Financial Statement Analysis and Security Valuation

How to find out the problems of the company from the annual reports according to international standards – IFRS? Which reporting lines to pay attention to to calculate the company’s main risks?

Public companies, whose securities are admitted to organized trading on the stock exchange, as well as banks, insurers and large state-owned companies, publish annual financial statements prepared in accordance with International Financial Reporting Standards (IFRS).

photo/ Gerd Altmann

What is IFRS financial statement

IFRS financial statements are a structured presentation of a company’s financial position, financial results of operations and cash flows. The financial statements also present the results of the management of resources entrusted to the management of the company by its owners. It is assumed that the application of IFRS enables the generation of financial statements that provide the most reliable presentation of the consequences of transactions, other events and conditions of the company’s activities. A good reference is Financial Statement Analysis and Security Valuation book by Stephen Penman.

In a nutshell, analysis of financial statements in accordance with IFRS allows you to answer the following questions:

• what types of risk this business is exposed to;
• what resources are used to conduct business;
• what is the current cost of these resources;
• where the company receives funds to do business;
• what is the performance / efficiency of the use of resources.

Financial analysis is the study of key indicators, coefficients that provide an objective assessment of the current financial condition of organizations in order to make management decisions.

Having calculated the financial indicators, it is possible to know the current state of affairs in the enterprise, the problems and evaluate its capabilities and prospects in the future.

Competent analysis allows you to correctly build a development strategy, improve the mechanism of managing assets and funds borrowed from the company.

Important details

The first thing an investor should pay attention to when reading a report is the auditor’s report, which is given at the very beginning of the document. In conclusion, reservations can be made as to the fact that during the audit, problems were noted in the activities of the company or deviations from the requirements of IFRS, as well as explanatory paragraphs. It is also important to pay attention to the audit firm, on whose behalf the opinion was signed. Well-known key auditors are usually able to influence company management to fully and correctly disclose information in financial statements under IFRS.

But the absence of reservations in the auditor’s report does not guarantee that everything is in order with the company, since the auditor expresses only an opinion on the reliability of the financial statements on the basis of a random check and taking into account numerous rules and requirements. limitations of international auditing standards.

Horizontal and vertical analysis

When analyzing financial statements, horizontal and vertical analysis are used. Horizontal analysis is a comparison of financial reporting ratios in dynamics, from year to year, identifying trends. Vertical analysis is the study of ratios of various items in financial statements, the structure of assets, liabilities, income and costs.

Annual financial statements in accordance with IFRS necessarily contain information for at least 2 years – reporting and previous years. Thus, a simple comparison with the previous year can be made:

• Have the company’s assets increased over the year? If it increases, will this change be higher or lower than inflation? Above or below the industry average or average? Due to what the assets increased;
• Has the company’s net profit increased over the year compared to last year? If so, to what extent and by what factors? If the indicator has not increased or even there is a loss, then this is a negative sign, and it is important to understand why this happened;
• Has the company’s equity (net assets) increased over the year? Due to what – additional issue of shares, revaluation of fixed assets, obtaining help from shareholders, capitalization of profits;
  Has the payment of dividends to shareholders increased and were they paid in principle?

Reporting notes

Notes are an important component of IFRS financial statements. They contain additional information and transcripts of articles in the main reports. The notes have been prepared in accordance with IFRS as carefully as the main statements – statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows.

It makes sense for an investor to analyze the information in the notes to the most significant items of reports, such as, for example, financial investments, loans and borrowings issued, receivables and payables, fixed assets and intangible assets, investment property, loans and borrowings received, revenue, costs, administrative or operating expenses. The relevant notes usually contain very important information and explanations that help to understand the structure of assets and liabilities, income and expenses, as well as the specifics of the company’s business.

Author: Trycia Marks