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
Sample Question:
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