Basic Financial Intelligence

What is Financial Intelligence?

Fundamentally, financial intelligence boils down to following distinct skill sets:

1. Understanding the foundation. understand the basics of financial measurement.

They can read:
a) balance sheet
b) income statement
c) cash flow statement
a)Balance Sheet

• The Balance Sheet: At the end of each fiscal year, a company publishes a balance
sheet however, a balance sheet is also usually prepared quarterly and monthly.[3]

• The balance sheet is constructed using the relation

Assets = liabilities + net worth

• . Liabilities are specific obligations that represent claims against the assets of the
business, ranking ahead of the owners in repayment priority. [2]
 The major categories of assets, or resources committed, are:

• Current assets (items that turn over in the normal course of business within a
relatively short period of time, such as cash, marketable securities, accounts
receivable, and inventories).[2]

• Fixed assets (such as land, mineral resources, buildings, equipment, machinery,

and vehicles), all of which are used over a longer time frame.[2]

• Other assets, such as deposits, patents, and various intangibles, including goodwill
that arose from an acquisition.[2]
Major sources of the funds obtained are:

• Current liabilities, which are obligations to vendors, tax authorities, employees,

and lenders due within one year or less.[2]

• Long-term liabilities, which are a variety of debt instruments repayable beyond

one year, such as bonds, loans, and mortgages.[2]
• Owners’ (shareholders’) equity, which represents the recorded net amount of
funds contributed by various classes of owners of the business as well as the
accumulated earnings retained in the business after payment of dividends.
Balance Sheet in Decisional Context:[2]
b)Income Statement

The income statement summarizes the profits or losses of the corporation for a stated
period of time. Income statements always accompany balance sheets. The major
categories of an income statement are[3]

• Revenues. This includes all sales and interest revenue that the company has received
in the past accounting period. [3]

• Expenses. This is a summary of all expenses (operating and others, including taxes)
for the period.[3]

• Revenues - expenses = profit (or loss)[3]

c)Cash Flow Statement:

• The statement is prepared by comparing beginning and ending balance sheets and
using key items of the income statement for the period, all interpreted in terms of
uses and sources of cash:[2]

1)Cash generated by profitable operations or drained by unprofitable results.[2]

2)Cash impact of changes in working capital requirements.[2]
3)Commitments of cash to invest in assets or to repay liabilities.[2]
4)Raising of cash through additional borrowing or by reducing asset
investments.[2]
5)Cash impact of issuance of new shares or repurchase of shares.[2]
6)Cash impact of dividends paid.[2]
7)Adjustments for accounting allocations, write-offs, and other
noncash[2]
8)elements in the income statement and the balance sheets.[2]
9)Net impact of the period’s cash movements on the company’s cash balance.[2]
2-Understanding the art. Finance and accounting are an art as well as a science. The
two disciplines must try to quantify what can’t always be quantified

a)Accounting:
The Basis of Decision Making: We need financial information when we are
making business decisions. Virtually all businesses and most individuals keep
accounting records to aid in making decisions. As illustrated in Figure
2.1accounting is the information system that measures business activities, processes
the resulting information into reports, and communicates the results to decision
makers[1]
b)Financial Status for Businesses:[1]
What would managers
and investors want to know about a company at the end
of the fiscal year? Following are four basic questions that
managers or investors are likely to ask:
• What is the company’s financial position at the end of
the fiscal period?
• How well did the company operate during the fiscal
period?
• On what did the company decide to use its profits?
• How much cash did the company generate and spend
during the fiscal period?
Information Analysis:[4]
Because of the diversity of users, their different levels of knowledge, the varying
information needs for particular decisions, and the general nature of financial
statements, a variety of analysis techniques has been developed. In the following
sections, we explain several common methods of analysis. The choice of method
depends on which technique appears to provide the most relevant information in a
given situation
1)Horizontal Analysis:[4]
Horizontal analysis, also called trend analysis, refers to studying the behavior of
individual financial statement items over several accounting periods. These periods
may be several quarters within the same fiscal year or they may be several different
years.

1.1)Absolute Amounts[4]
The absolute amounts of particular financial statement items have many uses.
Various national economic statistics, such as gross domestic product and the amount
spent to replace productive capacity, are derived by combining absolute amounts
reported by businesses.
1.2)Percentage Analysis[4]
Percentage analysis involves computing the percentage relationship between two
amounts. In horizontal percentage analysis, a financial statement item is expressed
as a percentage of the previous balance for the same item. Percentage analysis
sidesteps the materiality problems of comparing different size companies by
measuring changes in percentages rather than absolute amounts.

2)Vertical Analysis[4]
Vertical analysis uses percentages to compare individual components of financial
statements to a key statement figure. Horizontal analysis compares items over many
time periods; vertical analysis compares many items within the same time period.
2.1)Vertical Analysis of the Income Statement [4]
Vertical analysis of an income statement (also called a common size income
statement) involves converting each income statement component to a percentage of
sales. Although vertical analysis suggests examining only one period, it is useful to
compare common size income statements for several years

2.2) Vertical Analysis of the Balance Sheet[4]

Vertical analysis of the balance sheet involves converting each balance sheet
component to a percentage of total assets.