As always we start with the broad level understanding of what Financial Reporting and Analysis (FRA) is all about. We then get down to how to prepare for the same in CFA Level 1. Just to get you serious about this blog, I can tell you only this – With ~20% weightage you can expect close to 50 odd questions in CFA L1 exam and this is the last section you want to screw up in your CFA L1 exam!
So the story goes like this – When a firm starts its operation it has cash and non-cash transactions. For now lets take an example of Tata Motors. So this firm may buy steel sheets and other small metal components like nuts and bolts etc to build the overall car. Some of these parts are bought on credit and the others are bought on cash. These nuts and bolts and the sheet of metal is then processed and worked on by the operations team of Tata Motors to produce the final car. This car is then sold may be on cash and may be on credit. The company makes profit in this process, pays back its creditors, doles out perks to its employees and lives happily after 🙂
The entire story though looks simple is composed of thousands of transactions which a company makes over a period of 12 months. The transaction could be as simple as booking a cash on the sale of a product or it could be as complex as declaring a dividend to the equity investor. Financial reporting is that part of finance which analyses ways to create a structured output of these transaction such that an average Doe who is interested in the company can understand what the company is upto 🙂
Post your CFA certification the first thing you are expected to do as an analyst is financial analysis. And financial analysis my dear friends start from understanding the financial reports 🙂
Wont bog you down with the financial terminologies here, but I think the Tata Motors story must have laid down a good foundation for understanding this section. This is one section which is at the heart of any financial understanding and it is imperative on the CFA aspirant to have a solid understanding of the concepts in this section. It’s 20% weightage in CFA L1 is a good enough testament of its importance. Also with the weightage of 35% in CFA L2, the importance of this section only grows with the increasing levels in CFA.
I can bet this section can give you a high if approached in the correct manner. Strong understanding of the concepts in this section will only increase your chances of understanding other tougher sections of CFA (including fixed income etc). Traditionally this section has been approached in the T-Table format which is not only cumbersome but has minimal industry application. The current approach being followed in the industry is to use Transaction Tables for understanding this section. I owe my understanding of Transaction tables to my faculty Prof Kanagaraj in IIM-Indore and we use the same teaching methodology at 360DegreeCFACoaching as well. It is not only easy to understand the financial reporting through transaction tables, but it also has immediate utility in the financial industry as well.
Net net, financial analysis and reporting is one of the sections which a CFA aspirant cannot afford to ignore. Not only should this be your first section to approach in CFA L1 preparation, but attention should also be paid to grasp the fundamentals in the correct manner. T-Tables have to be avoided at any cost and the more practical and industry useful approach of Transaction tables should be followed.
Lastly, this is one of my favorit(est) section and would love to solve any queries you have on this section. Feel free to drop your comments below and would revert on the same.
Cheers and looking forward to catch you guys up in my next blog which would be on Understanding Corporate Finance.