Understanding Financial Statements - Intermediate

Training 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 does this make life inherently and inevitably difficult for analysts and investors?

Core qualities of financial statements analysis and reporting. This reading financial statements course includes 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

The three principal financial statements: their objectives, rationale and limitations

The five elements of business financial statements: 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

• Questions about ‘Earnings’:

• The big question: how comparable are operating earnings (i) over time and (ii) vis-a-vis the competition?

• Are the company’s financial 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 expenses separately identified, and are they really exceptional? (examples: Oil & Gas and environmental damage costs, financial sector and PPI settlements)

• 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: Loss carry forward producing possible future tax savings - assets)

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’)

• Redcliffe's Understanding Financial Statements training will revisit 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)

• What is the basis for Fair Value? Market value or value in use? And how is it measured?

• Leased assets: how are they reported under IFRS 16, and what are the exemptions that could hide the true asset and liability position

• Financial assets: introduction to main problem areas

• Different policies for depreciation, amortisation and impairment

Accounting and financial statements for liabilities:

• Current and noncurrent

• Provisions and contingent liabilities: problems of classification and measurement

• Financial liabilities

Bringing It All Together in Financial Analysis

• 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

Course Wrap-up and Conclusion

Training Objectives

This intermediate course on reading financial statements will sharpen your skills and judgement. You will learn to accurately analyse and interpret accounting information in varied contexts and for specific analytical purposes. By taking this course, you will gain a sophisticated grasp of how financial data supports decision-making. Aligned with real-world financial analysis needs. Taking guidance from the IASB’s conceptual framework, we recognise that while general-purpose financial reports are not intended to determine an entity's value, they are a crucial resource for investors, lenders, and creditors in assessing value potential. This distinction sets the foundation for deep analysis and understanding of financial statements in this course.

Training Course Summary

We kick off financial statements training with an overview of key accounting principles. Particularly those that underpin challenges in financial analysis. Departing from traditional, linear course structures, this training adopts a hands-on, practice-driven approach.

Here, essential valuation metrics and performance measures serve as analytical anchors, including:

• EBITDA

• RoE

• RoCE

• RoNA

• Asset turnover

• Working capital

• And cash flow ratios

This helps participants investigate the deeper complexities and uncertainties embedded within accounting data. This analysis-driven course references IFRS, ensuring that the content is current and relevant. However, where applicable, understanding financial statements training will include comparative insights into significant national GAAP standards to enhance participants' understanding of nuanced, global accounting practices.