Section A – Financial Statement Analysis
Introduction to the Financial Statement Analysis Section
The Financial Statement Analysis part contains 20% of the CMA Part two Exam. Part two is a four-hour
exam that will include one hundred multiple-choice questions and two essay scenarios. Topics inside an examination
part and the concern areas inside matters can also be mixed in character questions. Therefore, the range
of multiple-choice questions on Financial Statement Analysis in any one examination can't be predicted, nor can
it be estimated whether or not or now not a character examination will have any essay questions on the topic. The nice
approach to getting ready for the examination is to recognize and recognize the standards very properly and be prepared for
anything.
In analyzing the following section, make sure to comprehend all of the ratios listed, what everyone means,
and what everyone is used for. Candidates want to be in a position to interpret the ratios, now not simply calculate them.
The flash playing cards that are a phase of the CMAKID Questions can be beneficial for analyzing the ratios greater than for
studying different subjects due to the fact the ratios all want to be memorized. Using the flash playing cards will sincerely assist
to memorize the ratios.
Know-how in economic accounting is wanted for the Financial Statement Analysis element of the exam.
1. Basic Financial Statement Analysis
Measures of Income
Earnings Before Interest and Taxes (EBIT) and Earnings Before Taxes (EBT) are phrases regularly used in
financial announcement analysis.
Earnings Before Interest and Taxes and Earnings Before Taxes Defined
The fashionable multiple-step earnings declaration structure consists of the following sections:
Note: “Income from persevering with operations” on a multi-step earnings declaration is now not the identical factor as
“operating income.”
Operating profits consist of revenues and charges generated through the company’s core business. Operating
income does now not consist of economic earnings (interest and dividend income) or economic price (interest
expense), nor does it consist of non-operating positive factors and losses or the provision for earnings taxes on continuing operations.
Income from persevering with operations, on the different hand, does consist of economic income, economic expense,
non-operating positive factors and losses, and earnings taxes on persevering with operations, in addition to revenues and
expenses generated with the aid of the company’s core business.
Income from persevering with operations refers to reap or loss that the employer generated on all of its activities that are anticipated to proceed in the future. It is known as earnings from persevering with operations to
distinguish it from beneficial properties and losses on discontinued operations. Income from persevering with operations does
not encompass earnings from discontinued operations because profits from discontinued operations represent earnings or loss that is now not predicted to proceed in the future. The plausible consumer of an enterprise
should seem to profit from persevering with operations as an alternative to internet earnings due to the fact earnings from persevering with
operations will proceed in the future.
The line “Income from persevering with operations” seems on a profits assertion solely if the association
is reporting the consequences of discontinued operations.
Earnings Before Interest and Taxes (EBIT)
is now not equal to running income, even though in some instances
the two matters may additionally be the same.
A line titled “EBIT” no longer shows up on a standard, multi-step profits announcement due to the fact EBIT is a calculated
amount used in monetary assertion evaluation and other sorts of analysis. Earnings Before Interest and Taxes
is equal to internet profits adjusted to add again any deduction for hobby price and any deductions for
taxes. EBIT can be calculated in extra than one way. Beginning with running income, it would be calculated
as follows, apart from any deductions for hobby cost or earnings tax expense:
In summary, the variations between running earnings and EBIT are:
• Operating profits no longer consist of pastime and dividend income, whereas EBIT does encompass interest and dividend income.
• Operating profits do now not encompass non-operating features and losses on acquisitions or investments,
whereas EBIT does consist of non-operating beneficial properties and losses on acquisitions or investments.
• Operating profits do now not encompass pre-tax good points and losses on discontinued operations, whereas
EBIT does consist of pre-tax good points and losses on discontinued operations.
Neither EBIT nor running profits encompass any deductions for hobby price or for taxes.
Therefore, if the organization has beneficial properties and/or losses on acquisitions or investments, interest, or dividend
income, and/or income/losses from discontinued operations, its Earnings Before Interest and Taxes will not
be identical to its working income. All of these gadgets represent the distinction between working
income and EBIT. If the agency has none of these items, its running profits will be equal as its
EBIT, however, that will be proper solely due to the fact the gadgets that would create the distinction no longer exist.
Note: Non-operating good points and losses and hobby and dividend earnings earned on investments can also be
excluded from EBIT if the analyst prefers. However, pastime profits earned on deposits prolonged to customers need to constantly be blanketed in EBIT.
Exam Tip: Despite the truth that running earnings and EBIT are now not equal thing, they may additionally be used
interchangeably, even on an exam, below the assumption that the profits assertion carries no
gains/losses on acquisitions or investments, no activity or dividend income, and no income/losses from
discontinued operations.
Earnings Before Taxes (EBT) is Earnings Before Interest and Taxes (EBIT) minus Interest Expense.
Comparative Financial Statement Analysis
One of the fundamental difficulties in the evaluation of economic statements between corporations or between durations
of time for equal organization is the distinction in size.
• When evaluating two companies, one agency may also have a greater internet profit in reality due to the fact it is
bigger and no longer because it is greater efficient, wonderful, or sells a higher product.
• When evaluating economic statements for the equal organization over several accounting periods, the
income statements may additionally document huge income increases at some stage in one of the periods, making comparison difficult.
One of the approaches to deal with these measurement variations is thru comparative economic announcement analysis.
Comparative monetary statements nation every object of the monetary assertion now not as a numerical amount,
but as an alternative as a proportion of an applicable base amount.
Comparative monetary statements can be both vertical and horizontal.
• Vertical analysis, additionally known as common-size monetary statements, makes it feasible to evaluate
the overall performance of businesses of distinctive sizes at some stage in an equal duration of time.
• Horizontal or style analysis, additionally known as common-base 12 months statements, allows the contrast
of statistics for a single organization or a single enterprise over a duration of time.
Vertical Common-Size Financial Statements
An easy vertical common-size economic announcement covers one year’s running outcomes and expresses every
component as a proportion of a total.
• Line objects on the profits declaration are normally introduced as a share of income revenue.
• Line gadgets on the stability sheet are normally introduced as a proportion of whole assets.
For example, the constant property will now not be noted as a greenback quantity but instead will be noted as a proportion of
total assets. Each rate object will be cited as a share of the complete revenue.
However, common-size monetary statements do now not want to relate every stability sheet object to whole assets
only. For example, the evaluation may center attention on the company’s stock and calculate percentages of uncooked
materials, work in process, and completed items in whole inventories. Or the evaluation may center attention on the
composition of the company’s investments, each present-day and noncurrent.
A vertical common-size profits assertion would possibly kingdom every classification of income or charges as a
percentage of whole revenues. Alternatively, it may nation universal and administrative fees and promoting
expenses every as a share of complete running expenses. A common-size monetary declaration can be
anything the analyst needs to see or analyze.
The analyst would possibly additionally examine a company’s common-size profits declaration with enterprise common-size
income statements to doubtlessly divulge a problem. For instance, if the fee of items bought as a proportion of
total income is substantially greater than the norm for different corporations in the equal line of business, it should
indicate that “inventory shrinkage” (in different words, theft) is taking place.
In addition, common-size economic statements for one organization can be organized facet with the aid of facets for a length
of various years to disclose tendencies over time in character line objects as percentages of income revenue.
Common-size monetary statements via enterprise are handy in posted shape from quite a few sources. Two of
they are:
1) A e-book known as Annual Statement Studies is posted using the Risk Management Association (formerly
Robert Morris Associates), a bankers’ alternate association. The announcement research data is provided by way of RMA member banks from the economic statements of their small and medium-sized enterprise
customers. The statistics cover extra than 300 industries and are damaged down through asset dimension and
sales size so that a specific company’s common-size assertion can be in contrast with these of
businesses in its enterprise that are about its very own size. The Annual Statement Studies can
be bought both in challenging reproduction or online get admission through RMA’s internet site at www.rmahq.org.
2) Dun & Bradstreet® Key Business Ratios on the Web (KBR), posted by way of Mergent, Inc., provides
industry benchmarks compiled from Dun & Bradstreet's database of public and non-public companies.
KBR presents common-size economic statements and 14 key ratios developed from the real corporation
income statements and stability sheets.
The sources above comprise statistics on each public and nonpublic company, although the full-size majority of the
information in the Annual Statement Studies is on nonpublic companies.
Much greater statistics are accessible for public organizations than for nonpublic companies. Various Internet
sites grant facts on public groups that are already in a shape that can be effortlessly analyzed. Some of this
information is free and some are on a subscription basis. In the U.S., statistics on any organization that archives
reports with the SEC (Securities Exchange Commission)
Horizontal Trend Analysis
Horizontal vogue evaluation is used to consider developments for a single commercial enterprise over a length of numerous years. In
analyzing the earnings statement, modifications in revenues or charges over time can indicate, for example, the
effectiveness of a company’s alternative pricing approach or its efforts to enhance operations.
Horizontal vogue evaluation can be in the structure of common-base year monetary statements or as a version
analysis, a presentation of the annual boom fees of line items.
Common-base 12 months monetary statements use the first year as the base year. Financial declaration quantities
for subsequent years are introduced now not as greenback quantities but as percentages of the base 12 months amount,
with the base year assigned a cost of a hundred percent or one hundred For example, every year’s stock stability is noted
as a proportion of the base year’s stock and every year’s constant belongings are mentioned as a proportion of the
base year’s constant assets.
Horizontal evaluation can additionally be finished in the shape of a variant evaluation using calculating the annual increase
rate of every man or woman line item. For every line item, the share of trade year-over-year is calculated.
Each year’s cost is in contrast with that of the preceding year.