance of debt or stock are shown on the statement of cash flows. The statement of financial position (balance sheet) presents the firm's assets, liabilities, and equity at a point in time. The statement of comprehensive income (income statement) does not directly reflect a firm's financing transactions. Cash  raised is not included in a firm's revenues and dividends paid and debt principal repaid are not included in its expenses .

The notes disclose information about the accounting policies, methods, and estimates used to prepare the financial statements.

(a discussion of significant trends, events, and uncertainties that affect the operating results) is incorrect. The management commentary (or MDA), which is not part of the notes to financial statements, includes a discussion of significant trends, events, and uncertainties that affect the operating results.

(an auditor’s opinion as to the fair presentation of the financial statements) is incorrect. The Auditor’s Report, which is not part of the notes to financial statements, includes the auditor’s opinion as to the fair presentation of the financial statements.