FINANCIAL ANALYSIS

Nguyen Thu Thuy, PhD.

Head of Money and Banking Department
Faculty of Banking and Finance, FTU
Email: [email protected]
 References

1. Palepu, K. G. and Healy, P. M. (2013), Business Analysis and

Valuation: Using Financial Statements, 5th Edition, South-
Western: Cengage Learning.
2. Gibson, C. H. (2010), Financial Reporting and Analysis: Using
Financial Accounting Information, 12 Edition, South-Western:
Cengage Learning.
3. CFA Institute (2009), Financial Reporting and Analysis, Level
1 (Volume 3), Custom Edition, Pearson.
Assessment

No. Assessment Rate

1 Class Attendance 10%
2 Mid-Term Test 30%
Written report  
Oral presentations  
3 Final Exam 60%
Short – answer test  
Case studies  
 Content
Chapter 1: Introduction to Financial Analysis

Chapter 2: Understanding Balance Sheet

Chapter 3: Understanding Income Statement

Chapter 4: Understanding Statement of Cash Flows

Chapter 5: Basics of Analysis

 Discussion Questions
1. John, who has just completed his first finance course, is
unsure whether he should take a course in business analysis
and valuation using financial statements since he believes that
financial analysis adds little value, given the efficiency of
capital markets. Explain to John when financial analysis can
add value, even if capital markets are generally seen as
being efficient.
2. Joe Smith argues that “learning how to do business analysis
and valuation using financial statements is not very useful,
unless you are interested in becoming a financial analyst.”
Comment.
 Accounting

 The purpose of accounting is to organize the financial details of

business;
 To identify the financial transactions;
 To organize the financial data into useful information;
 To measure the value of these information in terms of money;
 To analyze, interpret, and communicate the information to
persons or groups, both inside or outside the business.
 Scope and role of financial statements
• The objective of financial statements is to provide information about
the financial position, performance and changes in financial position
of an enterprise that is useful to a wide range of users in making
economic decisions (IASB Framework).
• Financial statements are an important source of information to the
capital markets and business analysts.
• Analyzing financial statements addresses a number of issues of
interest to external stakeholders and company insiders.
 The Role of Financial Reporting in
Capital Markets
• Financial reporting provide much needed
information to capital market
participants

– Financial intermediaries depend upon the information

in financial statements to evaluate investment
opportunities.
– Information intermediaries assure the quality of
financial statement representations.
– Relevant and reliable financial information is essential
for the functioning of capital markets.
Types of Financial statements

Balance sheet
Financial position at a point in time (asset, liabilities ad equity)
Income statement
Financial performance over a period of time
Cash flow statement
Cash receipts and payment

Provide further details about the information summarized in the

financial statements Financial statement notes
Balance Sheet

The Balance Sheet, presents the financial position of an entity at

a given date. It is comprised of the following three elements:
Assets: Something a business owns or controls (e.g. cash,
inventory, plant and machinery,…)
Liabilities: Something a business owes to someone (e.g.
creditors, bank loans,…)
Equity: What the business owes to its owners. This represents
the amount of capital that remains in the business after its assets
are used to pay off its outstanding liabilities. Equity therefore
represents the difference between the assets and liabilities.
Accounting Equation

Liabilities Equity Assets

Income Statement

Income Statement, also known as the Profit and Loss Statement,

reports the company's financial performance in terms of net profit
or loss over a specified period. Income Statement is composed of
the following two elements:
Income: What the business has earned over a period (e.g. sales
revenue, dividend income,…)
Expense: The cost incurred by the business over a period (e.g.
salaries and wages, depreciation , rental charges,…)
Net profit or loss is arrived by deducting expenses from income.
Cash Flow Statement

Cash Flow Statement, presents the movement in cash and bank

balances over a period. The movement in cash flows is classified
into the following segments:
Operating Activities: Represents the cash flow from primary
activities of a business.
Investing Activities: Represents cash flow from the purchase and
sale of assets other than inventories (e.g. purchase of a factory
plant)
Financing Activities: Represents cash flow generated or spent on
raising and repaying share capital and debt together with the
payments of interest and dividends.
Account System

Classifying accounts
Assets
Liabilities
Equity
Revenue
Expense
Contra accounts–used to offset some part of the value of
another account, i.e. accumulated depreciation
 Accounting Equation

Liabilities Equity Assets

Contributed Retained
Liabilities Assets
Capital Earning
Accounting Equation

Assets = Liabilities
+ Contributed Capital
+ Beginning Retained Earning
+ Revenue
– Expenses
– Dividends

16
Example 1

Canon- a photocopy producer reported the balance sheet as of 31 st

December in 2004 and 2005 as follow:
31/12/2004 31/12/2005
(Million JPY) (Million JPY)
Total asset 3,587,021 4,043,553

Liabilities 1,190,331 1,238,535

Owners’ equity 2,396,690 ?

Total resource 3,587,021 4,043,553

Example 1

Requirements:
1. Calculate owners’ equity at 31/12/2005
2. Compare the absolute change in total asset in 2004 with that in
2005 and give comment on the importance of liabilities and
equity in financing asset growth over the two years.
Solution 1
1. Owners’ equity = Assets-Liabilities
2005 equity= 4,043,553-1,238,535=2,805,018 million JPY
2. Total asset increase : 4,043,553-3,587,021= 456,532 million JPY
Equity increase: 2,805,018-2,396,690=408,423 million JPY
Comment: Asset increase at higher rate than equity and the difference
between increase in asset and increase in equity are equal to the
difference between liabilities over two years.
456.532-408.423=1.238.535-1.190.331=48.204 million JPY
Equity took much more important role in financing growth of asset.
The linkage among financial statements

Income statement Balance sheet Cash flow statement

Revenue Current asset Cash flow from operating
Cost of good sold Cash activities
Gross profit Long term asset Cash flow from investing
Financial expense Total asset activities
S&A expense Current liabilities Cash flow from financing
Operating profit Long term liabilities activities
Other profit Total liabilities Change in cash balance
Profit before tax Charter capital Beginning cash balance
Corporate tax Retained earning Ending cash balance
Profit after tax Total equity
Total resource

Ending Retained
earning=Beginning Ending cash
retained earning + balance (CF)= Cash
Net profit-dividends Total asset=Total balance (BS)
resource
Financial Reporting Mechanics

Double entry accounting: a transaction has to be recorded in at

least two accounts to keep the accounting equation in balance
For example: an increase in an asset account must be balanced by
a decrease in another asset account or by an increase in a liability
or owners’ equity account.
Example 3

Accounting for following transactions

Transaction Accounting Treatment

Purchase equipment for 10,000$ cash

Borrow 10,000 USD to purchase

equipment
Buy office supplies for 100$ cash

Buy inventory for 8,000$ cash and sell it

for 10,000$ cash
Example 3

Accounting for following transactions

Transaction Accounting Treatment

Purchase equipment for Tangible asset increases by 10,000 USD. Cash (an asset)
10,000$ cash decreases by 10,000 USD
Borrow 10,000 USD to Tangible asset increases by 10,000 USD. Notes payable (a
purchase equipment liability) increases by 10,000 USD
Buy office supplies for Cash decreases by 100$. Supply expense increases by 100$.
100$ cash An expense reduces retained earnings, so owners’ equity
decreases by 100$

Buy inventory for 8,000$ Inventories increases by $8,000; cash decreases by $8,000
cash and sell it for Cash increases by 10,000, inventory reduces by $8,000
10,000$ cash Asset increases by 2,000
Revenue increases by 10,000$, cost of good sold increases
by $8.000 net profit increases by $2.000 retained
earning increases 2.000$ equity increases $2,000
Example 4
Accounting for the following transaction according to double entry
accounting principle
1, Receive 150,000 USD contributed from three owners
2, Set up a 100,000 USD investment account and purchase a portfolio of
equities and fixed income securities
3, Pay $3,000 to landlord for office/warehouse. $2,000 represents a refundable
deposit and 1.000$ represents the first month’s rent
4, Receive $1,200 cash for one year subscription to monthly newsletter
5, Spend $600 on newspaper and trade magazine advertising for the month
6, Borrow $ 12.000 from a bank for working capital. Interest is payable annually
at 10%. The principal is due in two years.
7, Ship first order to a customer consisting of five books at 25$ per book. Invoice
terms are that payment is due in 30 days. No cash changes hands. The
company purchased those books at 20$ per book
8. Sell for cash 10 books at $25 per book. The company bought these book at
20$ per book.
 Example 4

Transaction Accounting treatment

Receive 150,000 USD contributed from Cash (asset) increases by 150.000$;
3 owners Contributed capital (equity) increases by
150,000$
Set up a portfolio of equities and fixed Investments (A) increases by 100,000$; Cash
income securities valued at 100,000 (A) reduces by $100.000
USD
Pay 3,000 USD for office/warehouse. Cash(A) reduces by 3,000 USD; Deposit (A)
2,000 USD is deposit and 1,000 USD is rises by 2,000 USD, prepaid expense (A) rises
first month’s rent by 1,000 USD
Receive $1,200 cash for one year Cash (A) increases by 1,200 USD, unearned
subscription to monthly newsletter revenue (L) rises by 1,200 USD
Spend $600 on newspaper and trade Cash (A) reduces 600 USD; advertising
magazine advertising for the month expense (E) rises by 600 USD; Net profit
decreases 600 USD; retained earning (E)
decreases by 600 USD; equity reduces by
600 USD
 Example 4

Transaction Accounting treatment

Borrow $ 12.000 from a bank for Cash (A) increases by 12,000 USD, bank debt
working capital. Interest is payable (L) increase by 12,000 USD
annually at 10%. The principal is due in
two years.

Ship first order to a customer consisting Account receivables (A) increases by 125
of five books at 25$ per book. Invoice USD, revenue (R) rises by 125 USD.
terms are that payment is due in 30 Inventories(A) decreases 100 USD, cost of
days. No cash changes hands. The good sold rises by 100 USD.
company purchased those books at 20$
per book

Sell for cash 10 books at $25 per book. Cash (A) rises by 250$, revenue rises by 250$,
The company bought these book at 20$ inventories (A) reduces 200$, COGS rises by
per book. 200$.
Accrual Basis

Revenue Recognition

Revenue is recorded when earned and expense is recorded when

incurred, irrespective of when the related cash movements occur.
The purpose of accrual entries is to report revenue and expense in
the proper accounting period.
 Accrual Basis
Cash movement prior to Cash movement in Cash movement after
accounting recognition the same period accounting recognition
as accounting
recognition

Unearned revenue Accrued revenue

Originating entry – record Originating entry: record
cash receipt and establish a revenue and establish an asset
liability (receivables)
Adjusting entry- reduce Adjusting entry- when cash is
Revenue the liability while recording collected, eliminate the
revenue No accrual entry receivables
needed

Prepaid expense (A) Accrued expense (L)

Originating entry: Cash Originating entry- establish a
reduces, prepaid expense liability and record an expense
Expense (A) rises Adjusting entry- reduce the
Adjusting entry: recording liability as cash is paid
expense while reducing
prepaid expense,
Accrual Basis

ACCRUAL Balance Sheet

BASIS Income Statement

CASH
BASIS Cash Flow Statement
 Framework for financial reporting

 Accounting standards regulates amount and type of

information that companies have to provide for creditors and
investors
 Standard-setting bodies are professional organizations of
accountants and auditors that establish financial reporting
standards.
 Regulatory authorities are government agencies that have
the legal authority to enforce compliance with financial
reporting standards.
Financial Accounting Standards

Vietnam USA International

Standard setting Ministry of Financial International
bodies finance Accounting Accounting
Standards Board Standards Board
(FASB) (IASB)

Standards Vietnam Generally International

accounting Accepted Financial
standards Accounting Reporting
(VAS) principles Standards (IFRS)
(GAAP)
 Vietnam Internationa Explanation
Fundamentals principles
( VAS N0 21)
GAAP
l (IFRS) for preparing
financial
Going statements
Going Principle of Financial statements are based on the
concern concern continuity assumption that the firm will continue to
basis basis exist unless its management intend to
(must) liquidate it
Accrual basis Accrual Accrual accounting is used to prepare the
basis financial statements other than the
statement of cash flow
Consistency Consistency Principle of Apply consistent definition, standards,
consistency accounting method from period to period.
Principle of
permanence of
methods
No No No offsetting of assets against liabilities or
offsetting offsetting income against expenses
Essential Small and inessential misstatements or
and omissions that do not effect the
comprehensi faithfulness and reasonability of financial
ve statements
Comparable Financial statements must present
comparative information
 Fundamentals principles for preparing
financial statements

(IFRS) GAAP Explanation

Fair Principle of Faithfully representing the effects
presentation utmost good of the entity’s transactions and
faith events according to the standards
Principle of for recognizing assets, liabilities,
sincerity revenues and expenses
Materiality Principle of Financial statements should be free
materiality of misstatements or omissions that
could influence the decisions of
users of financial statements.
Scope of financial statement analysis

Evaluate the past, Purpose:

Use Financial current and
reports + Other prospective Making investment,
information performance and credit and other
financial position economic decision
Financial Statement Analysis

Financial statement analysis is an important element of

fundamental analysis
Fundamental analysis aims to determine the intrinsic value of a
stock by analyzing related economic, financial, quantitative and
qualitative factors.
Macro Economic analysis
Industry Analysis
Company
Stock valuation
Investment Philosophy

 A stock’s market price always moves around its

intrinsic value
 If stock price is below its intrinsic value, the market will
move the stock price up to its intrinsic value in the
future.
 If stock price exceed its intrinsic value , in the future the
stock price will be pulled down to its intrinsic value
Investment Philosophy

70
60 Sell
50
Buy
40
Instrinsic
30 value
Market price
20
Face value
10
Buy Book value
0
0 1 2 3 4 5
How Capital Markets Function
 From Business Activities to
Financial Statements
• Financial statements measure and summarize
the economic consequences of business
activities.

• Accounting systems facilitate information

quality.
– The role of accrual basis accounting.
– The need for generally accepted accounting
principles (GAAP).
– Auditing and the quality of financial
information.
 From
Business
Activities to
Financial
Statements
Financial Statements and Business Analysis

• Business intermediaries use financial statements

to accomplish four key objectives:

– Business strategy analysis

– Accounting analysis
– Financial analysis
– Prospective analysis
Business

Strategy

Analysis