Now let's discuss the analysis and use of financial statements in general. By the end of this week, we'll first have this overview, then we'll study some of the important parameters, and then we'll come up the overall conclusion. This is an overview of financial statements. Well, first of all financial statements are used in accounting and in other disciplines for the following goals. Financial statements. This is forecasting. Then, this is assessment. Then finally, decision making and then also some other things that are sort of important for us. There's signaling, and then I will put quoted the risk return profiles. So, the idea is that if you took any of these statements as a standalone one, you can extract some numbers but also you can have some overall idea of what's going on in this company or in this project. If you take a couple of these statements, and if you take them on a comparative basis, then you will have a very nice ability to study some signals, to see some trends, and to analyze the potential returns provided by these projects and companies, and also risk exposure. Now, so what can we add to that? The important idea here without which it's sort of senseless to the extent to study financial statements, is the idea that is widely used by us as stakeholders, who uses these financial statements and for what. Then, we will have a breakdown that we had before, and that we will study in much greater detail in the video of the next week when we'll move on to managerial accounting. These are internal users. This is the management in the first place. And these are external users so you can say well wait a minute, you said that financial accounting deals with these. Well indeed. But these external users are primarily providers of capital. So, these are lenders, stockholders, and some other people, like let's say suppliers, clients, customers. They are all here. It seems to us that for the insiders, for the people who are active in management who actually make decisions, it seems that financial statements are not sufficient. Indeed they are not. But, they oftentimes use these financial statements for at least two major reasons. One they would like sometimes to take a look at themselves as outsiders, that provides important insights and information. They have to compare the behavior of their companies and projects to their competitors. In this case, they used financial statements of competitors. Without going deeper in this, we can say here I would just like to drop a word, that actually the analysis use of financial statements is also a big discipline, that well deserves the whole specialization in detail. But we have a overview and we analyze that only with respect to how we can apply that to our valuation procedures. Now, the next important thing is what kind of information people extract from financial statements. This is all information on what? I would point out just some. This is information on resources. Let's say this is cash, current assets, then this is information on profitability. This is taken from the income statement. Now, this is the information on capital structure. This is taken from the balance sheet. Also, from all these statements people make forecasts/trends. So what sources, or financial statements do we have? Well, first of all, these are all good sources. You can say, "Well, wait a minute. Why do we talk about that?" It's important because sources are clearly reports and these reports are published for public companies by law, but then also if they include some other pieces, let's say financial services. So there are companies whose job is to collect this information to analyze, publish that with comments, and sometimes with some analytical studies, so that helps a great deal. And then also there are newspapers, journals, and others. Well, you know that everyone who is interested in finance, for them, the Wall Street Journal is basically the the main source of just general financial information if you don't go deep in that. If you study a specific company, then you start to find these reports and then also to go the Internet, or to see how you can get some inputs from these financial services companies. Then, there are some other special things that are published in the report. This is auditor's reports. Here, I would just like to draw your attention to the fact that there are two kinds of them: the unqualified and qualified opinions. Unqualified is good while qualified is bad. That's just the professional slang, because qualified that means the auditors say, "Well, we have found something, and we qualify the something as a potential threat or potential mistakes, and so on and so forth." So here, we see what source, this is the info, and then these sources of information. And then finally in this overview, I would like to say that how do people examine them, examination of financial statements, what exactly they do to extract this information? Here we have, first of all, comparative financial statements. Let's say we have balance sheets for a couple of years. This way, we can extract the trend between these years and within one of that, we can also see certain things. Then the other thing, like I said, this is the percentage analysis and that is of two kinds. This is a vertical and horizontal. Again, horizontal means that this changes over time in percent over time, while vertical means that we analyze let's say balance sheet items, as percent of total assets, and then the income statement items as percent of total revenues. Well, this is very natural. Let's say if we have total assets of 1 billion dollars, and cash is one 100 million dollars, we can say that cash is 10 percent of total assets. So this is, that's a lot of cash if you will. Then on the income statement, we can see what's the percentage of net income, what's percentage of certain expenses and so on and so forth. From here, we can see that this analysis gives us some trends and signals. Well, in what follows I will use the most simplistic example of the income statement analysis, and you'll see how this goes. Well, the example is really simplistic. Let's say here is the shortest possible income statement then these are years 2013, 2012, 2011, and here in the year 2013, and in the year 2012. Here, we have only the following parameters. We have sales. We have total expenses and then we will have net income and that will be it and see how we proceed. These are the numbers from these three years, the output numbers: 700, 600, 500, so that grows this way. Now, for total expenses we have 400 here, 300 here so it went better, and then 800 here, which is worse. Now you can see that that was a 100 net income here, 300 here, and unfortunately, negative 100 this year. Then, we see what happens. First of all, we see some changes and here will be changes in numbers, and then in percentage points. You can see that the change in sales in 2013, this is this number less this number. That was one hundred and that was about 17 percent and rounding up. Here, in the previous year, that was again 100 but here 20 percent because we have the lower base. If we go to total expenses, then we can see that here the difference is 500 and this is 167 percent. That's a huge growth. But here, it was negative 100. That was negative 25 percent. The most drastic things, they happened to net income because here you can see that, if we started in year 2012, we had fundamental growth. We had here, the difference is 200 and this is basically 200 percent so it grew up three times. But unfortunately, the next year, from 300 positive, it went to 100 negative so we had here negative 400, which is negative 133 percent. That's about how we calculate these changes and then we can see some trends on this example. In what follows, we will go over some of these specific analyses and we will study some of the numbers, and we will study some ratios in some somewhat greater detail.
