1. Overview of Financial Statement Analysis
Chapter 1
Robinson, Munter, Grant

2. Learning Objectives Nature and purpose of Financial Analysis
Accounting standards and processes underlying financial reports
Role of professional financial analysts
Grant, Munter & Robinson
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3. Analysis for Decision Making
Financial statement analysis is a tool for making complex investment and credit decisions. Specifically, it is used to:
Evaluate historical performance
Predict future cash flows
Establish the value of an enterprise
Evaluate management
Grant, Munter & Robinson
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4. Pricing Investments
The price an investor is willing to pay depends on predicted future cash flows
Future cash flows from extending credit
Interest income
Return of principal
Future cash flows from equity investments
Dividends
Proceeds – attributable to value growth – from stock sale
Grant, Munter & Robinson
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5. Estimating cash flows requires
Current and relevant information
An evaluation of the firm’s profit and growth potential
An assessment of the firm’s survival likelihood
Grant, Munter & Robinson
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6. Cash Flows and Prices
Investors would like to pay an amount for an investment such that its annual future cash flows will provide a rate of return (r) greater than or equal to the return other potential uses of the money would provide.
Grant, Munter & Robinson
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7. Cash Flows and Prices In cases of identical payouts, return equals
Grant, Munter & Robinson
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8. Cash Flows and Prices
Given a desired rate of return and an estimate of future cash flows, purchase price can be estimated as:
Grant, Munter & Robinson
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9. Evaluating Management
Financial statement analysis may be the basis for a manger’s performance appraisal
Managers’ compensation may be a function of the this appraisal
It’s important to understand which elements of performance are within or beyond managers’ control
Grant, Munter & Robinson
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10. Analysis Techniques
Use publicly available data from financial statements including
Income Statement
Statement of Owners’ Equity
Balance Sheet
Statement of Cash Flows
Notes to Financial Statements
Grant, Munter & Robinson
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11. Analysis Techniques Time series analysis
Compare a firm to itself over time
Firms provide at least two periods of comparable data in each set of financial statements
Grant, Munter & Robinson
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12. Analysis Techniques Cross-sectional Analysis
Compare several firms over the same time period
Designed to hold economic effects constant
Enables analyst to determine how a firm is doing given the prevailing macroeconomic conditions
Comparison of large, diverse, multinational firms is complex (and covered in detail in chapters 9 and 18)
Grant, Munter & Robinson
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13. Financial Statements and Performance
Financial statements are prepared in a consistent manner (enabling cross-sectional and time series comparisons)
Accounting rules are designed to reflect firm performance
Grant, Munter & Robinson
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14. Basic Financial Statements
Income Statement
provides results of business activities
Balance Sheet
states assets and claims against them (liabilities and owner’s equity)
Statement of Cash Flows
provides prior cash flow information
helps analyst assess the firm’s ability to pay interested parties
Grant, Munter & Robinson
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15. Accounting and Reporting Standards
Analysts must become familiar enough with the accounting options available to the firm being studied in order to understand and evaluate the information presented in the financial statements
Grant, Munter & Robinson
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16. Development of US Accounting Standards
1900
No mandated reporting requirements even though the professions of accounting and auditing existed.
1933/34
Securities Acts give the SEC authority to regulate financial reporting.
The accounting profession worked to develop and refine accounting principles and auditing procedures.
1970s
Financial Accounting Standards Board is created as the authority on financial reporting for publicly traded US firms.
Grant, Munter & Robinson
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17. Development of International Accounting Standards
International Accounting Standards (IASB)
14 member committee of auditors, accountants, academics and financial statement users
Developed International Accounting Standards (IAS) to help investors cope with financial analysis in global capital markets
Rules are not used worldwide, but a number of countries do use the framework
Grant, Munter & Robinson
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18. Regulatory Requirements
SEC filing requirements
Form 10-K audited annual report
Form 10-Q quarterly report
Form 8-K periodic informational reports
Grant, Munter & Robinson
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19. Transactions and the Accounting Process
Remember, Assets = Claims
Original owners put $1,000 in corporate checking account
Grant, Munter & Robinson
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20. Transactions and the Accounting Process
Maintain the Assets = Claims equality
Build on previous transaction
Corporation spends $50 on inventory
Grant, Munter & Robinson
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21. Transactions and the Accounting Process
Change the previous transaction:
Corporation purchases $50 of inventory on credit
Grant, Munter & Robinson
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22. Transactions and the Accounting Process Expanded Transaction Model
Original owners put $1,000 in corporate checking account
Corporation purchases $50 of inventory on credit
Purchase a $5,000 building for $500 cash and $4,500 mortgage
Grant, Munter & Robinson
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23. Expanded Transaction Model
Assets =
Claims
Cash
Inventory
Building
Accounts Payable
Mortgage
Payable
Common Stock
$1,000
$50
($500)
$5,000
$4,500
$500
Grant, Munter & Robinson
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24. Transactions and the Accounting Process Expanded Transaction Model
The company pays rent of $2,000 for the current month
The company sells inventory to a customer on account (receivable) at a retail price of $30,000
The portion of the inventory which was sold cost $15,000 to purchase
Grant, Munter & Robinson
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25. Expanded Transaction Model
Assets =
Claims
Cash
A/R
Inventory
Accounts Payable
Common
Stock
Retained
Earnings
($2,000)
$30,000
($15,000)
$13,000
Grant, Munter & Robinson
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26. Basic Financial Statements Using recorded information the…
Balance Sheet
Reports totals of assets and claims on the date ending the reporting period
Statement of Cash Flows
Reports all cash inflows and outflows (more in chapter 4)
The cash column of the transaction model
Statement of Shareholders’ Equity
Reports changes in the owners’ claim accounts during the period
Grant, Munter & Robinson
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27. The Professional Analyst Buy-Side and Sell-Side Analysts
Provide information within the investment firm
Information is rarely available to outsiders
Sell-side
Provide information to brokers who work with external clients
Reports are created with external clients in mind
Grant, Munter & Robinson
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28. The Professional Analyst Professional Designation
Association for Investment Management and Research (AIMR)
Established professional standards and ethics for financial analysts
Sets disciplinary procedures in the event that unethical behavior is suspected or detected
Manages the Chartered Financial Analyst (CFA®) exam
A series of three examinations covering economics, finance, statistics and financial statement analysis
Grant, Munter & Robinson
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29. The Professional Analyst Role of the Analyst
Incorporate incrementally informative data into recommendations
Analysis is an ongoing process utilizing many types of resources
Financial statement analysis is the starting point of this process
Grant, Munter & Robinson
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30. Summary Objectives of financial analysis
Forecasting future cash flows
Evaluating past performance
Role of accounting information
Importance of accounting standards
Primary financial statements
Market efficiency (role of analysts)
Grant, Munter & Robinson
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