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.
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%.
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.
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.
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.
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:
|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:
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|
|Normal profit margin||20|
Based on this data, the inventory amount reported on the balance sheet (in $ millions) is closest to :
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
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.
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.