Bundoora Campus

FIN2001
Financial Statement Analysis

Topic 1
Financial Statement Analysis:
An Introduction
INNOVATIVE | RESPONSIBLE | ENGAGED
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Subject Intended Learning Outcomes (SILOS)

 Explain the accounting, financial and economic theory on which the practice of
financial analysis is founded.
 Analyse the differences which exist between accounting standards and their
application in different countries, in particular the difference between US and
International accounting standards.
 Demonstrate the skills, of a financial analyst, to source, deconstruct, and analyse,
utilising appropriate digital tools, a company's financial statements, so as to extract
meaningful information to guide relevant financial decisions.
 Present a financial analysis of a company and be able to explain your professional and
empirical conclusions as to the implications of such analysis for stakeholders.
 Engage professionally and effectively to contribute to the success of a diverse team, in
a manner which is respectful of the needs, values, personalities and capabilities of
others.

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Learning Management System (LMS)

 Subject web page can be accessed from the University’s LMS:
 Subject learning guide.
 Teaching martials and Workshop questions and answers
are available and can be found under each week.
 Assessments.
 Important instructions and events will be announced
through LMS
 Students are expected to check the site regularly for
announcements

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Textbook
Resource Type Title Author and Year Publisher

Required

Prescribed text Business Analysis and Palepu, K.G., Healy, P.M., Cengage
Valuation: Using Financial Wright, S., Bradbury, M. and
Statements - Text and Coulton, J., 2020 (ISBN
Case 9780170289160).

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Assessments
SILOs
Week Session Date due % Assessment Feedback method
assessed
Week 2,4, & 5 LMS 20 Online quizzes (Equivalent to Feedback via LMS 1,2, 3
1000 words) and consultation

Week 3 26 Nov 40 1,500-word individual assignment Feedback via LMS 1,2,3,4

and consultation

Week 6 17 Dec 40 Group assignment (30%) and Feedback via LMS 1,2,3,4,5
presentation (10%) (Equivalent to and consultation
1,500 words)

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How to Succeed in This Subject?

 FIN2001 is a Blended learning subject which means there will be no lectures
and tutorials activities.
 Instead, there will be 2-hours weekly workshops, in which instructors will
guide students to apply theories into practice/application or solving
problems via face-to-face or online Zoom classes.
 Workshops would include a brief revision of the main concepts, theoretical
and practical questions, and further self-practices.
 Students are required to work through and complete each week's learning
material and activities, complete the workshop questions before attending
each workshop, and ensure that you attend the workshops.

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Workshops Instructions:
 Instructor will start with a very brief revision of the main concepts of each
week topic (approx. 15-20 minutes)
 You will be divided into groups (4 - 5 students) using breakout room
function.
 Each group will have 5 – 7 minutes to complete Workshops Activities within
your group i.e., workshops questions.
 Once all groups have completed the task, you will be required to present
your answers at the end of each activity, so be ready!
 Instructors will then walk you through the correct answers.
 You will then have the chance to ask questions.
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Financial Statement Analysis:

An Introduction

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Learning Objectives
 Explain the role of capital markets in the economy and the potential for
financial reporting to enhance capital market efficiency
 Identify the features of accounting that provide the potential for financial
reports to inform external users
 Describe the importance of financial reports in financial statement analysis
for business valuation.

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Does financial statement analysis useful?

 Yes, because financial statements provide the most widely available
data on any organisation’s economic activities, investors and other
stakeholders rely on financial reports to assess the plans and
performance of organisations and corporate managers
 A variety of questions can be addressed by business analysis using
financial statements.

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Does financial statement analysis useful?

 A loan officer may need to ask: ‘What is the credit risk involved in lending a
certain amount of money to this organisation?
 An independent auditor would want to ask: ‘Are the accounting policies and
accrual estimates in this organisation’s financial statements consistent with my
understanding of this business and its recent performance?
 A security analyst may be interested in asking: ‘How well is the firm I am
following performing? Did the firm meet my performance expectations? If not,
why not? What is the value of the firm’s shares given my assessment of its
current and future performance?’
 A corporate manager may ask: ‘Is my firm properly valued by investors? How
much value can be added if we acquire this firm?

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The Role of Financial Reporting

in Capital Markets
 Critical challenges for any given economy is to allocate savings
provided by Surplus Economic Units (e.g. households) to Deficit
Economic Units (e.g. investment opportunities).
 Information and incentive problems between savers and
entrepreneurs lead to the ‘lemons’ problem, and ‘crowd out’ good
business investment opportunities, which can potentially break down
the functioning of the capital market
 Intermediaries can prevent such a market breakdown and plays a
critical role in the effective functioning of the capital markets.

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The Role of Financial Reporting

in Capital Markets
 Information intermediaries (auditors, company audit committees,
financial analysts, credit rating agencies, financial press) add value
either by enhancing the credibility of financial reports (as auditors do)
or by analysing the information in the financial statements (as analysts
and the rating agencies do)
 Financial intermediaries [venture capital (VC – quỹ đầu tư mạo hiểm)
and private equity firms (PE – quỹ đầu tư tư nhân), banks,
superannuation and managed funds, insurance companies] rely on
information in the financial statements to analyse investment
opportunities and supplement this information from other sources
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The Role of Financial Reporting

in Capital Markets

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Australia Inter-sectoral Financial Flows

June quarter 2022

Australian Bureau of Statistics - June quarter 2022

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From Business Activities to Financial Statements

 Corporate managers acquire physical and financial resources to create value for the
firm’s investors through business activities
 A firm’s business activities are influenced by its economic environment and its own
business strategy
 The accounting system provides a mechanism through which business activities are
selected, measured and aggregated into financial statement data
 Financial statements summarise the economic consequences of business activities
 Intermediaries using financial statement data to do business analysis have to be
aware that financial reports are influenced both by the firm’s business activities and
by its accounting system

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Accounting System Feature:

Accrual accounting
 Corporate financial reports prepared using accrual rather than cash
accounting
 Unlike cash accounting, accrual accounting distinguishes between the
recording of costs and benefits associated with economic activities
 Example: company receives electricity bill ($1,400)
o Cash accounting: amount not recorded until the company pays the bill
o Accrual accounting: amount recorded as an expense the day company receives bill
 Effects of economic transactions are recorded on the basis of expected and
not actual cash receipts and payments
 Under accrual accounting system, expected cash receipts from the delivery of products
or services are recognised as revenues.
 Expected cash outflows associated with these revenues are recognised as expenses.
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Accounting System Feature:

Accrual accounting

 Because firms undertake economic transactions continually, the arbitrary

closing of accounting books at the end of a reporting period leads to a
fundamental measurement problem
 Since cash accounting does not report the full economic consequence of the
transactions undertaken in a given period, accrual accounting is designed to
provide more complete information about a firm’s periodic performance

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Examples of Accrual Accounting

 Prepaid Expenses:
Expenses paid in cash and recorded as assets before they are used or consumed.
 Unearned Revenues:
Cash received before service are performed.
 Accrued Revenues:
Revenues for services performed but not yet received in cash or recorded.
 Accrued expenses:
Expenses incurred but not yet paid in cash or recorded.

Example:
Jones Co. pays $5,000 for Insurance for 24 months on January 1. What is the journal entry on
January 1 and the adjusting entry at the END of the year when 12 months of the insurance is USED UP?
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Accounting System Feature:

Accounting standards
 Accrual accounting is subjective and relies on a variety of assumptions. Firm’s
managers should be charged with the primary responsibility of making these
assumptions.
 The delegation of financial reporting decisions to corporate managers has
both costs and benefits:
 Allows managers to reflect inside information in reported financial
statements.
 Incentives to use their accounting discretion to distort/ manipulate
reported profits by making biased assumptions.

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Accounting System Feature:

Accounting standards
 Accounting standards are developed to improve the quality of financial
reporting by limiting potential distortion that managers can introduce into
reported numbers.
 Accounting standards ensure that managers are not able to use their
accounting flexibility to disguise (cover) reality for self-serving purposes.
 And to ensure comparability of accounting over time, across organizations and
international by increasing uniformity.
 However, the benefit comes at the expense of reduced flexibility
=> Managers cannot reflect true business differences in their firm’s
financial statement.

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Advantages of Accrual Accounting

1. Provide a more accurate picture of a company’s financial position:
Recording expenses and revenues when they are incurred or earned, rather when cash is paid or
received.
=> It takes into account all financial transactions, whether or not cash has changed hands.

2. Better tracking of business performance.

By recording revenues and expenses when they occur, companies can see how their business is doing
=> Make informed decisions.

3. Facilitates financial analysis.

Investors and analysts can better assess a company’s profitability, liquidity, and financial health.
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Advantages of Accrual Accounting

4. Helps with budgeting and forecasting.
By tracking revenues and expenses when they occur, companies can make more informed decisions
about future cash flows and resource allocation.

5. Enables compliance with accounting standards.

Accrual accounting is the preferred method of accounting under generally accepted accounting principles
(GAAP) and International Financial Reporting Standards (IFRS).

5. Provide a clearer audit trail.

Easier for auditors to verify financial transactions and ensure that financial statements are accurate.
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Accounting System Feature:

Managers’ reporting strategy
 It is not optimal to use accounting regulation to eliminate managerial
flexibility completely.
 Accounting systems leave considerable room for managers to influence
financial statement data.
 A firm’s reporting strategy – that is, the manner in which managers use their
accounting discretion – has an important influence on the firm’s financial
statements.
 Corporate managers can choose accounting and disclosure policies to hide the
true economic picture of their business and manipulate investors’ perceptions
(optimistic assessment of performance and controlling of voluntary
disclosure)
 Superior disclosure strategy will enable managers to communicate the
underlying business reality to outside investors
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Accounting System Feature:

Auditing
 Auditing is a verification of the integrity of the reported financial statements
by someone independent of the preparer
 Auditor ensures that managers use accounting rules and conventions
consistently over time
 Auditing improves the quality of accounting data
 Threat of lawsuits and resulting penalties has the beneficial effect of
improving the accuracy of financial information and disclosure
 However, the potential for a significant legal liability may also discourage
managers and auditors from supporting accounting proposals that require
risky forecasts, such as forward- looking disclosures

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From Financial Statements to Business Analysis

 Investors can have only an imprecise assessment of an individual firm’s
performance due to the possible presence of data distortion and noise.
 Financial and information intermediaries can add value by improving
investors’ understanding of a firm’s current performance and its future
prospects
 Business intermediaries use financial statements to accomplish four key
objectives:
 Business strategy analysis
 Accounting analysis
 Financial analysis
 Prospective analysis
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From Financial Statements to Business Analysis

 Business intermediaries use financial statements to accomplish four key
objectives:
 Business strategy analysis.
 Accounting analysis.
 Financial analysis.
 Prospective analysis.

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From Financial Statements to Business Analysis

1. Business strategy analysis:
• Involves analysing a firm’s industry and its strategy to create a sustainable
competitive advantage.
 aims to identify key profit drivers and business risks, and to assess profit
potential
 involves analysing the potential for profit and growth and the strategy
 enables the analyst to frame the subsequent accounting and financial analysis
better
 enables the analyst to make sound assumptions in forecasting future
performance.
• This qualitative analysis is an essential first step because it enables the analyst to
frame the subsequent accounting and financial analysis better.

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From Financial Statements to Business Analysis

2. Accounting analysis:
• To evaluate the degree to which a firm’s accounting captures the underlying
business economics.
• Enables analysts to assess the degree of distortion in a firm’s accounting numbers
• Enables the analyst to recast accounting numbers to create unbiased accounting
data.
• Sound accounting analysis improves the reliability of conclusions from financial
analysis.

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From Financial Statements to Business Analysis

3. Financial analysis:
• Aims to use financial data to evaluate the current and past performance and to
assess sustainability.
• Should be systematic and efficient and allow the analyst to use financial data to
explore business issues.
• There are two primary tools in financial analysis:
 Ratio analysis – to evaluate a firm’s product market performance and financial
policies
 Cash flow analysis – to evaluate a firm’s liquidity and financial flexibility

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From Financial Statements to Business Analysis

4. Prospective analysis:
• Focuses on forecasting a firm’s future.
• Financial statement forecasting and valuation are two commonly used techniques
in prospective analysis.
• Both these tools allow the synthesis of the insights from business analysis,
accounting analysis and financial analysis so that predictions can be made about a
firm’s future.

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