Introduction and Financial Statement Analysis

Introduction and Financial Statement Analysis

Financial Statements | Users of Financial Statements | Accounting Analysis | Analysis of Financial Statements | Ratio Analysis | Expert Says

Financial Statements

Financial statements filed with the Securities and Exchange Commission (SEC) are uniform and standardized. The SEC regulates the financial reports of the company and makes information available to investors.

Obviously, the SEC requires reports. A few of the more notable reports are the 10-K and the 10-Q. These reports are audited and submitted annually for the 10-K and quarterly for the 10-Q. If a company has a change in current activities, then it files an 8-K. If the company is looking to raise funds in the marketplace, then it will issue a prospectus which details the use of the funds.

Common SEC Filings

Financial statements are prepared using accrual accounting. Accrual accounting is a way of matching income to expenses in a given time period. It provides a better picture (than cash flows) to the ongoing business of a company. For instance, a maker of high-end imaging equipment will have thousands of hours of research and development before a piece of equipment is sold. Accrual accounting will allocate the cost of those hours to the sale of a machine. This process provides a better picture of the true cost of developing the equipment. If accounting was done on a cash basis, the company would show thousands of hours of costs before any sale of equipment. Once the equipment is sold and subsequent units are sold, the company would show significant income without any costs to show the underlying expense of the development. A company would realize revenues when the cash is received and realize costs when they occurred.

Therefore, the timing of recognizing revenue and the matching against costs is superior to cash flow.

Financial statements give us information on how effective a business is in generating return for shareholders. The return that is achieved in any one period on the invested capital of a company consists of the returns (and losses) realized by its various segments and divisions. In turn, these returns are made up of the results achieved by individual product lines and projects. A well managed company exercises rigorous control over the returns achieved by each of its profit centers, and it rewards the managers on the basis of such results. Specifically, when evaluating new investments in assets or projects, management will compute the estimated returns it expects to achieve and use these estimates as a basis for its decision to invest or not. Profit generation is the first and foremost purpose of a company. The effectiveness of operating performance determines the ability of the company to survive financially, to