CFA® Financial Statement and Analysis
Financial analysis assesses a company's performance in relation to its industry and economic environment to make an investment recommendation or decision. Financial analysts' opinions and recommendations frequently concern giving capital to businesses—specifically, whether to invest in their issues of debt or equity and at what price. A debt securities investor is concerned about the company's ability to pay interest and repay the amount borrowed. An equity securities investor is a firm owner with a residual interest, who is concerned about the company's ability to pay dividends and to realize an increase in value and stock price.
Overall, financial analysis evaluates a company's ability to create a return on capital that is at least equivalent to the cost of that capital, grow its activities profitably, and create enough cash to satisfy obligations and pursue opportunities.
The information obtained from a company's financial reports is the starting point for fundamental financial analysis. These financial reports include audited financial statements, regulation-required additional disclosures, and any accompanying (unaudited) management commentary.
What to Expect in CFA Level 1 Financial Statement Analysis?
The CFA Level 1 Financial Statement Analysis (FSA), formerly known as Financial Reporting and Analysis (FRA), is the second most weighty topic on the CFA exam after Ethics. FSA is not only fundamental to passing Level 1 but succeeding in the CFA Program overall. 20% of Level 1 readings are dedicated to the topic and cover a breadth of financial accounting knowledge.
Candidates will study the various components of financial statements, how to assess their quality, and how to adjust data to improve their analysis and thus value companies and assets more accurately.
Exam Weighting
The CFA Financial Statement Analysis has a weight of 13%-17%, so that approximately 23-31 of the 180 CFA Level 1 exam questions focus on this topic.
| Topic Weight | No. of Learning Modules | No. of Formulas | No. of Questions |
|---|---|---|---|
| 13-17% | 12 | Nearly 100 | ca. 26 |
Level 1 Financial Statement Analysis Syllabus, Readings, and Changes
The CFA Level 1 exam includes 73 total Learning Modules for 2023, with 12 (20%) of the total readings centering on Financial Statement Analysis. Financial Statement Analysis is among the most technical and weighty topics of the CFA Level 1 exam. Candidates will learn to assess a company’s financial position and associated risks through a comprehensive analysis of financial statements.
In the Financial Statement Analysis topic area, there are no changes to the curriculum for 2023. This is a lengthy topic, with 12 readings (16.4%) of the total curriculum. The weight of the Financial Statement Analysis section on the exam decreased from 2018 to 2019. Since 2021, the weight has consistently fluctuated between 13-17%.
| 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
|---|---|---|---|---|---|
| 20% | 15% | 15% | 13-17% | 13-17% | 13-17% |
Financial Statement Analysis
This first reading of Financial Statement Analysis introduces financial reporting roles, and how to use various financial statements to evaluate a company’s performance and financial position. The reading also covers the importance of financial statement notes, the objective of audits, and information sources used by analysts.
Financial Reporting Standards
Focuses mainly on the roles of financial reporting- and standard-setting bodies and regulatory authorities, particularly the International Financial Reporting Standards (IFRS) framework and its comparison to the U.S. Generally Accepted Accounting Principles (GAAP).
Understanding Income Statements
Covers the components of the income statement and general principles and accounting standards for revenue and expense recognition. The reading also includes how earnings per share (EPS) is calculated and interpreted, and the fundamentals of non-recurring items in financial analysis.
Understanding Balance Sheets
Provides detailed descriptions of balance sheet items (assets, liability, equity) and the uses and limitations of the balance sheet in financial analysis. The reading also contrasts current and noncurrent assets/liabilities and demonstrates how to calculate and interpret liquidity and solvency ratios.
Understanding Cash Flow Statements
Cash flows from operating, investing, and financing activities are compared, contrasted, and classified. The readings detail how the cash flow statement is linked to the income statement and the balance sheet and introduce several analytical ratios.
Financial Analysis Techniques
Covers tools and techniques used to analyze companies. The reading is highly theoretical and includes an overview of methods used to identify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Inventories
Costs included in inventories are contrasted with costs counted as expenses. The reading explains important inventory valuation methods like FIFO and LIFO as well as the LIFO reserve and liquidation, and their relation to financial statements and ratios, as well as.
Long-Lived Assets
Details the difference between tangible and intangible assets, depreciation and amortization methods, and impairment, revaluation, and derecognition of long-term assets. The reading also covers finance and operating leases.
Income Taxes
Defines and distinguishes accounting profit and taxable income and the resulting deferred tax assets or liabilities, or valuation allowance. This is a particularly important reading as the material is typically less familiar to candidates.
Non-Current (Long-Term) Liabilities
Covers financial statement presentation, disclosures, and derecognition of debt, as well as the treatment of debt covenants in protecting creditors. The reading also includes descriptions of the effective interest method and how to calculate interest expense, amortization of bond discounts/premiums, and interest payments.
Financial Reporting Quality
Provides tips on distinguishing between conservative and aggressive accounting and identifying the conditions that can lead to low-quality or fraudulent financial reports. The reading also details accounting methods for managing earnings, cash flow, and balance sheet items.
Applications of Financial Statement Analysis
Describes methods for forecasting future net income and cash flow and determines how past financial performance signals a company’s strategy. The reading also covers how financial statements are used to screen for potential equity investments and how knowledge from the FSA section can be applied in the real world.
CFA Financial Statement Analysis Level 1 Sample Questions and Answers
The sample questions are typical of the probing multiple-choice questions on the L1 exam. During the exam, you have about 90 seconds to read and answer each question, carefully designed to test knowledge from the CFA Curriculum. UWorld’s question bank is built to expose you to exam-like questions and illustrate and explain the concepts tested thoroughly.
Using DuPont analysis, an analyst compiles the following data for a company:
| 20X7 | 20X6 | 20X5 | |
|---|---|---|---|
| Return on equity | 16.7% | 16.5% | 15.9% |
| Return on assets | 6.0% | 6.2% | 6.4% |
Based only on this information, and assuming revenue and net income were unchanged during this period, the most appropriate conclusion is that the company’s:
- leverage increased
- total asset turnover increased
- average shareholders’ equity increased
A manufacturing company that uses LIFO under US GAAP shows the following inventory-related information at the end of 20X8:
| Selected Data ($ millions) | |
|---|---|
| Cost of ending inventory | 100 |
| Selling price | 110 |
| Completing cost | 15 |
| Normal profit margin | 20 |
| Replacement cost | 70 |
Based on this data, the inventory amount reported on the balance sheet (in $ millions) is closest to :
- 70
- 75
- 95
An increase in the statutory tax rate will most likely:
- increase both deferred tax assets and deferred tax liabilities
- increase deferred tax assets and decrease deferred tax liabilities
- decrease deferred tax assets and increase deferred tax liabilities
What to Expect in CFA Level 2 Financial Statement Analysis?
The CFA Level 2 Financial Statement Analysis (FSA) is one of the more weighty topics: 7 of the 49 (14.3%) of the Level 2 Learning Modules are dedicated to FSA. FSA is not only fundamental to passing Level 2 but succeeding in the CFA overall. Candidates will dive deeper into the details of a narrower range of concepts and principles presented in the Level 1 FSA.
Exam Weighting
The CFA Level 2 Financial Statement Analysis has a weight of 10%-15% on the L2 exam, meaning that approximately 8-12 of the 88 CFA Level 2 exam questions or 2-3 item sets focus on this topic.
| Topic Weight | No. of Learning Modules | No. of Formulas | No. of Questions |
|---|---|---|---|
| 10-15% | 7 | Nearly 40 | ca. 8-12 or 2-3 item sets |
Level 2 Financial Statement Analysis Syllabus, Readings, and Changes
The CFA Level 2 exam includes 49 total Learning Modules for 2023, and 7 (14.3%) of these readings focus on Financial Statement Analysis. Level 2 Financial Statement Analysis focuses on fewer topics but in greater detail than Level 1.
Financial Statement Modeling reading which was previously Industry and Company Analysis, has a minor revision in which a reading moved from Equity Valuation topic to FSA. Furthermore, LES introduced spreadsheets for financial modeling and behavioral biases in forecasting. The weight of the Financial Statement Analysis section decreased from 2018 to 2019. Since 2019, the weight has fluctuated between 10-15%.
| 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
|---|---|---|---|---|---|
| 15-20% | 10-15% | 10-15% | 10-15% | 10-15% | 10-15% |
Intercorporate Investments
Describes the classification, measurement, and disclosure under International Reporting Standard (IFRS) for various investments and compares and contrasts to US GAAP. The reading also covers the effect of various accounting methods for intercorporate investments on financial statements and ratios.
Employee Compensation: Post-Employment and Share-Based
Look at strategies to explain and calculate measures of a defined benefit pension obligation, the effect of a defined benefit plan’s assumptions on the defined benefit obligation and periodic pension cost, and the effect of adjusting for pension items and other post-employment benefits reported in financial statement notes on financial statements and ratios.
Multinational Operations
Covers foreign currency transaction exposure, how currency fluctuations affect financial results, and how a company’s effective tax rate is affected by multinational operations. The reading also compares and contrasts presentations in reporting various currencies and the current rate and temporal methods.
Analysis of Financial Institutions
Describes the differences between financial institutions and companies and key aspects of financial regulations of financial institutions. The reading also explains various approaches to analyzing banks, including the capital adequacy, asset quality, management, earnings, and liquidy and sensitivity (CAMELS) approach.
Evaluating Quality of Financial Reports
Demonstrates conceptual frameworks for assessing financial report quality (balance sheets, cash flow, etc.), including identifying potential issues that negatively affect quality. The reading also explains mean reversion in earnings and how the accrual component of earnings affects the speed of mean reversion.
Integration of Financial Statement Analysis Techniques
Demonstrates frameworks for analyzing particular problems within financial statements (e.g., critiquing a credit card rating, valuing equity based on comparables, etc.). The reading also covers how to evaluate financial and reporting biases, the quality of a company’s financial data, and recommends appropriate adjustments to improve quality and comparability with similar companies.
Financial Statement Modeling
This Learning Module was moved from its 2022 home in Equity Valuation (formerly “Industry and Company Analysis”). It focuses on the complexities of modeling pro forma financial statements and includes additional material on behavioral biases in forecasting.
CFA Financial Statement Analysis Level 2 Sample Questions and Answers
The sample questions here are typical of the L2 exam’s complexity and depth: formatted as item sets, with a vignette to deliver a scenario that tests the CFA L2 Curriculum. (On the actual exam, each vignette applies to four questions; we’ve thrown in a couple extra to get a bit more learning in). And be sure to review the illustrated explanations we’ve provided for each question: UWorld’s question bank is designed to expose you to exam-like questions and explain the concepts tested thoroughly.
Passage
Lang & Bauer Group (LBG) is a German company that reports using IFRS. LBG has two retirement benefit plans: a defined contribution plan, open to all employees, and a defined benefit plan, closed to new participants.
LBG’s chief executive officer, Emma Schuster, asks the chief financial officer, Jan Berger, to outline the current situation of the company’s retirement benefit plans. Berger explains that the plans have distinct features, and although the accounting treatment of the defined contribution plan is relatively simple, the defined benefit plan requires a more detailed analysis. Berger presents the following information from the defined benefit plan:
| Exhibit 1 Lang & Bauer Retirement Plan Information | |
|---|---|
| (EUR millions) | 20X8 |
| Discount rate assumption | 5.00% |
| Current service costs | 1,250 |
| Past service costs | 850 |
| Actuarial loss (gain) | 200 |
| Employer contribution | 2,300 |
| Benefits paid | 1,800 |
| Actual return on plan assets | 900 |
| Pension obligation at beginning of year | 13,000 |
| Fair value of plan assets at beginning of year | 11,400 |
Berger warns Schuster that this information relies on some key assumptions, and that changes in these assumptions would have material effects on the estimates of benefit obligations and periodic pension costs. Berger lists the discount rate, the annual compensation growth, and life expectancy as some of these key assumptions.
Schuster asks Berger to prepare a comparison with defined benefit plans of LBG’s peers in Europe and in the United States. Berger explains that, since US companies comply with US GAAP, there are several differences in the way that pension costs are recognized in the profit and loss (P&L) and other comprehensive income (OCI) statements. Schuster asks Berger to provide examples of how the accounting treatment under US GAAP differs from the treatment under IFRS. Berger states that under US GAAP:
Example 1: Actuarial losses (gains) recognized in OCI are not subsequently amortized to P&L.
Example 2: The effects of plan amendments on obligations for prior services are recognized in P&L.
Example 3: Differences between actual and expected return on assets result in an actuarial loss or gain.
Which of the following best describes a feature of LBG’s defined contribution plan?
- Contributions and payments are usually made through a pension trust.
- The employer is not responsible for the investment risk of the plan assets.
- An increase in compensation levels will increase the future plan obligation.
Based on Exhibit 1, the defined benefit pension obligation (in EUR millions) at the end of the year is closest to:
- 13,950
- 14,150
- 15,950
Based on Exhibit 1, the fair value of plan assets (in EUR millions) at the end of the year is closest to:
- 10,500
- 12,800
- 14,600
What Is the CFA Level 3 Financial Statement Analysis?
There is no distinct study session or readings for CFA Level 3 Financial Statement Analysis. It is one of several foundational topics that the CFA Level 3 exam tests implicitly, while focusing on Portfolio Management.
Study Tips for the CFA Financial Statement Analysis
- The Level 1 FSA curriculum is the elephant in the room for the CFA exam. If you have no accounting background and don’t know a balance sheet from an income statement, you can get through it, but plan to devote serious time to it.
- And if you do have an accounting background, don’t skip over this lightly. In the CFA curriculum, accounting is a means to an end, financial statement analysis, so there’s a lot more to it.
- Both Levels 1 and 2 require a lot of attention to and—let’s face it—memorization of detail, all of which will be a lot easier if you learn the logic behind the systems.
- The CFA curriculum assumes IFRS throughout, but still requires knowledge of US GAAP and the differences between the two, especially as that affects financial statement analysis.
- Each level’s curriculum builds on the last, so be sure you build a solid understanding to go forward.
- The math is not complex, but accounting is about recording and measuring performance, so you will have to understand the math.
- Here are some hints/steps when reviewing financial statements:
- Clearly define the analysis' goal and context: the target audience, timeline, and primary topic of the analysis.
- Gather information: Gather the information needed to respond to the questions posed in step 1.
- Data processing: To synthesize the data, perform computations and create charts or other outputs.
- Examine and understand the information: Examine the data and draw conclusions or make recommendations based on it.
- Conclusions and recommendations should be developed and communicated.
- Follow-up: Update and evaluate the data on a regular basis to see if it still supports the initial conclusion.
Visit our CFA Level 1 Study Guide, CFA Level 2 Study Guide, and CFA Level 3 Study Guide for more information.
Frequently Asked Questions
Understanding the fundamental rule of each formula will help you unlock related concepts and formulas. Think of it as learning the grammatical structures of a new language rather than memorizing phrases one by one. As you build this foundation of understanding, reinforce it through repetition and application. Take a look at our CFA L1 Formula sheet for further resources and tips.