In a previous article, we introduced the CFA Institute Investment Foundation Program (Read more here). It is a free program designed for anyone who wants to enter or advance within the investment management industry, including IT, operations, accounting, administration, and marketing. Candidates who successfully pass the online exam earn the CFA Institute Investment Foundations Certificate.
There are total of 20 Chapters in 7 modules, covering all the essential topics in finance, economics, ethics and regulations. This series of articles will highlight the core knowledge of each chapter.
Chapter 7 provides an overview of financial statements. The learning outcome of chapter 7 is as follows:
· Describe the roles of standard setters, regulators, and auditors in financial reporting;
· Describe information provided by the balance sheet;
· Compare types of assets, liabilities, and equity;
· Describe information provided by the income statement;
· Distinguish between profit and net cash flow;
· Describe information provided by the cash flow statement;
· Identify and compare cash flow classifications of operating, investing, and financing activities;
· Explain links between the income statement, balance sheet, and cash flow statement;
· Explain the usefulness of ratio analysis for financial statements;
· Identify and interpret ratios used to analyse a company’s liquidity, profitability, financing, shareholder return, and shareholder value.
Although each major financial statement—balance sheet, income statement, and cash flow statement—offers different types of financial information, they are not entirely separate. The income statement is linked to the balance sheet in many ways. The revenues and expenses reported on the income statement that have not been settled in cash are reflected on the balance sheet as current assets or current liabilities.
The balance sheet reflects financial conditions at a certain point in time, whereas the income and cash flow statements explain what happened between two points in time. So, although the three financial statements show different kinds of information and have different purposes, they are all related to each other and should not be read in isolation.
Financial statement analysis involves the use of information provided by financial statements and also by other sources to identify critical relationships. These relationships may not be observable by reading the financial statements alone. The use of ratios allows analysts to standardise financial information and provides a context for making meaningful comparisons. In particular, investors can compare companies of different sizes as well as the performance of the same company at different points in time.
Ratios help managers of the company or outside creditors and investors answer the following questions that are important to help determine a company’s potential future performance:
· How liquid is the company?
o Current ratio; Quick ratio
· Is the company generating enough profit from its assets?
o Return on assets; Basic earning power
· How is the company financing its assets?
o Financial leverage
· Is the company providing sufficient return for its shareholders?
o Return on equity