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Financial reporting is how a company shows its performance and financial position to investors, creditors and others: it prepares and presents financial statements.
Financial statement analysis is what users do with them. Its role is to use the statements, plus other relevant information, to make economic decisions.
Reporting produces the information. Analysis turns it into a decision.
Typical economic decisions:
To make them, analysts judge past performance and the current financial position to form a view of the company's future ability to earn profits and generate cash flow. Along the way they identify the risk factors that could change that view.
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Whatever the question (a bond, a stock, an acquisition), analysts can follow the same steps:
Priya, a credit analyst, is asked whether her bank should lend to Kestrel Foods.
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Professional bodies of accountants and auditors. They set financial reporting standards.
Standard setters write the standards. Regulatory authorities make companies follow them.
Most national regulators belong to IOSCO, whose members regulate more than 95% of the world's financial markets. IOSCO itself is not a regulator. Its three objectives:
In the US, the SEC enforces the Sarbanes-Oxley Act (2002): it limits extra paid services from the external auditor, makes executive management certify the statements and report on internal controls, and has the auditor confirm those controls work.
A proxy statement is the place to read about board elections and qualifications, management pay and stock option grants.
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Financial statement notes (footnotes) are audited along with the statements. They help users judge the amount, timing and uncertainty of reported estimates. They cover:
A business (operating) segment must be reported if it accounts for more than 10% of the company's revenue, assets or income, and has distinct risk and return. Reported segments must cover at least 75% of external sales.
Kestrel Foods has external revenue of 1,000:
Segment disclosures are only a subset of what the company reports as a whole. For each segment:
There's no segment cost of goods sold. Even so, segment margins, turnover and growth rates sharpen a forecast.
Management commentary (also called management's discussion and analysis, MD&A) is one of the most useful parts of the annual report. IFRS guidance says it should cover the business, management's objectives, past performance and the measures used, and key resources, risks and relationships.
The SEC also requires trends, significant events and uncertainties affecting liquidity, capital resources and results, plus inflation effects, off-balance-sheet and contractual obligations, accounting policies needing significant judgment, and planned spending and divestitures.
Parts of it may be unaudited.
An audit is an independent review of the financial statements. Its objective is an opinion on their fairness and reliability. The standard opinion says:
Reasonable assurance is not a guarantee.
The statements are free of material omissions and errors.
Any opinion other than unqualified is a modified opinion.
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The IASB and FASB work to converge, but differences remain:
Compare an IFRS reporter with a US GAAP reporter only after adjusting for these.
New products and transactions may not fit existing standards neatly. Analysts can use the financial reporting framework to judge how such items should affect the statements.
To stay current:
Issuer sources are unlikely to be audited. Analysts also study the economy, the industry and competitors.
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That's the reading.
Now test it on exam-style questions while it's fresh.