1. I-19.Introduction to Financial Statement Analysis
1.1. Learning Outcomes
1.1.1. a.describe the roles of financial reporting and financial statement analysis
1.1.2. 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
1.1.3. c.describe the importance of financial statement notes and supplementary information— including disclosures of accounting policies, methods, and estimates— and management’s commentary
1.1.4. d.describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls
1.1.5. e.identify and describe information sources that analysts use in financial statement analysis besides annual financial statements and supplementary information
1.1.6. f.describe the steps in the financial statement analysis framework
1.2. Roles of Financial Reporting and Financial Statement Analysis
1.2.1. Role of financial statement reporting
1.2.2. Role of financial statement analysis
1.3. Primary Financial Statements and Other Information Sources
1.3.1. Financial Statements and Supplementary Information
1.3.1.1. Balance Sheet
1.3.1.2. Statement of Comprehensive Income
1.3.1.2.1. Income Statement
1.3.1.2.2. Other Comprehensive Income
1.3.1.3. Statement of Changes in Equity
1.3.1.4. Cash Flow Statement
1.3.1.5. Financial Notes and Supplementary Schedules
1.3.1.6. Management Commentary or Management’s Discussion and Analysis
1.3.1.7. Auditor’s Reports
1.3.1.7.1. Unqualified
1.3.1.7.2. Qualified
1.3.1.7.3. Adverse
1.3.1.7.4. Disclaimer
1.3.2. Other Sources of Information
1.3.2.1. Interim reports
1.3.2.2. Proxy statements
1.3.2.3. Press releases
1.3.2.4. External sources
1.4. Financial Statement Analysis Framework
1.4.1. 1.Articulate the Purpose and Context of Analysis
1.4.2. 2.Collect Data
1.4.3. 3.Process Data
1.4.4. 4.Analyze/ Interpret the Processed Data
1.4.5. 5.Develop and Communicate Conclusions/ Recommendations
1.4.6. 6.Follow-Up
2. I-20.Financial Reporting Standards
2.1. The Objective of Financial Reporting
2.2. Standard-Setting Bodies and Regulatory Authorities
2.2.1. Accounting Standards Boards
2.2.1.1. International Accounting Standards Board's (IASB's)
2.2.1.2. Financial Accounting Standards Board (FASB)
2.2.2. Regulatory Authorities
2.2.2.1. International Organization of Securities Commissions (IOSCO)
2.2.2.2. The Securities and Exchange Commission (US SEC)
2.2.2.2.1. Securities Act of 1933
2.2.2.2.2. Securities Exchange Act of 1934
2.2.2.2.3. Sarbanes– Oxley Act of 2002
2.2.2.2.4. Securities Offerings Registration Statement
2.2.2.2.5. Forms 10-K, 20-F, and 40-F
2.2.2.2.6. Annual Report
2.2.2.2.7. Proxy Statement/ Form DEF-14A
2.2.2.2.8. Forms 10-Q and 6-K
2.2.2.2.9. Form 8-K
2.2.2.2.10. Forms 3, 4, 5 and 144
2.2.2.2.11. Form 11-K
2.2.2.3. Capital Markets Regulation in Europe
2.3. The International Financial Reporting Standards Framework
2.3.1. Qualitative Characteristics of Financial Reports
2.3.1.1. Fundamental qualitative characteristics
2.3.1.1.1. Relevance
2.3.1.1.2. Faithful representation
2.3.1.2. Conceptual Framework
2.3.1.2.1. Comparability
2.3.1.2.2. Verifiability
2.3.1.2.3. Timeliness
2.3.1.2.4. Understandability
2.3.2. Constraints on Financial Reports
2.3.3. The Elements of Financial Statements
2.3.3.1. Underlying Assumptions in Financial Statements
2.3.3.1.1. Accrual basis
2.3.3.1.2. Going concern
2.3.3.2. Recognition of Financial Statement Elements
2.3.3.3. Measurement of Financial Statement Elements
2.3.3.3.1. Historical cost
2.3.3.3.2. Amortised cost
2.3.3.3.3. Current cost
2.3.3.3.4. Realizable (settlement) value
2.3.3.3.5. Present value (PV)
2.3.3.3.6. Fair value
2.3.3.4. Reporting Elements
2.3.3.4.1. Measurement of financial position
2.3.3.4.2. Measurement of financial performance
2.3.4. General Requirements for Financial Statements
2.3.4.1. Required Financial Statements
2.3.4.2. General Features of Financial Statements
2.3.4.2.1. Fair presentation
2.3.4.2.2. Going concern
2.3.4.2.3. Accrual basis
2.3.4.2.4. Materiality and aggregation
2.3.4.2.5. No offsetting
2.3.4.2.6. Frequency of reporting
2.3.4.2.7. Comparative information
2.3.4.2.8. Consistency
2.3.5. Structure and Content Requirements
2.3.5.1. Classified Statement of Financial Position (Balance Sheet)
2.3.5.2. Minimum Information on the Face of the Financial
2.3.5.3. Minimum Information in the Notes
2.3.5.3.1. Disclosure of accounting policies
2.3.5.3.2. Estimation uncertainty
2.3.5.3.3. Other disclosures
2.3.5.4. Comparative Information
2.4. Comparison of IFRS with Alternative Reporting Systems
2.5. Monitoring Developments in Financial Reporting Standards
2.5.1. New Products or Types of Transactions
2.5.2. Evolving Standards and the Role of CFA Institute
3. I-21.Understanding Income Statements
3.1. Learning Outcomes
3.1.1. a.Describe the components of the income statement and alternative presentation formats of that statement
3.1.2. b.Describe general principles of revenue recognition and accounting standards for revenue recognition
3.1.3. c.calculate revenue given information that might influence the choice of revenue recognition method
3.1.4. d.describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis
3.1.5. e.describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, unusual or infrequent items) and changes in accounting policies
3.1.6. f.distinguish between the operating and non-operating components of the income statement
3.1.7. g.describe how earnings per share is calculated and calculate and interpret a company’s earnings per share (both basic and diluted earnings per share) for both simple and complex capital structures
3.1.8. h.distinguish between dilutive and antidilutive securities and describe the implications of each for the earnings per share calculation
3.1.9. i.convert income statements to common-size income statements
3.1.10. j.evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement
3.1.11. k.describe, calculate, and interpret comprehensive income
3.1.12. l.describe other comprehensive income and identify major types of items included in it
3.2. Components and Format of the Income Statement
3.2.1. Revenue
3.2.2. Expenses
3.2.2.1. Grouping by Nature
3.2.2.2. Grouping by Function
3.2.3. Gross profit
3.2.4. Operating profit
3.2.5. Net income
3.2.6. Noncontrolling Interests
3.3. Revenue Recognition
3.3.1. Revenue General Principles
3.3.1.1. 1.Identify the contract(s) with a customer
3.3.1.2. 2.Identify the separate or distinct performance obligations in the contract
3.3.1.3. 3.Determine the transaction price
3.3.1.4. 4.Allocate the transaction price to the performance obligations in the contract
3.3.1.5. 5.Recognize revenue when (or as) the entity satisfies a performance obligation
3.3.2. Accounting Standards for Revenue Recognition
3.3.2.1. Revenue from Contracts with Customers
3.3.2.1.1. Identifying the Performance Obligation
3.3.2.1.2. Percentage-of-completion
3.3.2.1.3. Variable consideration
3.3.2.1.4. Cumulative catch-up adjustment
3.3.2.1.5. Suppliers deliver
3.4. Expense Recognition
3.4.1. Expense General Principles
3.4.2. Issues in Expense Recognition
3.4.2.1. Doubtful Accounts
3.4.2.2. Warranties
3.4.2.3. Depreciation and Amortisation
3.4.2.3.1. Straight-line method
3.4.2.3.2. Double declining balance depreciation
3.4.3. Implications for Financial Analysis
3.5. Non-Recurring Items and Non-Operating Items
3.5.1. Discontinued Operations
3.5.2. Unusual or Infrequent Items
3.5.3. Changes in Accounting Policies
3.5.4. Non-Operating Items
3.6. Earnings per Share
3.6.1. Simple versus Complex Capital Structure
3.6.2. Basic EPS
3.6.3. Diluted EPS
3.6.3.1. Diluted EPS When a Company Has Convertible Preferred Stock Outstanding
3.6.3.2. Diluted EPS When a Company Has Convertible Debt Outstanding
3.6.3.3. Diluted EPS When a Company Has Stock Options, Warrants, or Their Equivalents Outstanding
3.6.3.4. Other Issues with Diluted EPS
3.6.4. Changes in EPS
3.7. Analysis of the Income Statement
3.7.1. Common-Size Analysis of the Income Statement
3.7.2. Income Statement Ratios
3.7.2.1. Net Profit Margin = Net Income / Revenue
3.7.2.2. Gross Profit Margin = Gross profit / Revenue
3.8. Comprehensive Income
4. II-9.Intercorporate Investments
4.1. Learning Outcomes
4.2. Introduction
4.3. Basic Corporate Investment Categories
4.4. Investments In Financial Assets: IFRS 9
4.4.1. Classification and Measurement
4.4.2. Reclassification of Investments
4.5. Investments In Associates And Joint Ventures: Equity Method of Accounting, Basis Principles
4.5.1. Equity Method of Accounting: Basic Principles
4.6. Investment Costs That Exceed the Book Value of the Investee, Amortization of Excess Purchase Price, Fair Value Option and Impairment
4.6.1. Amortization of Excess Purchase Price
4.6.2. Fair Value Option
4.6.3. Impairment
4.7. Transactions with Associates and Disclosure
4.7.1. Disclosure
4.7.2. Issues for Analysts
4.8. Business Combinations: Acquisition Method and Impact of the Acquisition Method on Financial Statements Post-Acquisition
4.8.1. Acquisition Method
4.8.1.1. Recognition and Measurement of Identifiable Assets and Liabilities
4.8.1.2. Recognition and Measurement of Contingent Liabilities
4.8.1.3. Recognition and Measurement of Indemnification Assets
4.8.1.4. Recognition and Measurement of Financial Assets and Liabilities
4.8.1.5. Recognition and Measurement of Goodwill
4.8.1.6. Recognition and Measurement when Acquisition Price Is Less than Fair Value
4.8.2. Impact of the Acquisition Method on Financial Statements, Post-Acquisition
4.9. The Consolidation Process
4.9.1. Business Combination with Less than 100% Acquisition
4.9.2. Non-controlling (Minority) Interests: Balance Sheet
4.9.3. Non-controlling (Minority) Interests: Income Statement
4.9.4. Goodwill Impairment
4.10. Financial Statement Presentation Subsequent to the Business Combination
4.11. Variable Interest and Special Purpose Entities
4.11.1. Securitization of Assets
4.12. Additional Issues in Business Combinations That impair Comparability
4.12.1. Contingent Assets and Liabilities
4.12.2. Contingent Consideration
4.12.3. In-Process R& D
4.12.4. Restructuring Costs
5. II-10.Employee Compensation: Post-Employment and Share-Based
5.1. Learning Outcomes
5.2. Introduction
5.3. Pensions and Other Post-Employment Benefits
5.3.1. Types of Post-Employment Benefit Plans
5.4. Measuring a Defined Benefit Pension Plan's Obligations
5.5. Financial Statement Reporting of Pension Plans and Other Post-Employment Benefits: Defined Contribution Pension Plans
5.5.1. Defined Contribution Pension Plans
5.6. Financial Statement Reporting of Pension Plans: Balance Sheet Reporting for Defined Benefit Pension Plans
5.6.1. Balance Sheet Presentation
5.7. Financial Statement Reporting of Pension Plans: Periodic Pension Costs for Defined Benefit Pension Plans Reporting the Periodic Pension Cost.
5.8. More on the Effect of Assumptions and Actuarial Gains and Losses on Pension and Other Post-Employment Benefit Costs
5.9. Calculation of Defined Benefit Pension Obligation and Current Service Costs
5.10. Disclosures of Pension and Other Post-Employment Benefits: Assumptions
5.10.1. Assumptions
5.11. Disclosures of Pension and Other Post-Employment Benefits: Net Pension Liability (or Asset) and Periodic Pension Costs
5.11.1. Total Periodic Pension Costs
5.11.2. Periodic Pension Costs Recognised in P& L vs. OCI
5.11.3. Classification of Periodic Pension Costs Recognised in P& L
5.12. Disclosures of Pension and Other Post-Employment Benefits: Cash Flow Information
5.13. Share-Based Compensation
5.14. Stock Grants
5.15. Stock Options
5.16. Other Types of Share -Based Compensation
6. II-11.Multinational Operations
6.1. Learning Outcomes
6.2. Introduction and Foreign Currency Transactions: Foreign Currency Transaction Exposure to Foreign Exchange Risk and Analytical Issues
6.2.1. Foreign Currency Transactions
6.2.1.1. Foreign Currency Transaction Exposure to Foreign Exchange Risk
6.2.1.1.1. Accounting for Foreign Currency Transactions with Settlement before Balance Sheet Date
6.2.1.1.2. Accounting for Foreign Currency Transactions with Intervening Balance Sheet Dates
6.2.1.2. Analytical Issues
6.3. Disclosures Related to Foreign Currency Transaction Gains and Losses
6.4. Translation of Foreign Currency Financial Statements and Translation Conceptual Issues
6.4.1. Translation Conceptual Issues
6.4.1.1. All Assets and Liabilities Are Translated at the Current Exchange Rate
6.4.1.2. Only Monetary Assets and Monetary Liabilities Are Translated at the Current Exchange Rate
6.4.1.3. Balance Sheet Exposure
6.5. Translation Methods
6.5.1. Foreign Currency Is the Functional Currency
6.5.2. Parent’s Presentation Currency Is the Functional Currency
6.5.3. Translation of Retained Earnings
6.5.4. Highly Inflationary Economies
6.6. Illustration of Translation Methods (Excluding Hyperinflationary Economies)
6.7. Translation Analytical Issues
6.8. Translation When a Foreign Subsidiary Operates in an Hyperinflationary Economy
6.9. Companies Use Both Translation Methods at the Same Time and Disclosures Related to Translation Methods
6.9.1. Disclosures Related to Translation Methods
6.10. Multinational Operations and a Company's Effective Tax Rate
6.11. Additional Disclosures on the Effects of Foreign Currency
6.11.1. Disclosures Related to Sales Growth
6.11.2. Disclosures Related to Major Sources of Foreign Exchange Risk
7. II-12.Analysis of Financial Institutions
7.1. Learning Outcomes
7.2. Introduction to Financial Institutions
7.2.1. What Makes Financial Institutions Different?
7.2.2. Global Organizations
7.2.3. Individual Jurisdictions’ Regulatory Authorities
7.3. Analyzing a Bank: the CAMELS Approach
7.3.1. The CAMELS Approach
7.3.1.1. Capital Adequacy
7.3.1.2. Asset Quality
7.3.1.3. Management Capabilities
7.3.1.4. Earnings
7.3.1.5. Liquidity Position
7.3.1.6. Sensitivity to Market Risk
7.4. Analyzing a Bank: non-CAMELS Factors
7.4.1. Banking-Specific Analytical Considerations Not Addressed by CAMELS
7.4.2. Analytical Considerations Not Addressed by CAMELS That Are Also Relevant for Any Company
7.5. Analyzing a Bank: Example of CAMELS Approach
7.5.1. Capital Adequacy
7.5.2. Asset Quality
7.5.3. Management Capabilities
7.5.4. Earnings
7.5.5. Liquidity Position
7.5.6. Sensitivity to Market Risk
7.5.7. Overall CAMELS Assessment
7.6. Analyzing Property and Casualty Insurance Companies
7.6.1. Property and Casualty Insurance Companies
7.6.1.1. Operations: Products and Distribution
7.6.1.2. Earnings Characteristics
7.6.1.3. Investment Returns
7.6.1.4. Liquidity
7.6.1.5. Capitalization
7.7. Analyzing Life and Health Insurance Companies
7.7.1. Life and Health Insurance Companies
8. II-13.Evaluating Quality of Financial Reports
8.1. Learning Outcomes
8.2. Introduction
8.3. Quality of Financial Reports: Conceptual Framework
8.3.1. Conceptual Framework for Assessing the Quality of Financial Reports
8.4. Potential Problems that Affect the Quality of Financial Reports and Reported Amounts and Timing of Recognition
8.4.1. Reported Amounts and Timing of Recognition
8.5. Classification
8.6. Quality Issues and Mergers and Acquisitions & Financial Reporting that Diverges from Economic Reality Despite Compliance with Accounting Rules
8.6.1. Financial Reporting that Diverges from Economic Reality Despite Compliance with Accounting Rules
8.7. Evaluating the Quality of Financial Reports: General Steps
8.7.1. General Steps to Evaluate the Quality of Financial Reports
8.8. Quantitative Tools to Assess the Likelihood of Misreporting
8.8.1. Beneish Model
8.8.2. Other Quantitative Models
8.8.3. Limitations of Quantitative Models
8.9. Earnings Quality Indicators and Recurring Earnings
8.9.1. Indicators of Earnings Quality
8.9.1.1. Recurring Earnings
8.10. Earnings Persistence and Related Measures of Accruals
8.11. Mean Reversion in Earnings, Beating Benchmarks and External Indicators of Poor-Quality Earnings
8.11.1. Beating Benchmarks
8.11.2. External Indicators of Poor-Quality Earnings
8.12. Evaluating the Earnings Quality of a Company - Revenue Recognition Case: Sunbeam Corporation
8.12.1. Revenue Recognition Case: Sunbeam Corporation Premature/ Fraudulent Revenue Recognition
8.13. Revenue Recognition Case: MicroStrategy, Inc.
8.13.1. Multiple-Element Contracts
8.14. Cost Capitalization Case: WorldCom Corp.
8.14.1. Property/ Capital Expenditures Analysis
8.15. Bankruptcy Prediction Models: Altman Model, Developments in Bankruptcy Prediction Models
8.15.1. Altman Model
8.15.2. Developments in Bankruptcy Prediction Models
8.16. Cash Flow Quality
8.16.1. Indicators of Cash Flow Quality
8.16.2. Evaluating Cash Flow Quality
8.17. Balance Sheet Quality
8.18. Sources of Information about Risk and Limited Usefulness of Auditor's Report
8.18.1. Limited Usefulness of Auditor’s Opinion as a Source of Information about Risk
8.19. Risk-Related Disclosures in the Notes
8.20. Management Commentary (MD& A), Other Required Disclosures, Financial Press
8.20.1. Other Required Disclosures
8.20.2. Financial Press as a Source of Information about Risk
9. II-14.Integration of Financial Statement Analysis Techniques
9.1. Learning Outcomes
9.2. Introduction
9.3. Case Study 1: Long -Term Equity Investment: Early Phases of the Analysis
9.3.1. Phase 1: Define a Purpose for the Analysis
9.3.2. Phase 2: Collect Input Data
9.3.3. Phases 3 & 4: DuPont Analysis: Isolating "Pure Nestle"
9.3.3.1. Phase 3: Process Data and Phase 4: Analyze/ Interpret the Processed Data
9.3.4. Phases 3 & 4: DuPont Decomposition
9.3.5. Phases 3 & 4: Adjusting for Unusual Charges
9.3.6. Phases 3 & 4: Asset Base Composition Asset Base Composition
9.3.7. Phases 3 & 4: Capital Structure Analysis Capital Structure Analysis
9.3.8. Phases 3 & 4: Segment Analysis: Earnings & Capital Segment Analysis and Capital Allocation
9.3.9. Phases 3 & 4: Segment Analysis: Cash Flow & Capital
9.3.10. Phases 3 & 4: Segment Analysis by Product Group
9.3.11. Phases 3 & 4: Accruals and Earnings Quality
9.3.12. Phases 3 & 4: Cash Flow Relationships
9.3.13. Phases 3 & 4: Decomposition and Analysis of the Company's Valuation
9.3.14. Phases 5 & 6: Develop and Communicate Conclusions and Recommendations and Follow-up
9.3.14.1. Phase 5: Develop and Communicate Conclusions and Recommendations (e.g., with an Analysis Report) Support for an Investment in Nestlé Shares Causes for Concern
9.3.14.2. Phase 6: Follow-up
10. I-22.Understanding Balance Sheets
10.1. Components and Format of the Balance Sheet
10.1.1. Balance Sheet Components
10.1.2. Current and Non-Current Classification
10.1.3. Liquidity-Based Presentation
10.2. Current Assets
10.2.1. Cash and Cash Equivalents
10.2.2. Marketable Securities
10.2.3. Trade Receivables
10.2.4. Inventories
10.2.5. Other Current Assets
10.3. Current Liabilities
10.3.1. Trade payables
10.3.2. Accrued expenses
10.3.3. Deferred income
10.4. Non-Current Assets
10.4.1. Property, Plant, and Equipment
10.4.2. Investment Property
10.4.3. Intangible Assets
10.4.3.1. Identifiable Intangibles
10.4.4. Goodwill
10.4.4.1. Accounting Goodwill
10.4.4.2. Economic Goodwill
10.4.4.3. Goodwill Impairment
10.4.5. Financial Assets
10.4.5.1. Derivatives
10.4.5.2. Amortised cost
10.4.5.3. Held-to-maturity
10.4.5.4. Available-for-sale
10.4.6. Deferred Tax Assets
10.5. Non-Current Liabilities
10.5.1. Long-term Financial Liabilities
10.5.2. Deferred Tax Liabilities
10.6. Equity
10.6.1. Components of Equity
10.6.1.1. Common stock
10.6.1.2. Preferred shares
10.6.1.3. Treasury stock
10.6.1.4. Retained earnings
10.6.1.5. Accumulated other comprehensive income
10.6.1.6. Noncontrolling interest
10.6.2. Statement of Changes in Equity
10.7. Analysis of the Balance Sheet
10.7.1. Common-Size Analysis of the Balance Sheet
10.7.2. Balance Sheet Ratios
10.7.2.1. Liquidity Ratios
10.7.2.1.1. Current = Current assets / Current liabilities
10.7.2.1.2. Quick (acid test) = (Cash + Marketable securities + Receivables) / Current liabilities
10.7.2.1.3. Cash = (Cash + Marketable securities) / Current liabilities
10.7.2.2. Solvency Ratios
10.7.2.2.1. Long-term debt-to-equity = Total long-term debt / Total equity
10.7.2.2.2. Debt-to-equity = Total debt / Total equity
10.7.2.2.3. Total debt = Total debt / Total assets
10.7.2.2.4. Financial leverage = Total assets / Total equity
11. I-23.Understanding Cash Flow Statements
11.1. Components and Format of the Cash Flow Statement
11.1.1. Classification of Cash Flows and Non-Cash Activities
11.1.2. A Summary of Differences between IFRS and US GAAP
11.1.3. Direct and Indirect Methods for Reporting Cash Flow from Operating Activities
11.1.3.1. An Indirect-Format Cash Flow Statement Prepared under IFRS
11.1.3.2. A Direct-Format Cash Flow Statement Prepared under IFRS
11.1.3.3. Illustrations of Cash Flow Statements Prepared under US GAAP
11.2. The Cash Flow Statement: Linkages and Preparation
11.2.1. Linkages of the Cash Flow Statement with the Income Statement and Balance Sheet
11.2.2. Steps in Preparing the Cash Flow Statement
11.2.2.1. Operating Activities: Direct Method
11.2.2.1.1. Cash Received from Customers
11.2.2.1.2. Cash Paid to Suppliers
11.2.2.1.3. Cash Paid to Employees
11.2.2.1.4. Cash Paid for Other Operating Expenses
11.2.2.1.5. Cash Paid for Interest
11.2.2.1.6. Cash Paid for Income Taxes
11.2.2.2. Investing Activities
11.2.2.3. Financing Activities
11.2.2.3.1. Long-Term Debt and Common Stock
11.2.2.3.2. Dividends
11.2.2.4. Overall Statement of Cash Flows: Direct Method
11.2.2.5. Overall Statement of Cash Flows: Indirect Method
11.2.3. Conversion of Cash Flows from the Indirect to the Direct Method
11.3. Free Cash Flow to the Firm and Free Cash Flow to Equity
11.4. Cash Flow Statement Analysis
11.4.1. Evaluation of the Sources and Uses of Cash
11.4.2. Common-Size Analysis of the Statement of Cash Flows
11.4.3. Cash Flow Ratios
12. I-24.Financial Analysis Techniques
12.1. The Financial Analysis Process
12.1.1. The Objectives of the Financial Analysis Process
12.1.2. Distinguishing between Computations and Analysis
12.2. Analytical Tools and Techniques
12.2.1. Ratios
12.2.2. Common-Size Analysis
12.2.3. The Use of Graphs as an Analytical Tool
12.2.4. Regression Analysis
12.3. Common Ratios Used in Financial Analysis
12.3.1. Interpretation and Context
12.3.2. Activity Ratios
12.3.2.1. Inventory turnover = Cost of sales or cost of goods sold / Average inventory
12.3.2.2. Days of inventory on hand (DOH) = Number of days in period / Inventory turnover
12.3.2.3. Receivables turnover = Revenue / Average receivables
12.3.2.4. Days of sales outstanding (DSO) = Number of days in period / Receivables turnover
12.3.2.5. Payables turnover = Purchases / Average trade payables
12.3.2.6. Number of days of payables = Number of days in period / Payables turnover
12.3.2.7. Working capital turnover = Revenue / Average working capital
12.3.2.8. Fixed asset turnover = Revenue / Average net fixed assets
12.3.2.9. Total asset turnover = Revenue / Average total assets
12.3.3. Liquidity Ratios
12.3.3.1. Current ratio = Current assets / Current liabilities
12.3.3.2. Quick ratio = (Cash + Short-term marketable investments + Receivables) / Current liabilities
12.3.3.3. Cash ratio = (Cash + Short-term marketable investments) / Current liabilities
12.3.3.4. Defensive interval ratio = (Cash + Short-term marketable investments + Receivables) / Daily cash expenditures
12.3.3.5. Cash conversion cycle (net operating cycle) = DOH + DSO – Number of days of payables
12.3.4. Solvency Ratios
12.3.4.1. Debt Ratios
12.3.4.1.1. Debt-to-assets ratio = Total debt / Total assets
12.3.4.1.2. Debt-to-capital ratio = Total debt / (Total debt + Total shareholders’ equity)
12.3.4.1.3. Debt-to-equity ratio = Total debt / Total shareholders’ equity
12.3.4.1.4. Financial leverage ratio = Average total assets / Average total equity
12.3.4.1.5. Debt-to-EBITDA = Total debt / EBITDA
12.3.4.2. Coverage Ratios
12.3.4.2.1. Interest coverage = EBIT / Interest payments
12.3.4.2.2. Fixed charge coverage = (EBIT + Lease payments) / (Interest payments + Lease payments)
12.3.5. Profitability Ratios
12.3.5.1. Return on Sales
12.3.5.1.1. Gross profit margin = Gross profit / Revenue
12.3.5.1.2. Operating profit margin = Operating income / Revenue
12.3.5.1.3. Pretax margin = EBT / Revenue
12.3.5.1.4. Net profit margin = Net income / Revenue
12.3.5.2. Return on Investment
12.3.5.2.1. Operating ROA = Operating income / Average total assets
12.3.5.2.2. ROA = Net income / Average total assets
12.3.5.2.3. Return on total capital = EBIT / Average short- and long-term debt and equity
12.3.5.2.4. ROE = Net income / Average total equity
12.3.5.2.5. Return on common equity = (Net income – Preferred dividends) / Average common equity
12.3.6. DuPont Analysis: The Decomposition of ROE
12.3.6.1. ROE = Net income/ Average shareholders’ equity
12.3.6.2. ROE = ROA × Leverage
12.3.6.2.1. ROA = Net Income / Average Total Assets
12.3.6.2.2. Leverage = Average total assets / Average shareholders' equity
12.3.6.3. ROE = Net profit margin × Total asset turnover × Leverage
12.3.6.3.1. Net profit margin = Net income / Revenue
12.3.6.3.2. Total asset turnover = Revenue / Average total assets
12.3.6.3.3. Leverage = Average total assets / Average shareholders' equity
12.3.6.4. ROE = Tax burden × Interest burden × EBIT margin × Total asset turnover × Leverage
12.3.6.4.1. Tax burden = Net income / EBT
12.3.6.4.2. Interest burden = EBT / EBIT
12.3.6.4.3. EBIT margin = EBIT / Revenue
12.3.6.4.4. Total asset turnover = Revenue / Average total assets
12.3.6.4.5. Leverage = Average total assets / Average shareholders' equity
12.4. Equity Analysis
12.4.1. Valuation Ratios
12.4.1.1. Valuation Ratios
12.4.1.1.1. P/ E = Price per share / Earnings per share
12.4.1.1.2. P/ CF = Price per share / Cash flow per share
12.4.1.1.3. P/ S = Price per share / Sales per share
12.4.1.1.4. P/ BV = Price per share / Book value per share
12.4.1.2. Per-Share Quantities
12.4.1.2.1. Basic EPS = Net income minus preferred dividends / Weighted average number of ordinary shares outstanding
12.4.1.2.2. Diluted EPS = Adjusted income available for ordinary shares, reflecting conversion of dilutive securities / Weighted average number of ordinary and potential ordinary shares outstanding
12.4.1.2.3. Cash flow per share = Cash flow from operations / Weighted average number of shares outstanding
12.4.1.2.4. EBITDA per share = EBITDA / Weighted average number of shares outstanding
12.4.1.2.5. Dividends per share = Common dividends declared / Weighted average number of ordinary shares outstanding
12.4.1.3. Dividend-Related Quantities
12.4.1.3.1. Dividend payout ratio = Common share dividends / Net income attributable to common shares
12.4.1.3.2. Retention rate (b) = (Net income attributable to common shares – Common share dividends) / Net income attributable to common shares
12.4.1.3.3. Sustainable growth rate = Retention rate (b) × ROE
12.4.2. Industry-Specific Ratios
12.4.2.1. Business Risk
12.4.2.1.1. Coefficient of variation of operating income = Standard deviation of operating income / Average operating income
12.4.2.1.2. Coefficient of variation of net income = Standard deviation of net income / Average net income
12.4.2.1.3. Coefficient of variation of revenues = Standard deviation of revenue / Average revenue
12.4.2.2. Financial Sector Ratios
12.4.2.2.1. Capital adequacy— banks = Various components of capital / Various measures such as risk-weighted assets, market risk exposure, or level of operational risk assumed
12.4.2.2.2. Monetary reserve requirement (Cash reserve ratio) = Reserves held at central bank / Specified deposit liabilities
12.4.2.2.3. Liquid asset requirement = Approved “readily marketable” securities / Specified deposit liabilities
12.4.2.2.4. Net interest margin = Net interest income / Total interest-earning assets
12.4.2.3. Retail Ratios
12.4.2.3.1. Same (or comparable) store sales = Average revenue growth year over year for stores open in both periods
12.4.2.3.2. Sales per square meter (or square foot) = Revenue / Total retail space in square meters (or square feet)
12.4.2.4. Service Companies
12.4.2.4.1. Revenue per employee = Revenue / Total number of employees
12.4.2.4.2. Net income per employee = Net income / Total number of employees
12.4.2.5. Hotel
12.4.2.5.1. Average daily rate = Room revenue / Number of rooms sold
12.4.2.5.2. Occupancy rate = Number of rooms sold / Number of rooms available
12.4.3. Historical Research on Ratios in Equity Analysis
12.5. Credit Analysis
12.5.1. The Credit Rating Process
12.5.2. Credit Ratio
12.5.2.1. EBITDA interest coverage = EBITDA / Interest expense, including non-cash interest on conventional debt instruments
12.5.2.1.1. EBITDA = earnings before interest, taxes, depreciation, and amortization
12.5.2.2. FFO (Funds from operations) to debt = FFO / Total debt
12.5.2.2.1. FFO = funds from operations, defined as EBITDA minus net interest expense minus current tax expense (plus or minus all applicable adjustments).
12.5.2.3. Free operating cash flow to debt = CFO (adjusted) minus capital expenditures / Total debt
12.5.2.3.1. CFO = cash flow from operations
12.5.2.4. EBIT margin = EBIT / Total revenues
12.5.2.4.1. EBIT = earnings before interest and taxes
12.5.2.5. EBITDA margin = EBITDA / Total revenues
12.5.2.6. Debt to EBITDA = Total debt / EBITDA
12.5.2.7. Return on capital = EBIT / Average beginning-of-year and end-of-year capital
12.5.2.7.1. Capital = debt plus noncurrent deferred taxes plus equity (plus or minus all applicable adjustments)
12.6. Business and Geographic Segments
12.7. Model Building and Forecasting
13. I-30.Applications of Financial Statement Analysis
13.1. Application: Evaluating Past Financial Performance
13.2. Application: Projecting Future Financial Performance
13.2.1. Projecting Performance: An Input to Market-Based Valuation
13.2.2. Projecting Multiple-Period Performance
13.3. Application: Assessing Credit Risk
13.4. Application: Screening for Potential Equity Investments
13.5. Analyst Adjustments to Reported Financials
13.5.1. A Framework for Analyst Adjustments
13.5.2. Analyst Adjustments Related to Investments
13.5.3. Analyst Adjustments Related to Inventory
13.5.4. Analyst Adjustments Related to Property, Plant and Equipment
13.5.5. Analyst Adjustments Related to Goodwill
14. I-25.Inventories
14.1. Cost of Inventories
14.1.1. Costs of purchase
14.1.2. Costs of conversion
14.1.3. Exclude the costs from inventory
14.2. Inventory Adjustments
14.3. Inventory Method Changes
14.4. Inventory Valuation Methods
14.4.1. Specific Identification
14.4.2. First-In, First-Out (FIFO)
14.4.3. Weighted Average Cost
14.4.4. Last-In, First-Out (LIFO)
14.4.4.1. LIFO Reserve
14.4.4.2. LIFO Liquidations
14.4.5. Calculation of Cost of Sales, Gross Profit, and Ending Inventory
14.4.6. Periodic versus Perpetual Inventory Systems
14.4.7. Comparison of Inventory Valuation Methods
14.5. Evaluation of Inventory Management
14.5.1. Presentation and Disclosure
14.5.2. Inventory Ratios
14.5.3. Financial Analysis Illustrations
15. I-26.Long-Lived Assets
15.1. Acquisition of Long-Lived Assets
15.1.1. Property, Plant, and Equipment
15.1.2. Intangible Assets
15.1.2.1. Intangible Assets Purchased in Situations Other Than Business Combinations
15.1.2.2. Intangible Assets Developed Internally
15.1.2.3. Intangible Assets Acquired in a Business Combination
15.1.3. Capitalising versus Expensing: Impact on Financial Statements and Ratios
15.1.4. Capitalisation of Interest Costs
15.1.5. Capitalisation of Internal Development Costs
15.2. Depreciation and Amortisation of Long-Lived Assets
15.2.1. Depreciation Methods and Calculation of Depreciation Expense
15.2.2. Amortisation Methods and Calculation of Amortisation Expense
15.3. The Revaluation Model
15.4. Impairment of Assets
15.4.1. Impairment of Property, Plant, and Equipment
15.4.2. Impairment of Intangible Assets with a Finite Life
15.4.3. Impairment of Intangibles with Indefinite Lives
15.4.4. Impairment of Long-Lived Assets Held for Sale
15.4.5. Reversals of Impairments of Long-Lived Assets
15.5. Derecognition
15.5.1. Sale of Long-Lived Assets
15.5.2. Long-Lived Assets Disposed of Other Than by a Sale
15.6. Presentation and Disclosures
15.7. Investment Property
16. I-27.Income Taxes
16.1. Differences between Accounting Profit and Taxable Income
16.1.1. Current Tax Assets and Liabilities
16.1.2. Deferred Tax Assets and Liabilities
16.2. Determining the Tax Base of Assets and Liabilities
16.2.1. Determining the Tax Base of an Asset
16.2.2. Determining the Tax Base of a Liability
16.2.3. Changes in Income Tax Rates
16.3. Temporary and Permanent Differences Between Taxable and Accounting Profit
16.3.1. Taxable Temporary Differences
16.3.2. Deductible Temporary Differences
16.3.3. Examples of Taxable and Deductible Temporary Differences
16.3.4. Temporary Differences at Initial Recognition of Assets and Liabilities
16.3.5. Business Combinations and Deferred Taxes
16.3.6. Investments in Subsidiaries, Branches, Associates and Interests in Joint Ventures
16.4. Unused Tax Losses and Tax Credits
16.5. Recognition and Measurement of Current and Deferred Tax
16.5.1. Recognition of a Valuation Allowance
16.5.2. Recognition of Current and Deferred Tax Charged Directly to Equity
16.6. Presentation and Disclosure
16.7. Comparison of IFRS and US GAAP
17. I-28.Non-Current (Long-Term) Liabilities
17.1. Bonds Payable
17.1.1. Accounting for Bond Issuance
17.1.2. Accounting for Bond Amortisation, Interest Expense, and Interest Payments
17.1.3. Current Market Rates and Fair Value Reporting Option
17.1.4. Derecognition of Debt
17.1.5. Debt Covenants
17.1.6. Presentation and Disclosure of Long-Term Debt
17.2. Leases
17.2.1. Lessee accounting
17.2.2. Lessor accounting
17.3. Introduction to Pensions and Other Post-Employment Benefits
17.4. Evaluating Solvency: Leverage and Coverage Ratios
18. I-29.Financial Reporting Quality
18.1. Conceptual Overview
18.1.1. GAAP, Decision-Useful, Sustainable, and Adequate Returns
18.1.2. GAAP, Decision-Useful, but Sustainable?
18.1.3. Biased Accounting Choices
18.1.3.1. Within GAAP, but “Earnings Management”
18.1.4. Departures from GAAP
18.1.5. Differentiate between Conservative and Aggressive Accounting
18.1.5.1. Conservatism in Accounting Standards
18.1.5.2. Bias in the Application of Accounting Standards
18.2. Context for Assessing Financial Reporting Quality
18.2.1. Motivations
18.2.2. Conditions Conducive to Issuing Low-Quality Financial Reports
18.2.3. Mechanisms That Discipline Financial Reporting Quality
18.2.3.1. Market Regulatory Authorities
18.2.3.2. Auditors
18.2.3.3. Private Contracting
18.3. Detection of Financial Reporting Quality Issues
18.3.1. Presentation Choices
18.3.2. Accounting Choices and Estimates
18.3.2.1. How Accounting Choices and Estimates Affect Earnings and Balance Sheets
18.3.2.2. How Choices Affect the Cash Flow Statement
18.3.2.3. Choices That Affect Financial Reporting
18.3.3. Warning Signs