FINANCIAL STATEMENT

ANALYSIS
A Valuation Approach

by
Leonard Soffer and Robin Soffer
 Accounting Analysis and the
Financial Statements
Where We Are Going

We will begin our study of financial

statement analysis

Chapter 4

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 Second Phase
of Security Analysis
Business Analysis

GAAP
Financial Financial Statement Forecast
Statements Analysis Assumptions

Valuation

Time Historical Periods Valuation Date Forecast Periods

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 Three Primary
Financial Statements

 Balance Sheet
 Income Statement
 Cash Flow Statement

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 The Balance Sheet

Presents assets and liabilities

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 The Balance Sheet Equation

Assets = Liabilities + Shareholders' equity

Shareholders' equity = Assets - Liabilities = Net assets

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 Recognition Criteria and
Valuation Method Determination

GAAP sets balance sheet recognition

criteria and valuation rules

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 The Income Statement
is closely related to the balance sheet

Change in shareholders' equity =

Change in net assets

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 The Income Statement Continued

Lists those items that affected the income

Revenues Expenses
Special Items

Gains Losses

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 The Income Statement Continued

Revenues include:

 Increases in net assets from selling

normal goods and services

 Other income not from selling

a security or other asset

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 The Income Statement Continued

Expenses are decreases in net assets

from preparing normal goods and
services

Depreciation Advertising

Salaries Taxes Rent

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 The Income Statement Continued

Gains are like revenues

 They represent increases in net assets

Gains are not like revenues

 They do not arise in the ordinary course

of business

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 The Income Statement Continued

Losses are

Decreases in net assets resulting from

transactions not part of normal course
of business operations

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 The Income Statement Continued

Special Items include:

 Extraordinary items
 Changes in accounting principles
 Discontinued operations

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 Accounting Analysis of the
Income Statement
Focuses on earnings quality:

 Conservative accounting methods

 Earnings free of manipulation
 Exclusion of nonrecurring items

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 Conservative
Accounting Methods

 Lead to lower values for reported net

assets
 Lower income in early years
 Increase income in later years

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 Earnings Free of Manipulation

The analyst should try to undo any

management manipulation before using
historical data

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 Exclusion of
Nonrecurring Items
The analyst can ignore unusual or
nonrecurring items

For example:
 Loss from an earthquake

 Earnings from discontinued operations

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 The Cash Flow Statement

Not a GAAP statement

Reconciles net income to the

change in cash

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 The Cash Flow Statement Con’t.

Consists of three sections:

Cash flow from operations

Cash flow from investing
Cash flow from financing

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 The Cash Flow Statement Con’t.

Cash Flow from Operations

Includes items that relate to the

determination of net income

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 The Cash Flow Statement Con’t.

Cash Flow from Investing

Cash flow from activities in which the firm

acquires or divests long-term assets or
investment securities

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 The Cash Flow Statement Con’t.

Cash Flow from Financing Includes:

 Borrowing money

 Repaying debt

 Obtaining funds from stockholders

 Paying dividends

 Repurchasing shares

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 Summary
We have learned:
 Balance sheet

 Income statement

 Cash flow statement

 Recognition criteria and

valuation methods

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