International Financial

Statement Analysis
BU7504
Trinity Business School
Caroline Kirrane, CFA, MBA
Lecture 1

1
 AGENDA
• Introduction and Housekeeping
• Background to Accounting and Finance
• Types of Accounting – Financial and Management
• Accounting Frameworks
• Contents of an Annual Report
• Explanation and exercises on 5 key pieces of financial information –
• Income Statement (or P&L)
• Balance Sheet
• Cash Flow Statement
• Statement of Shareholders Equity
• Notes to Financial Statement

2
 Introduction
• Introduction and background
• Learning – participation, homework, frequent revision, questioning concepts,
studying together, student-directed approach, masters level vs undergrad
• Class Introduction
• Who has previously worked in a full time professional job?
• Who has studied Accounting previously?
• Who likes Accounting as a subject?
• Who dislikes Accounting as a subject?
• Who is afraid of Accounting as a subject?
• Who has no intention of ever working in an area requiring Accounting?
• Who intends to work in an area requiring Accounting?
• Module explanation, learning outcomes and evaluation
• Importance of presence in lectures, group assignment and homework
3
 Background to Accounting and Finance
• Why do we “do” accounting?
• Accounting as language of business
• Importance of Finance
• Finance manager manages finances AND information
• Advanced and evolved systems with underlying concepts
• Relevance, Reliability, Matching, Timeliness, Neutrality, Faithful
Representation, Prudence, Completeness, Single Economic Entity Concept,
Money Measurement Concept, Comparability/Consistency,
Understandability, Materiality, Going Concern, Accruals, Business Entity,
Substance over Form, Realisation, Duality
4
 Types of Accounting
Financial Management
• Report to outside world • Report internally
and shareholders • Budgeting and planning
• Statutory reporting – • Pricing and costing
regulators
• Internal decision-making
• Comply with standards
• Used by many stakeholders
– primary use is valuation
of the enterprise

5
 Types of Accounting
Financial Management
• Report to outside world • Report internally
and shareholders • Budgeting and planning
• Statutory reporting – • Pricing and costing
regulators
• Internal decision-making
• Comply with standards
• Used by many stakeholders
– primary use is valuation
of the enterprise

6
 Accounting Frameworks
• Frameworks needed to establish parameters/conventions
• Generally Accepted Accounting Practice (GAAP)
• Two major global frameworks
• International Accounting Standards Board (IASB) sets IFRS
(International Financial Reporting Standards)
• U.S. Financial Accounting Standards Board (FASB) sets U.S. GAAP
(generally accepted accounting principles)
• Frameworks are continuously evolving (improvements,
convergence)

7
Users of Financial Statements

Questions: How might the needs of these

users differ? Who is internal in this list and
who is external? 8
 Users of Financial Statements
• Managers ………………………… help making business decisions
• Shareholders …………………… assess risk and return of investment
• Prospective investors ……… capital allocation decisions
• Financial institutions ………. banks => lending decisions and terms; credit rating agencies
• Suppliers ………………………….. credit worthiness, terms of business
• Customers ……………………….. dependence, warranty

• Employees ……………………….. job security, pay prospects, bonus

• Public ………………………………. assessing externalities => positive + negative eg. economic

impact, environmental impact
• Governments……………………. tax
9
 “The Big Five”
Income Statement

Balance Sheet Consolidated

Financial
Cash Flow Statements

Shareholders Equity

Notes to the Accounts

10
 Contents of an Annual Report
• The consolidated financial statements – income statement or p&l, balance
sheet or statement of financial position, cash flow, statement of
shareholders equity
• Notes to the accounts
• MD&A – Management Discussion and Analysis
• Chairperson’s Statement
• Internal control reports (sometimes audited)
• Auditors reports
• Unqualified opinion - clean
• Qualified opinion – exception from accounting standards, usually explained
• Adverse opinion – material departure from standards, not fairly presented
• Disclaimer of opinion – scope limitation from client, conflict of interest 11
Understanding Financial Statements

REVENUE EXPENSES

ASSETS LIABILITIES

12
 Income Statement
REVENUE – EXPENSES = PROFIT
MEASURES PERFORMANCE OVER A PERIOD OF TIME

REVENUE EXPENSES
•• Sales,
Sales, Gains,
Gains, Investment
Investment Income
Income •• Cost
Cost of
of Goods
Goods Sold
Sold (COGS),
(COGS), Selling,
Selling, General
General &
&
Administrative (SG&A),
Administrative (SG&A), Depreciation,
Depreciation, Amortization,
Amortization,
Interest, Tax,
Interest, Tax, Losses
Losses (on
(on sales)
sales)

P&L EUR
Sales
Sales 100,000
100,000
Less Cost
Less Cost Of
Of Goods
Goods Sold
Sold (COGS)
(COGS) 50,000
50,000
Gross Profit
Gross Profit 50,000
50,000
Less Operating
Less Operating Expenses
Expenses 25,000
25,000
Operating Profit
Operating Profit or
or EBIT
EBIT 25,000
25,000
Less Interest
Less Interest Expense
Expense 5,000
5,000
Earnings Before
Earnings Before Tax
Tax 20,000
20,000
Less Tax
Less Tax 5,000
5,000
Net Profit
Net Profit 15,000
15,000 13
Income Statement – what it tells us

Effectiveness at How profits were

generating wealth - derived – business
profits model

And why do we need it?

Cash and profits

rarely move in
unison

14
Income Statement – Ryanair, Annual Report 2016, Page 144

15
Income Statement – THE GAP, Annual Report 2016, Page 44

16
 Balance Sheet
WHAT IS OWNED (ASSETS) AND WHAT IS OWED (LIABILITIES)
A=L+E / A–L=E
MEASURES FINANCIAL POSITION AT A POINT IN TIME

ASSETS LIAILITIES
•• Resource
Resource controlled
controlled by by the
the entity
entity as
as aa result
result of
of past
past •• Present
Present obligation
obligation ofof the
the enterprise
enterprise arising
arising from
from past
past
events and
events and from
from which
which future
future economic
economic benefits
benefits are
are events, the
events, the settlement
settlement of of which
which is
is expected
expected toto result
result in
in
expected to
expected to flow
flow to
to the
the owning
owning entity
entity (IASB)
(IASB) an outflow
an outflow from
from the
the enterprise
enterprise ofof resources
resources embodying
embodying
•• Can
Can generate
generate revenue
revenue or
or support
support business
business economic benefits
economic benefits (IASB)
(IASB)
•• Classified
Classified for
for reporting
reporting into
into Current
Current and
and Non-Current
Non-Current •• Obligation
Obligation to
to transfer
transfer cash
cash or
or other
other resources
resources to
to
based on
based on time
time period
period of
of benefits
benefits another party
another party
•• Current
Current << 1yr
1yr ;; Non-current
Non-current >> 1yr
1yr •• Classified
Classified as
as Current
Current and
and Non-Current
Non-Current
•• Can
Can also
also be
be classified
classified as
as Tangible
Tangible or
or Intangible
Intangible •• Examples
Examples ofof Liabilities
Liabilities –– LT
LT Loan,
Loan, Overdraft,
Overdraft, Debenture,
Debenture,
•• Examples
Examples –– Cash,
Cash, Building
Building (PP&E),
(PP&E), Machine
Machine (PP&E),
(PP&E), Tax Payable,
Tax Payable, Trade
Trade Payables,
Payables,
Inventory, Receivables,
Inventory, Receivables, Intangibles
Intangibles (Patent,
(Patent,
Trademarks, Copyright,
Trademarks, Copyright, Goodwill),
Goodwill), Prepaid
Prepaid expenses
expenses EQUITY –– residual
residual interest
interest in
in the
the assets
assets of
of the
the entity
entity
after deducting
after deducting all
all the
the liabilities
liabilities (IASB)
(IASB)
17
Balance Sheet – what it tells us

How business is How funds are

financed deployed

Assessing
Assessing position
value/worth of
of business
business

Why does the BS equation

make sense?

18
Balance Sheet, Ryanair, Annual Report 2014, Page 146

19
Balance Sheet, THE GAP, Annual Report 2016, Page 43

20
 Cash Flow Statement
BEGINNING CASH + CHANGES IN CASH = ENDING CASH
LINK BETWEEN PROFIT AND CASH
NEEDED BECAUSE OF ACCRUALS AND MATCHING

• Hardest statement to manipulate – cash balances provided by bank

• Cash flow divided according to activities involved in its use or generation – Operations (CFO), Investing (CFI)
and Financing (CFF)

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Cash Flow Statement

Long Run
–> profits = cash
–> we’re all dead

Can you think of some reasons why cash might be lower

than profits in the long run?
Why do we care about cash?
Is it easier for a company to survive with low profits or
low cash? What about with no profits/no cash?

22
Cash Flow Statement, Ryanair, Annual Report 2016, Page 149

23
Cash Flow Statement, THE GAP, Annual Report 2016, Page 38

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Statement of Changes in Shareholders’ Equity
BEGINNING EQUITY + CHANGES IN EQUITY = ENDING EQUITY

Shareholders Equity EUR

Contributed Equity
Contributed Equity 11 Jan
Jan 1,000
1,000
Add Shares
Add Shares issued
issued 500
500
Contributed Equity
Contributed Equity 31
31 Dec
Dec 1,500
1,500

Retained earnings
Retained earnings onon 11 Jan
Jan 3,000
3,000
Net profit
Net profit for
for year
year 1,750
1,750
Less Dividends
Less Dividends forfor year
year (( 750)
750)
Retained earnings
Retained earnings onon 31
31 Dec
Dec 4,000
4,000

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 Notes to the Accounts
KEY SOURCE OF INFORMATION – ACCOUNTING POLICIES, EXPLANATORY DETAIL &
DISCLOSURES
USED TO ADJUST P&L, BS AND CF – ANALYSIS AND COMPARABILITY
ARE AUDITED

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 From Accounting to Financial Statement Analysis
• Financial Reporting provides information to enable users to make a
decision

• Financial Statement Analysis is using financial information to assess

performance – past, present and likely future performance financially and
operationally

• Decisions are typically around investment or “capital allocation” but can

also be business decisions (partnerships, creditor relationships etc)
• Eg. For an asset manager – “Do I invest some of my assets in this company” or for a corporate entity
– “Should I buy this company”

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Understanding Financial
Statement Mechanics

Case Study

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 Small Business Example (1/3)
Period 1
A business is set up by the owners on Jan 1 in Year 1 with EUR400,000 cash

Period 2
A building is bought for EUR220,000 cash

Period 3
Plant & Machinery is purchased for EUR150,000 with a loan

Period 4
Stock is purchased for EUR200,000 on credit from suppliers

Period 5
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Stock costing EUR50,000 is sold for EUR65,000 cash
 Small Business Example (2/3)
Period 6
Stock costing EUR40,000 is sold on credit to customers for EUR52,000

Period 7
Stock costing EUR60,000 is further processed with EUR12,000 of labour and electricity costing EUR6,000
and both of these items are paid in cash. This stock is sold on credit to customers for EUR94,000

Period 8
Stock purchased for EUR32,000 is sold for EUR40,000 on credit to customers

Period 9
More stock is bought for EUR100,000 cash and EUR30,000 of it is sold on credit to customers for
EUR39,000. Marketing expenditure of EUR30,000 is incurred for a market research study and selling
expenses of EUR10,000 are incurred. Both of these expenses are paid in cash. Stock bought for
EUR40,000 is sold on credit for EUR52,000 30
 Balance Sheet Example (3/3)
Period 10
A new IT system is put in place: Hardware EUR30,000, Software EUR15,000 and internal staff cost of
EUR15,000. This is all financed with a term loan. A motor vehicle is bought for EUR30,000 in cash at
the beginning of the month. This vehicle is to be depreciated at EUR1,000 per month. Stock that was
purchased for EUR24,000 is sold for EUR28,000 in cash.

Period 11
Customers who have bought stock on credit pay EUR52,000. Interest of EUR5,000 is paid to the bank.
Stock bought for EUR10,000 is sold for EUR14,000 cash.

Period 12
The business pays EUR100,000 to suppliers and repays EUR50,000 of their loans. Stock purchased for
EUR12,000 is sold for EUR18,000 on credit to customers. Stock is purchased for EUR30,000 in cash.
(use bank overdraft as necessary)
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