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Reading Financial Statements

Structure and contents of financial statements generated by corporations

Quarterly and annual reports required to be filed by SEC and other disclosures for material events

Use financial reports to apply financial analysis concepts onto real companies

Financial reports to analyze company performance

Finding financial reports: at (click find filings) or on company websites (‘Investor Relations’) or with data services like Yahoo Finance, Google finance (free), Capital IQ, Factset or Bloomberg (paid)

The financial statements that are used to build financial statement models (commonly used by analysts):

10-K: Annual financial statements, latest share count on front cover, select financial data, detailed footnotes, MD&A. Filed within 60 to 90 days. Annual report is not a required SEC filing thus it is more marketing than 10k.

Table of contents:

Part I:

Item I: Business description – Strategy, markets and distribution, competitors

Item IA: Risk factors – boilerplate how to remain competitive

Item IB: Unresolved staff comments

Item II: Properties

Item III: Legal proceedings

Item IV: Mine safety disclosures – Dodd Frank

Part II:

Item V: Market for Equity

Item VI: Selected Financial Data – important disclosures here for some companies. Think of this in correspondence with MD&A and financial statements

Item VII: MD&A – summarizes financial results and expectations, forward looking statements, this year and prior year, breakout by geography and product and unit sales. Segment data for segment modeling in FSM. ANTICIPATES means giving guidance which should be included in the financial statement model projections. Goes down the income statement and then turns to the balance sheet. Sometimes include GAAP to non-GAAP reconciliation including organic sales growth and core EPS excluding effects of acquisitions, divestitures.

Item VIIA: Disclosures about market risk

Item VIII: Financial statements – 5 financial statements; IS, BS, SCF, SSE, SCI (new). Not presented in same order.

IS – Called statement of operations

SSE – puts magnifying glass for line items for shareholders equity, taking line items and explaining the change in each line item like the SCF explains the change in the line item of cash

SCI – magnifying glass on comprehensive income, nonoperating income under US GAAP

Item IX: Changes & Disagreements with Accountants

Item IXA: Controls and procedures

Item IXB: Other info

Part III:

Item X: Directors, executive officers and corporate governance

Item XI: Executive compensation

Item XII: Beneficial owners

Item XIII: Certain relationships

Item XIV: Principal accounting fees and services

Item XV: Exhibits and schedules


Certain disclosures for common analyses by analysts.

Accounting policies – Revenue recognition policies (deferred revenue), inventory methods (valuing using FIFO vs LIFO), depreciation method

Expense and income breakdowns – Income statement items, specific income and expense items (ex. advertising, leasing (capital vs. operating leases),

Taxes – Current vs deferred expense (note 5), deferred tax asset vs. deferred tax liablity

EPS – EPS disclosure, disconnect net income divided by diluted will not give you EPS due to changes to it. Have to look at note on EPS, gives you numerator and denominator

Restructuring – embedded within operating line items to exclude these, refer to the note

Non-GAAP reconciliations – include vs. exclude from financial performance

Discontinued operations – Net gain or loss from operations that are to be discontinued. REITS have discont. Operations as a part of normal operations.

PP&E – Straight line and useful life range, for new purchases, portion of land to be excluded. To project PP&E need gross PP&E (remove accumulated depreciation) in disclosure.

Intangibles – Historical and future amortization expenses, useful for forecasting amortization in future periods

Other assets and liabilties -Breakout of the line items from BS into components

Debt: Contains weighted average interest rate, tranches, when they are due, effective rate, revolver terms and balance

Equity: Share repurchases, issuances, guidance for future repurchases and issuances.

Stock options: most widely used by financial analysts, have to use to get diluted share count with stock options, warrants, and convertible securities. Search for exercisable and use exercisable, only available in 10k

Convertible securities: Conversion criteria to calculate diluted share count, Search for ‘convertible’ to see if they have convertible securities. Assume conversion.

Leases – critical disclosures for current and future lease commitments to normalize earnings, ‘rent expense’, ‘commitments’. Capital leases treated as payments in a debt capacity with interest

Segment data: at end of footnotes, products and geographies

Industry specific disclosures: Oil & gas industry, REITs

Not enough to look at the IS, want to look at the income and expense breakouts in the notes. Not enough to look at the BS, want to look at the asset and liability/equity breakouts.


10Q: Less detailed in footnotes and MD&A and missing option tranches, missing stock options (have to go to 10k), fixed and intangible assets, and debt disclosures. Not audited. Focus is financial statements & MD&A which are right in the front. Same financial statements. Differences in footnotes and M&DA sections.

8K aka Current Report: Material event filing. Filed for quarterly earnings. Coincides with a press release. Precedes 10Q by several weeks. Contain unusual charges and GAAP to Non-GAAP reconciliation which is used by analysts. Also filed for asset sales or restructuring. Can be more detailed than footnotes than 10K or 10Q.

S1: IPO with detailed financials and includes prospectus, more detailed than a 10K. S1 amended the day prior to the IPO itself S1A.

S3 or S4: S3 is shortform registration, similar to S1, proceeds use, financial statements not required since public

S4: Merger – peer groups and similar precedent transactions, background of the merger (history), comps analyses detailed along with certain multiples, the merger agreement and the form of consideration

Proxy aka Form 14A: Contains latest share count and management compensation and major shareholders. Useful when analyzing an acquisition. Corporate governance section about management compensation

20F: Foreign issuers. Annual report that conforms to US GAAP. Want to use 20F in conjunction with annual report filed by company in home country.


Primary M&A filings:

For the target:

10k, 10Q, and 8k (earnings release) – need targets most recent financials as of announcement date to calculate deal multiples

8K for the deal – terms to the deal, announcement data

Proxy with a 14 – target or acquirer to vote on the deal, contains deal information.

S-4 – Registration for securities issued in M&A (acquirer)

14-D, Schedule TO – When an acquirer makes a tender offer; will have deal terms

S-1 – Information becomes known through an IPO registration or high yield debt offering

Analysis is year over year comparisons and comparisons across companies from financial statement model

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