Study sheet: Financial Statement Analysis

📋 Course Outline

1. Purpose and Users of Financial Analysis
2. Trust, Expectations, and Firm Value
3. Financial Statements and Reporting Standards
4. Financial Analysis Framework
5. Balance Sheet Structure
6. Balance Sheet Interpretation
7. Income Statement and Wealth Creation
8. Accruals and Earnings Quality
9. Cash Flow Statement
10. Financing and Financial Risk

📖 1. Purpose and Users of Financial Analysis

🔑 Key Concepts & Definitions

• Financial analysis : evaluates whether a company is financially healthy enough to retain stakeholder trust and attract investors

★ Must-know

📌 Financial analysis must distinguish assets, wealth, and cash because what a firm owns, what it is worth, and the cash it holds are different concepts.

Further detail

• Financial analysis is used by equity-oriented stakeholders such as investors, companies, corporate finance employees, stock analysts, pension funds, and private equity providers; debt-capital-oriented stakeholders such as banks, mortgage-credit institutes, bondholders, and companies; and compensation-oriented stakeholders such as management, executives, and boards of directors.

💡 Memory Hook

Assets are not wealth, and wealth is not cash.

📖 2. Trust, Expectations, and Firm Value

★ Must-know

• Stock prices are influenced by supply and demand, investor expectations, and financial and extra-financial information, with future performance generally mattering more to investors than past performance.

📌 The financial manager should maximize firm value while considering the effects of decisions on all stakeholders and preserving confidence between the firm and its stakeholders.

Further detail

• Apple reported fourth-calendar-quarter 2015 revenue of $75.9B, profit of $18.4B, and cash of $216B, but its stock-price effect could not be inferred from those figures alone because investors also considered slowing iPhone growth and a strong dollar.

💡 Memory Hook

Reliable information → stakeholder trust → investor confidence.

📖 3. Financial Statements and Reporting Standards

🔑 Key Concepts & Definitions

• Financial statements : periodic accounting reports that present past performance and a snapshot of a firm’s assets and the financing of those assets

★ Must-know

• The main financial statements are:
  • balance sheet
  • income statement or profit and loss statement
  • statement of cash flows
  • statement of changes in shareholders’ equity

Further detail

• GAAP and IFRS are major financial reporting standards, while an auditor is a neutral third party that checks financial-statement compliance and reliability.

💡 Memory Hook

B-I-C-E: Balance sheet, Income statement, Cash flows, Equity changes.

📖 4. Financial Analysis Framework

📝 Essential Points

• 🔄 A financial analysis proceeds through:
  1. strategic and sector assessment
  2. growth analysis
  3. profitability analysis
  4. risk analysis
  5. recommendations

📌 In the long run, a company can survive only if it creates value for shareholders, meets commitments to stakeholders, generates wealth, invests, finances its investments, generates a sufficient return, and anticipates and manages illiquidity risk.

📐 Formula — Return on invested capital is calculated as $ROIC = \frac{NOPAT}{Capital\ Employed}$ and can also be decomposed as $ROIC = Operating\ Margin \times Asset\ Turnover$.

📐 Formula — Return on equity is calculated as $ROE = \frac{Net\ Income}{Equity}$ and can also be expressed as $ROE = ROIC + Leverage\ Effect$.

💡 Memory Hook

Sector → growth → profitability → risk → recommendations.

📖 5. Balance Sheet Structure

🔑 Key Concepts & Definitions

• Balance sheet : lists a firm’s assets and its liabilities and shareholders’ equity at a given point in time

★ Must-know

📐 Formula — The balance-sheet identity is $Total\ Assets = Liabilities + Shareholders’\ Equity$.

Further detail

• Long-lived assets produce benefits for more than one year, inventories are held for sale or production, accounts receivable are amounts owed by customers, and cash and marketable securities are liquid assets.

• Long-term financial debt has maturities beyond one year, short-term financial debt must be repaid within one year, and accounts payable are amounts owed to suppliers for purchases made on credit.

💡 Memory Hook

Assets show uses of funds; liabilities and equity show sources.

📖 6. Balance Sheet Interpretation

★ Must-know

📌 The balance sheet does not represent a firm’s financial position throughout the year because it provides a snapshot at a specific date.

Further detail

• Seasonality can materially change balance-sheet components: 80% of LEGO’s annual sales occur between September and December, affecting inventories and cash across the year.

• The relevant balance-sheet items depend heavily on the industry and business model, as illustrated by different asset and liability structures for Europages, RFM, and Toutconfort.

💡 Memory Hook

A snapshot taken on one date, with assets ordered by liquidity and debts by maturity.

📖 7. Income Statement and Wealth Creation

🔑 Key Concepts & Definitions

• Income statement : lists revenues and expenses that positively or negatively affect a company’s wealth over a period of time

★ Must-know

• 🔄 A condensed income statement proceeds from:
  1. net sales
  2. gross profit
  3. EBITDA
  4. EBIT
  5. earnings before taxes
  6. pretax income
  7. net earnings

📌 Operating expenses are consumed in the operating cycle and reduce wealth, whereas capital expenditures on fixed assets are investments that are used without being directly destroyed and are not immediately recorded as income-statement expenses.

Further detail

• In the JIT example, a €39 million expenditure on a new building is not recorded in the income statement at time zero as an operating expense.

💡 Memory Hook

Sales → EBITDA → EBIT → pretax income → net earnings.

📖 8. Accruals and Earnings Quality

★ Must-know

📌 Accrual accounting recognizes a sale when it is made rather than when cash is received, and the matching principle records costs in the period in which the related revenues are recognized.

📌 Net income typically does not equal the cash earned by a firm because of non-cash items, accruals, capital expenditures, and other uses of cash not recorded on the income statement.

Further detail

• Depreciation is a non-cash accounting charge that recognizes the wearing out and declining value of fixed assets as they get older.

💡 Memory Hook

Accounting profit records wealth effects; cash flow records cash movements.

📖 9. Cash Flow Statement

🔑 Key Concepts & Definitions

• Cash-flow statement : shows how much cash a company generated and how that cash was allocated during a period

★ Must-know

• 🔄 Cash flows are classified into:
  1. operating activities
  2. investing activities
  3. financing activities

Further detail

• In JIT’s Year 2 cash-flow statement, cash from operating activities was €1.3 million, cash from investing activities was −€39.8 million, cash from financing activities was €41.2 million, and the change in cash was €2.7 million.

💡 Memory Hook

Operations → investments → financing → change in cash.

📖 10. Financing and Financial Risk

★ Must-know

📌 An equity contract gives investors shares and shareholder status, whereas a debt contract gives a lender a creditor claim requiring repayment.

📌 Financial risk analysis includes capital-structure ratios, short-term illiquidity risk analysis, and insolvency analysis.

Further detail

• A startup is funded by its investors, whereas an established business is funded by its clients.

💡 Memory Hook

Equity investors share ownership; debt providers receive repayment obligations.

📊 Synthesis Tables

Main Financial Statements

Statement	Main purpose	Time perspective
Balance sheet	Assets, liabilities, and equity	Point in time
Income statement	Revenues, expenses, and earnings	Period
Cash-flow statement	Cash generated and allocated	Period
Statement of changes in shareholders’ equity	Changes in equity	Period