Understanding Financial Statements - Intermediate

Understanding Financial Statements Course Introduction

• The mixed-valuation model and its problems:
  • Evolution from a backwards-looking exercise in stewardship towards a support tool for forward-looking economic decision-making
  • Why this makes life inherently and unavoidably difficult for analysts and investors
• Financial statement training looks at some core qualities of financial statements analysis and reporting, with easily understood illustrations from real life:
  • Relevance and materiality (example: why inventory valuation is more critical in low-margin businesses)
  • Comparability (example: closely comparable competitors in an (apparently) homogeneous industry, but with different histories of organic growth versus external acquisition, leading to different bases of accounting for intangibles)
  • Understandability (example: pharmaceuticals, hi-tech generally)
  • Reliable measurement (example: intangible assets in knowledge-based support industries)
  • Fair value, time value of money, and discounted present values
  • Management discretion: the exercise of judgement, and the use of estimation techniques
• Understanding finance statements training introduces the three principal financial statements: their objectives, rationale and limitations
• The five elements of business financial statements are: assets, liabilities, equity, income and expense
• Accounting as a record of flows and stocks, of resources (assets) and obligations (liabilities)

Focus on Earnings-Based Metrics: Unpacking EBITDA

• Revision of basic calculations, and any technical problems arising
• This understanding financial statements course explores questions about ‘Earnings’:
  • The Big Question: how comparable are operating earnings (i) over time and (ii) vis-a-vis the competition? Specifically:
  • Are the company’s accounting policies for revenue and expense recognition appropriately selected, clearly described, and consistently applied? (examples: Vodafone’s mobile phone pricing contracts, Upfront payments and agent v principal issues)
  • How significant are figures for the capitalised expense, relative to operating profit?
  • Does the company also use a non-GAAP earnings measure, and if so what is its stated (and real) purpose? What are its merits and demerits? (many examples, but interesting to compare the non-GAAP measures within an industry, e.g. like-for-like in food retailing)
  • Are stated earnings ‘normal’ - or have they been ‘normalised’ by the exercise of management discretion? What about income/ expenses booked through OCI?
  • Are ‘exceptional’ income and expense separately identified, and are they really exceptional? (examples: Oil & Gas and environmental damage costs, financial sector and PPI settlements, COVID-related costs)
  • Do earnings include non-operating items such as gains/losses on non-current assets or discontinued operations?
  • Are there financing elements in some operating items, such as in the payment terms of trade suppliers? (example: supermarkets turning over inventory in 15 days, paying suppliers in 45 days, using the permanent float to finance a whole year’s CAPEX)
  • Does a relatively smooth development at the consolidated level mask significant (if mutually compensating) swings between operating segments?
• Questions about ‘Interest’:
  • If this is the net figure, what are the gross figures for income and expense, and are there one-off factors in either of them, e.g. interest received on temporary reinvestment of disposal proceeds?
  • What do the figures contain, other than interest on the conventional debt and financial investments, e.g. concerning the unwinding of discounts on provisions, and pension plans?
• Questions about ‘Taxes’:
  • Does the overall tax charge, or the current/deferred split, vary significantly from year to year, and if so, why? What is the effective tax rate and are there any uncertain tax positions (for example: Mulberry PLC)
• Questions about ‘Depreciation and Amortisation’:
  • Does the total include impairment charges (or reversals) or other indications of possible impending problems for future years’ EBITDA?
• What does EBITDA not tell us about cash generation?
  • Working capital management
  • Capex requirements – for maintenance and expansion

Focus on Balance Sheet Metrics (‘Return on . . .’)

• Finance statement training revisits these key principles:
  • Valuation basis: historic cost or Fair Value
  • Reliable measurement
• Specific problem areas, creating very different balance sheets for economically identical businesses:
  • Organic growth versus external acquisition. Does it make sense to omit assets altogether just because their value cannot be reliably measured? (example: internally developed intangibles such as footballers brought up through the academy)
  • Differences in accounting for liabilities development expenditure
  • Differences in accounting for historic mergers (for example: the substantial difference between GSK’s IFRS and US GAAP balance sheets, and earnings following the merger)
  • What is the basis for Fair Value? Market value or value in use? And how is it measured?
  • Leased assets: how were they and how are they now reported on the balance sheet following the introduction of the new IFRS (example: Mulberry PLC from 2019 to 2020)
  • Financial assets: introduction to main problem areas
  • Different policies for depreciation, amortisation and impairment
• Accounting and financial statements for liabilities:
  • Current and non-current
  • Provisions and contingent liabilities: problems of classification and measurement
  • Financial liabilities

Bringing it All Together in Financial Analysis

• Financial statements training explores how to use the other sections of the annual report: chairman’s and CEO’s letters: business and financial reviews
• Uses and abuses of financial ratio analysis:
  • The key drivers of profitability
  • The key drivers of cash generation
  • Trends in profitability
  • Management of working capital, liquidity and solvency
  • The identification and management of financial and other risks and uncertainties
• The importance of knowing what to expect and knowing the industry

Understanding Financial Statements Course Wrap-up and Conclusion

Following completion of an accountancy foundation course, this financial statements course trainer qualified in 1987 as a Chartered Accountant with Gilberts: a six-partner firm. In the same year, he joined Binder Hamlyn to work in their Business Development Group.

In 1990 he joined a major training company to work as a trainer on their accountancy exam courses. During the next four years, he taught auditing, intermediate financial reporting and taxation for ACA, ACCA, CIMA and AAT exams; he also taught the ACA multi-disciplinary case study. He mainly taught full-time courses organised for Deloitte, PWC and EY; he was also personally responsible for the ACA final-level auditing paper.

In 1993 he became a director of post-examination CPD training for accountants. He was also responsible for financial training programmes for non-accountants, especially solicitors. Around this time, he also started training in International Accounting Standards initially for Ernst & Young’s non-UK-based professional staff in Europe.

Since 1998 he has been training on a freelance basis, concentrating on financial training for both accountants and non-accountants, which includes this understanding financial statements course. He also specialises in training on IFRS and US accounting standards and has presented on both subjects throughout Europe for the past 20 years. He has considerable experience in presenting training on the following topics:

• Accounting for financial instruments and insurance contracts.
• IFRS reporting issues for energy and pharmaceutical businesses.
• Completion accounts and the role of financial standards in corporate finance transactions.
• Corporate financial accounting for business combinations – mergers, acquisitions and all joint and special purpose arrangements.

The objective of this financial statements training is to help participants develop the technical skills and judgement to use accounting information appropriately, according to the context and the purpose of their analysis.

This Understanding Financial Statements course takes its cue from the clear statement in the IASB’s 2010 revised conceptual framework document:

General-purpose financial reports are not designed to show the value of a reporting entity; but they provide information to help existing and potential investors, lenders and other creditors to estimate the value of the reporting entity.

• This Understanding Financial Statements course is delivered by a professional tutor who has over 30 years of experience. He is proficient at explaining financial statements to non-accountants working in many different environments. He also still provides technical updates to practising accountants and auditors to ensure that they are completely and technically up-to-date.
• The course tutor will happily take questions on all aspects of the programme and will provide unbiased and independent guidance.
• Understanding Financial Statements training will include many current case studies and examples and will be highly interactive.
• This financial statements course is highly practical and suitable for intermediate levels. The more challenging aspects will be introduced and explained.

Understanding Financial Statements training will begin with an overview of the fundamental accounting principles which, individually or in combination with each other, account for most problems of financial analysis. This course then discards the ‘logical’ order of a conventional accounting course in favour of a practice-driven approach. The commonly used valuation metrics and performance measures (EBITDA, RoE, RoCE, RoNA, asset turnover, working capital and cash flow ratios etc) are used as ‘pegs’ on which to hang a more searching examination of the problems and uncertainties lurking behind the accounting figures.

Please note: this financial statement analysis course is based primarily on IFRS as in force at the time that the course is delivered. But a reference to significant national GAAP is made as and when this sheds useful light on the topic under discussion.