Level 1 CFA® Exam:
Financial Statements - Basics
The role of financial reporting is to provide information about a company’s performance and its financial position. This information is of great use to different market participants and it helps them to make their economic decisions.
Who will be interested in a company’s financial position and performance in particular?
First of all, the owners of the company, but also the management, investors, banks, and public institutions. What’s more, also customers, employers, and a company’s counterparties would like to know what is happening in the company. The firm should provide all these entities with reliable, fair, and true information about its current and past situation to allow them to make reliable economic decisions.
To be more precise, we can say that the purpose of the financial reporting is to give information about:
- the company’s performance,
- the company’s financial situation, and
- changes in the company’s financial situation.
It is also worth mentioning that depending on the size of the company the requirements of financial reporting differ. Usually the bigger the company the more requirements it has to meet. A bigger company has more business partners than a small company, cooperates with more companies, and so on, and has a greater impact on the society and economy in general.
Financial statement analysis is aimed at evaluating the past, current, and potential performance of a company and its past, current, and potential financial position.
To do it, financial statement analysts use financial reports produced by companies and other information, such as reports and analyses of competitors.
Why should anybody need information provided by financial reporting analysis?
For example, investors want to analyze a company to invest in, whereas banks want to evaluate the credit situation of the company before lending it some money, and so on.
According to International Accounting Standards 1.9, "Financial statements provide information about company’s:
- assets,
- liabilities,
- equity,
- income and expenses, including gains and losses,
- contributions by and distributions to owners, and
- cash flows."
Financial statements include:
- a statement of financial position (i.e. a balance sheet),
- a statement of comprehensive income (i.e. a single statement of comprehensive income or an income statement and a statement of comprehensive income),
- a statement of changes in equity, and
- a statement of cash flows.
The balance sheet gives information about the company’s financial position at a given point in time, for example at year-end.
The statement of comprehensive income provides information about the company’s profits over a period of time.
The statement of cash flows allows us to see whether the profits from the statement of comprehensive income are supported by cash inflows. It may happen that although the company shows profits, it has problems collecting money from its counterparties.
The statement of changes in equity provides additional information regarding the changes in a company’s financial position.
You should also know that any notes and footnotes provided in a financial report constitute an essential part of financial statements and are the source of important and detailed information left out from the core statements for the sake of clarity.
The financial statements themselves are only sets of numbers. It is crucial to understand where these numbers come from and to know their source. This is the information you can find in the footnotes to the financial statement.
What kind of information are financial statements required to provide? It all depends on the country that the company operates in and its regulations. Generally, when studying Financial Statement Analysis, we focus on 2 main financial statement frameworks, namely:
- The role of financial reporting is to provide information about a company’s performance and its financial position.
- Financial statement analysis is aimed at evaluating the past, current, and potential performance of a company and its past, current, and potential financial position.
- Financial statements provide information about a company’s: assets, liabilities, equity, income and expenses, including gains and losses, contributions by and distributions to owners, and cash flows.
- There are 2 main financial statement frameworks: International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles developed in the United States (U.S. GAAP).