TCH424E

Financial statement analysis

Lecturer: MSc. Nguyen Huy Hieu
[email protected]
 Course Learning Outcomes

• Understand the roles of financial statement analysis and the steps in the financial statement analysis
framework
• Analyse the uses and limitations of the balance sheet in financial analysis; Understand different types of assets
and liabilities, the components of shareholders’ equity and the measurement bases of each
• Assess the components of the income statement, general principles of revenue recognition and accrual
accounting, specific revenue recognition, and implications of revenue recognition principles for financial analysis
• Categorise cash flows from operating, investing, and financing activities and classify cash flow items as relating
to one of those three categories given a description of the items. Analyse free cash flow to the firm and free cash
flow to equity
• Differentiate types of tools and techniques used in financial analysis, including their uses and limitations
• Apply tools and techniques, and appraise the financial performance of the companies based on FiinPro
database
 Course structure
Chapter 1: Introduction to Financial Statements

Chapter 2: Introduction to Financial Statement Analysis

Chapter 3: Income statement and Income statement analysis

Chapter 4: Balance sheet and Balance sheet analysis

Chapter 5: Cash flow statement and Cash flow statement analysis

Chapter 6: Financial statement quality and Financial statement techniques

Chapter 7: Financial statement modelling

 Chapter 1
Introduction to Financial Statement
Reading: CFA (2024) Prerequisite Reading Vol 3 (LM1)

My slides
 Content
• Introduction

• The role of financial reports & financial reporting standards

• FS standard – setting bodies & regulatory authorities

• The Income Statement (IS)

• The Balance Sheet (BS)

• The Cash Flow Statement (CF)

 Expected learning outcomes
• The objective of financial reporting and the importance of financial reporting standards

• The roles of financial reporting standard - setting bodies and regulatory authorities in establishing
and enforcing reporting standards

• Describe the roles of the statement of financial positions (BS), statement of comprehensive income
(IS), statement of changes in equity, and statement of cash flows (CF) in evaluating a company’s
performance and financial positions
 What are financial reports?
Financial reports of a company include financial statements and other supplemental disclosure
necessary to assess a company’s financial position and periodic financial performance.

Financial statements are the results of an accounting process that records a company’s economic
transactions, following the applicable accounting standards and principles.

According to The International Accounting Standards Board (IASB):

“The objective of financial reporting is to provide financial information that is usefil to users in
making decisions about providing resources to the reporting entity, where those decisions relate to
equity and debt instruments, or loans or other forms of credit, and in influencing management’s
actions that affect the use of the entity’s economic resources”

(The Conceptual Framework for Financial Reporting)

 What are financial reports?
Financial reports helps users to make informed decisions related to the company.

The final purpose of financial reports’ users is to understand company’s stories behind those
meaningless numbers.

Question

• Are companies required to prepare financial reports? (Yes)

• Who can use information given in financial reports? (Stakeholders)
• Who prepare financial reports? (Accountants)
• Do companies need to prepare financial reports with the same format? (Uhm..)
• Are we required to learn financial reports? (Uhmmm...)
• Should we believe numbers in financial reports? (Auditor?)
• How to get a company’s financial reports?
 What are financial reports?
bao cao tai chinh hop nhat bao cao tai chinh rieng le

Consolidated Financial Report vs. Separate Financial Report

When one company (The parent) controls another company (The subsidiary), the parent presents
its own financial statement information consolidated with that of the subsidiary.

When a parent company owns more than 50 percent of the voting shares of a subsidiary company, it is
presumed to control the subsidiary and thus presents consolidated financial statements.

Each line item of the consolidated income statement includes the entire amount from the relevant
line item on the subsidiary’s income statement (After removing any intercompany transactions).
loi ich cua co dong khong kiem soat

Non – controlling interest/ Minority interest: if the parent does not own 100 percent of the
subsidiary, it is necessary for the parent to present an allocation of net income to the minority
interest. Minority interest refers to owners of the remaining shares of the subsidiary that are not
owned by the parent.
Who use financial reports for decision making?

Shareholders Creditors

Suppliers Managers

COMPANY

Employees
Customers

Government Board of
/Regulators Directors

Companies’ stakeholders
 Financial reports standards
v Accounting reporting standards
The underlying economic activities are complicated and dynamic and sometimes need judgements.
Standard – setting bodies: Private sector, self - regulated organizations with board members who are
experienced accountants, auditors, users of financial statements and academic.
• The International Accounting Standards Board (IASB), which issues IFRS (International Financial Reporting
Standards)
• The Financial Accounting Standards Board (FASB), which issues US GAAP (United States Generally Accepted
Accounting Principles). FASB is officially recognized as authoritative by the SEC.
Regulatory authorities: Have the legal authority to enforce financial reporting requirements and exert other
controls over entities that participate in the capital markets within their jurisdictions
• Securities and Exchange Commission - SEC (In US)
• Ministry of Finance - MOF (in Vietnam) with Circular 200/2014/TT-BTC, issueed VFRS
In general, standard-setting bodies set the standards and regulatory authorities recognize and enforce the
standards
 Financial reports standards
2 fundamental qualitative characteristics of financial reports
Purpose of the Financial Report: help users to make informed decisions
1. Relevance: Information is relevant if it would potentially affect or make a difference in users’ decisions.
Materiality: Information is considered to be material if omission or misstatement of the information could
influence users’ decisions. Materiality is a function of the nature and/or magnitude of the information.
Q: Read the audit opiniton about materiality
2. Faithful representation: Information that faithfully represents an economic phenomenon that it purports to
represent is ideally complete, neutral, and free from error.
Faithful representation also means “reliability”
 Financial reports standards
04 enhancing qualitative characteristics
• Comparability: Allows users “to identify and understand similarities and differences of items”.
• Verifiability: Different knowledgeable and independent observers would agree that the information
presented faithfully represents the economic phenomena it purports to represent.
• Timeless: Timely information is available to decision-makers prior to their making a decision.
• Understandability: Clear and concise presentation of information enhances understandability. Information
should be prepared for and be understandable by users who have a reasonable knowledge of business
and economic activities, and who are willing to study the information with diligence.
=> Financial information exhibiting these qualitative characteristics – should be useful for making economic
decisions.
 Financial reports standards
v Financial statements of public companies and large, privately owned companies are typically audited by
independent public accounting companies (“Big Four” in Auditing services)
v Constraints on financial reports
• In fact, a good financial reports system is quite costly => Managers must balance the cost – benefit tradeoff.
• Financial reports do not include non-quantifiable information (Trademark/ Customer’s loyalty...)
• Financial reports usually reflect the result of firms’ performance
• Information in the financial reports is historical
 Assumptions in Financial statement
v Two important assumptions underlie financial statements:
• “Accrual accounting”: Financial statements should reflect transactions in the period when they
actually occur, not necessarily when cash movements occur.
E.g. A company reports revenues when they are earned, regardless of whether the company received
cash before or after delivering the product, at the time of delivery.
Accrual accounting helps ensure related revenues and expenses are recognized in the same reporting
period, resulting in a more meaningful measure of net income.
• “Going concern”: the assumption that the company will continue in business for the foreaseable
future.
E.g. Consider the value of a company’s inventory if it is assumed that the inventory must all be sold in a
day.
v FS’s items recognition: An item is included in the balance sheet or income statement. Recognition occurs
if the item meets the definition of an element and satisifes the criteria for recognition.
 Types of financial reports
v There are 03 main financial reports:
• Statement of financial position/ Balance sheet (BS)
• Statement of comprehensive income/ Income statement (IS)
• Statement of cash flows/ Cash flow statement (CF)
• Statement of changes in Equity
v Besides, we must also pay attentions on:
• Financial notes
• Management discussion and analysis (MD&A)
• External auditor’s opinion
• ESG reports
• CSR report
• Corporate governance report
• .....
 Further information can come from..
v Stakeholders also use a variety of other information sources to acquire an understanding about the
company’s financial positions and financial performance, therefore assessing the company’s future
• Issuer sources: Earning calls; Presentations and events (such as investor days); Press releases; Speaking
with management, investor relations, or other company personnel.
• Public third–party sources: Industry reports, Analyst reports, Economic or industry indicators; General
news outlets; Industry-specific news outlets; Social media
• Proprietary third–party sources: Analyst reports and communications (Sell-side analysts, credit rating
agencies); Reports and data from platforms; Reports and data from consultancies.
• Proprietary primary research: Surveys, conversations, product comparisons, and other studies
commissioned by the analyst or conducted directly.
 Financial reports’ items measurement
v Measurement: The process of determining the monetary amount at which the elements of the
financial statement are recognized and carried in the financial statement.
• Historical cost: the amount of cash or cash equivalents paid to purchase an asset, including any costs of
acquisitions and/or preparation.
• Amortized cost: Historical cost adjusted for amortization, depreciation, or depletion and/or impairment.
• Current cost: The amount of cash or cash equivalents that would have to be paid to buy the same or
equivalent asset today (replacement cost).
• Realizable (Setlement) value: Realizable value is the amount of cash or cash equivalents that could
currently be obtained by selling the asset in an orderly disposal.
• Present value (PV): The discounted CF that the item generate in the future
• Fair value: The price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
 Income statement
v The income statement (IS)/ Statement of operations/ Profit & loss (P&L) statement: represents
information on the financial performance of a company’s business activities over a period of time.

v IS: A basic accounting statement that measures the results of a firm’s operations over a specified period. IS
is like a film recorded what a company have done in a financial period.

v It communicates how much revenue and other income the company generated during a period and the
expenses it incurred to generate that revenue and other income.

v The key formula of the income statement:

Sales – Expenses = Profits

 Elements of Income Statement
v Two elements of financial statements are directly related to the measurement of financial
performance:
Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other than those
relating to contributions from holders of equity claims.
Income includes revenues and gains.
§ Revenues represent income from the ordinary operating activities of the enterprise.
§ Gains may result from ordinary activities or other activities.
Expenses: Decrease in assets, or increase in liabilities, that result in decreases in equity, other than those
relating to distributions to holders of equity claims.
Expenses include COGS, SG&A...
 Income statement

Sales (Revenue) - Cost of goods solds (COGS) = Gross profits

Operating expenses

Operating income/
Earnings before taxes (EBT) = Interest expense (I) - Earning before Tax and Interest
(EBIT)
-

Income tax (T)

Net income (NI)

 Income statement
• Revenue/ Sales: Amounts charged for the delivery of g&s in the ordinary activities of a business.

Sales can be calculated as: Total sales = Selling prices x Units solds

• Cost of good solds (COGS): The cost of producing or acquiring the goods or services that were sold.

COGS consists of fixed costs (do not depend on units solds) and variable costs (depends on units sold).

• Operating expenses: including Marketing and selling expenses (the expenses related to marketing, selling
and distributing the products or services) and the firm’s Overhead expenses (general and administrative
expenses). It can be refered as Selling, General and Administrative (SG&A)

• Operating income: Rev – COGS – Operating Expenses. It can be referred as EBIT.

• EBT (Earning before tax - Taxable income) = EBIT – Interest expense in order to calculate the tax
payables.

• Net income: represents income that is owned by shareholders. It may be reinvested or distributed to its
owners.

• Earning per share (EPS) and Diluted EPS.

 Income statement
Revenue recognization
• Revenue is recognized when it is earned, so the company’s financial records reflect revenue from the sale
when the risk and reward of ownershup is transferred (accrual basis vs cash basis) - This is often when the
company delivers the goods or services.

• If the delivery was on credit, a related asset (trade or accounts receivable) is created. When cash is received,
the company’s financial records simply reflect that cash has been received to settle an account receivable.

• If a company receives cash in advance but delivers the product or service later, the accountant would record
a liability for unearned revenue/ deferred revenue. Revenue would be recognized over time as products and
services are delivered. (e.g. a subscription payment received in advance).
 Balance sheet
A firm’s balance sheet (BS) provides a snapshot of the firm’s financial position at a specific point in time.

BS represents its asset holdings, liabilities, and owner–supplied capital (stockholders’ equity).

Formula of BS: Total assets = Total liability + Total shareholder equity

or: A = L + E

Total assets: Represent the resources owned by the firm

Total liability and total equity indicate how those resources were financed.

Items in the balance sheet can be recognized as historical costs (Historical transactions at their cost) =>
The balance sheet reports a company’s book value.

Question: Does it possibly raise concerns with the number in BS?

 Elements of Balance Sheet
v Three elements of financial statements are directly related to the measurement of financial
positions
• Assets: A present economic resource controlled by the entity as a result of past events
An economic resource is a right that has the potential to produce economic benefits. Assets are what a
company owns.
• Liabilities: A present obligation of the entity to transfer an economic resource as a result of past events.
An obligation is a duty or responsibility that the entity has no practical ability to avoid.
Liabilities are what a company owes.
• Equity: Assets less liabilities. Equity is the residual interest in the assets after subtracting the liabilities.
 Balance sheet

Short – term debt (Current

liabilities)
Current Assets
• Accounts payable
• Cash
• Short – term debt (Notes payable)
• Accounts receivable
• Other current liabilities
• Inventories
• Other current assets Net working capital Long - term liabilities
(NWC)
• Long – term debt (notes payable)
• Mortgage

Long – term (Fixed) assets

Stockholders’ equity
• Fixed assets (Net PPE)
• Preferred stock
• Other long – term assets
• Common stock
• Goodwill
• Pair value
• Patents
• Pair in capital
• Trademarks
• Retained earning
 Balance sheet
Types of asset: Assets are listed from the most liquid to the least liquid in the order of decreasing liquidity.

Liquidity refers to the ability of an asset to be quickly converted into cash without a significant loss of value.

=> A highly liquid asset can be sold quickly without causing a decrease in the value of the asset, while an
illiquid asset either cannot be easily converted to cash or can only be sold quickly at a significant discount.

• Current assets: Those assets that are expected to be converted into cash within 12 months or one business
period, which including cash, accounts receivable, inventories, other current assets.

• Long – term assets: A company’s long - term assets fall into two categories (1) fixed assets (PP&E and
Intangible assets) and (2) all other long – term assets.
 Balance sheet
Types of financing: It labels “Total liabilities (debt) + Stockholders’ Equity” , which indicates how the firm
finances its assets.

• Debt (Liabilities) is money that has been borrowed and must be repaid at some perdetermined date. Debt
capital is financing provided by a creditor, which are (1) Short – term debt (or Current liabilities) - and (2)
Long – term debt

Short – term debt includes borrowed money that must be repaid within the next 12 months.

Long – term debt includes loans from banks or other sources that lend money for longer than 12 months.
 Balance sheet
• Working capital
Current assets are also referred to as gross working capital. In contrast, net working capital is equal to a
company’s current assets less its current liabilities.

Net working capital = Current assets – Current liabilities

NWC compares the amount of current assets to the current liabilities.

 Cash flow statement
Why do we need to consider the Cash flow

Profit = Revenue – Cost

Net cash flow = In-cash flow – Out-cash flow
Example 1:
Student A has a business idea to make Moon Cake and ask you to invest in his project. He is such a great baker but
it is his first start – up and he is a newbie in finance
Suppose that X has $10,000 in bank account. The business has some information:
• In the first 3 months, he can achieve revenue of $20,000; $30,000 and $45,000 respectively.
• Cost of all materials to make this revenue play 60% of revenue.
• Other fixed cost (labor cost; store rent ...) is $10,000 per month (X must pay at the beginning of the month).
• X has a deal that he will pay for materials at the end of the month.
• X receive a deal from customers that he will receive money from them after 2 months
 Cash flow statement
Income statement Month 1 Month 2 Month 3

Revenue 20,000 30,000 45,000

Material cost (60% Revenue) 18,000 27,000

12,000

Other cost ($10,000/month) 10,000 10,000 10,000

Net profit - 2,000 2,000 8,000

Cash flow statement t=0 t=1 t=2 t=3

In – cash flow 0 0

Out - cash flow

Net cash flow - 10,000

Cash in bank account 0

 Cash flow statement
• Accounting profits are not equal to cashflows (because of the different view between accounting and
finance with an event). should consider both CF and Income statement when thinking abt investing

• Cash flows, not profits, drive the value of a business and attract the attention of financial analysts.
• Should we just pay attention on cashflows and ignore accounting profit?
Example 2:
Student B has a business idea to make Moon Cake and ask you to invest in his project. He is such a great baker but
it is his first start – up and he is a newbie in finance
Suppose that X has $10,000 in bank account. The business has some information:
• In the first 3 months, he can achieve revenue of $50,000; $70,000 and $95,000 respectively.
• Cost of all materials to make this revenue play 70% of revenue.
• Other fixed cost (labor cost; store rent ...) is $30,000 per month (X must pay at the beginning of the month).
• X can deal with customers that he receive money from them immediately after the transaction
• X has a deal with his suppliers that he will pay for materials after 2 month.
 Cash flow statement
Cash flow statement t=0 t=1 t=2 t=3

In – cash flow 50,000 70,000 95,000

Out - cash flow materials 35,000 49,000

others 30,000 30,000 30,000
Net cash flow 20,000 -5,000 19,000

Cash in bank account $10,000 30,000 35,000

Income statement Month 1 Month 2 Month 3

Revenue $50.000 $75.000 $95.000

Material cost (70% Revenue) 35,000 49,000 66,500

Other cost ($30,000/month) 30,000 30,000 30,000

Net profit -15,000 -9,000 1,500

 Cash flow statement
• Profits versus cash flows

The profits shown on a company’s IS are not the same as its cash flows.

“Profitable companies can go broke”

Why?

v In accrual basis accounting: Profits are recored when earned, no matter cash transactions are
made or not.

v In cash basis accounting: Profits are reported when cash is received, and expenses are record
when they are paid
 Cash flow statement
• Profits versus cash flows

Therefore, profits based on an accrual accounting system will differ from the firm’s cash flows
because:

v Sales reported in an income statement include both cash sales and credit sales.

v Some inventory purchases are financed by credit, so inventory purchases do not exactly
equal cash spent for inventory.

v The depreciation expense shown in the income statement is a noncash expense.

 Cash flow statement
• Statement of Cash Flows
There are three key activities that determine the cash inflows and outflows of a business:

v Generating cash flows from day-to-day business operations (Operating activities)

v Investing in fixed assets and other long – term investments (Investing activities)

v Financing the business (Financing activities)

 Cash flow statement
Cash flow from operating activities (OCF)

Cash flow from investing activities (ICF)

Cash flow from financing activities (FCF)

Beginning cash Ending cash

Cash flow from financing activities (FCF) + =
balance balance
 Cash flow statement
• Two types of cash flow statement
- Direct methods: Discloses operating cash inflows by sources (e.g. cash received from customers, cash received
from investment income) and operating cash outflows by use (e.g. cash paid to suppliers, cash paid for interest) in the
operating activities section of the cash flow statement.
- Indirect methods: Reconciles net incomes to operating cash flow by adjusting net income for all non – cash
tiems and the net chagnes in working capital accounts.
- Cash flows from operating activities reported under the indirect method can generally be converted to an
approximation of the direct format by following a simple three – step process.
- Cash flows from investing activities and from financing activities are both reported using a direct method,
regardless of the method used for reporting operating cash flows.
Relationship between Financial Statements

Point in time Period of Time Point in time

Income Statement
1/1/2021 – 31/12/2022

Balance Sheet Balance Sheet

(31/12/2021) Cash Flow Statement (31/12/2022)
1/1/2021 – 31/12/2022

Statement of
shareholders’ equity
1/1/2021 – 31/12/2022
Thank you !!!