CFA® Level I Financial Statement Analysis

The 12 learning modules

1. 01 Introduction to Financial Statement Analysis

   The steps an analyst follows, from defining the purpose of the analysis through collecting and processing data to drawing conclusions and following up. It also covers where information comes from: the financial statements and their notes, segment reporting, management commentary, the auditor's report and its possible opinions, regulatory filings, and sources outside the company. Questions are descriptive, often asking which step or document an activity belongs to.

   6 lessons in the Academy →

2. 02 Analyzing Income Statements

   When revenue and expenses are recognised, when costs such as interest during construction or development spending are capitalised rather than expensed, and how non-recurring items, discontinued operations and accounting changes are shown. The numerical core is basic and diluted EPS, using the if-converted method for convertibles and the treasury stock method for options and warrants. It ends with common-size income statements and margin ratios.

   9 lessons · 5 videos in the Academy →

3. 03 Analyzing Balance Sheets

   How intangible assets, goodwill, financial instruments, long-term debt and deferred tax liabilities are recognised and measured. You need to know when an item is carried at amortised cost or at fair value, and where fair value changes go (profit or loss, or other comprehensive income). The module closes with common-size balance sheets and liquidity and solvency ratios.

   7 lessons · 2 videos in the Academy →

4. 04 Analyzing Statements of Cash Flows I

   How the three statements link together, and how to prepare cash flow from operations under the direct and indirect methods, including converting one into the other. You classify items as operating, investing or financing, and work out figures such as cash paid to suppliers, proceeds from asset sales or dividends paid from balance sheet changes. IFRS and US GAAP differ on where interest and dividends go.

   6 lessons · 3 videos in the Academy →

5. 05 Analyzing Statements of Cash Flows II

   Analysis of the cash flow statement once it is built: what the main sources and uses of cash say about a company's stage and health, common-size cash flow statements, and cash flow ratios such as cash flow to revenue and cash-based coverage. The key calculations are free cash flow to the firm and free cash flow to equity.

   5 lessons · 2 videos in the Academy →

6. 06 Analysis of Inventories

   Cost flow methods (specific identification, FIFO, weighted average and, under US GAAP only, LIFO) and how each affects cost of sales, gross margin and inventory when prices are rising or falling. It covers measurement at the lower of cost and net realisable value, the different rules on reversing write-downs, and inventory ratios. Expect to convert LIFO figures to FIFO using the LIFO reserve.

   8 lessons · 4 videos in the Academy →

7. 07 Analysis of Long-Term Assets

   How intangible assets are recorded depending on whether they are bought separately, developed internally or acquired in a business combination. The core is impairment: the different IFRS and US GAAP tests, whether a loss can be reversed, and the treatment of assets held for sale and of gains or losses on disposal. You also use disclosures to estimate the average age and remaining useful life of a company's assets.

   8 lessons · 4 videos in the Academy →

8. 08 Topics in Long-Term Liabilities and Equity

   Three topics: leases, defined benefit pensions and share-based compensation. For leases, know the single lessee model under IFRS and the finance versus operating split under US GAAP, and how each affects the income statement and cash flows. For pensions, know how the net liability or asset is shown and where each cost component is reported; for share-based pay, that the fair value at grant date is expensed over the service period.

   8 lessons · 5 videos in the Academy →

9. 09 Analysis of Income Taxes

   Why accounting profit and taxable income differ, and whether a difference is temporary (creating a deferred tax asset or liability) or permanent (changing the effective tax rate instead). You calculate income tax expense from taxes payable and the change in deferred taxes, see how a change in the tax rate remeasures deferred balances, and judge when a deferred tax asset may not be realised.

   7 lessons · 4 videos in the Academy →

10. 10 Financial Reporting Quality

    The difference between the quality of reporting and the quality of earnings, and the spectrum from high-quality, sustainable results to fraudulent reporting. It covers motives and conditions for managing earnings, what disciplines reporting (regulators, auditors, contracts), and the choices and estimates that can be biased, such as depreciation lives, allowances, capitalisation and cash flow classification. Questions often describe a pattern and ask whether it is a warning sign.

    8 lessons · 1 video in the Academy →

11. 11 Financial Analysis Techniques

    The toolkit for comparing companies: common-size statements, trend and cross-sectional analysis, and the main ratio groups (activity, liquidity, solvency and profitability). DuPont analysis breaks return on equity into margin, turnover and leverage. This module carries a large share of the calculation questions in the topic, so the ratio definitions need to be automatic.

    9 lessons · 5 videos in the Academy →

12. 12 Introduction to Financial Statement Modeling

    How to build a simple forecast of the income statement, cash flows and balance sheet, starting from revenue and working through costs, taxes, capital spending and working capital. It also covers behavioural biases that affect forecasts (overconfidence, illusion of control, conservatism, representativeness and confirmation), the effect of competition and inflation on prices and costs, and how to choose a forecast horizon and normalise results.

    8 lessons · 1 video in the Academy →

What the questions cover

• Revenue and expense recognition, capitalising versus expensing, and basic and diluted EPS
• Balance sheet items: intangibles, goodwill, financial instruments and deferred taxes
• Cash flow statements (direct and indirect), sources and uses of cash, and free cash flow
• Inventory cost flow methods, write-downs and the LIFO reserve
• Impairment of long-lived assets, leases, pensions and share-based pay
• Deferred tax assets and liabilities, and the effective tax rate
• Ratio analysis, DuPont analysis, reporting quality and basic forecasting

Key formulas

Basic EPS

$\displaystyle \text{EPS} = \frac{\text{Net income} - \text{Preferred dividends}}{\text{Weighted average shares outstanding}}$Weight shares by the fraction of the year they were outstanding. Stock splits and stock dividends are applied retroactively.Learn it: Basic EPS and the weighted average number of shares →

Diluted EPS

$\displaystyle \frac{\text{NI} - \text{Pref div} + \text{Conv. pref div} + \text{Conv. debt interest}\,(1 - t)}{\text{WASO} + \text{Shares from conversion} + \text{Incremental option shares}}$Treasury stock method: incremental shares = shares issued − (exercise proceeds ÷ average market price). Leave out any security that would raise EPS.

DuPont (three-step)

$\displaystyle \text{ROE} = \frac{\text{Net income}}{\text{Revenue}} \times \frac{\text{Revenue}}{\text{Average total assets}} \times \frac{\text{Average total assets}}{\text{Average equity}}$Net profit margin × total asset turnover × financial leverage.

DuPont (five-step)

$\displaystyle \text{ROE} = \frac{\text{NI}}{\text{EBT}} \times \frac{\text{EBT}}{\text{EBIT}} \times \frac{\text{EBIT}}{\text{Revenue}} \times \frac{\text{Revenue}}{\text{Average assets}} \times \frac{\text{Average assets}}{\text{Average equity}}$Tax burden × interest burden × EBIT margin × asset turnover × leverage. A higher tax burden ratio means a lower tax rate.

Cash conversion cycle

$\displaystyle \text{CCC} = \text{DOH} + \text{DSO} - \text{DPO}$Days = 365 ÷ turnover. Inventory and payables turnover use cost of sales (or purchases for payables); receivables turnover uses revenue.Learn it: Liquidity ratios and the cash conversion cycle →

Free cash flow

$\displaystyle \text{FCFF} = \text{CFO} + \text{Int}(1 - t) - \text{FCInv}, \quad \text{FCFE} = \text{CFO} - \text{FCInv} + \text{Net borrowing}$FCInv is capital spending net of proceeds from asset sales. Add back after-tax interest only if interest paid was deducted in CFO.

LIFO to FIFO

$\displaystyle \text{Inv}_{\text{FIFO}} = \text{Inv}_{\text{LIFO}} + \text{LR}, \quad \text{COGS}_{\text{FIFO}} = \text{COGS}_{\text{LIFO}} - (\text{LR}_{\text{end}} - \text{LR}_{\text{beg}})$LR is the LIFO reserve. Only the change in the reserve affects cost of sales for the year.

Double-declining balance depreciation

$\displaystyle D_t = \frac{2}{\text{Useful life}} \times \text{Opening carrying amount}$Start from gross cost, not cost minus residual value, and stop once the carrying amount reaches residual value.

Income tax expense

$\displaystyle \text{Tax expense} = \text{Taxes payable} + \Delta\text{DTL} - \Delta\text{DTA}$Temporary differences create deferred taxes; permanent differences make the effective rate differ from the statutory rate.Learn it: Accounting profit, taxable income and the tax base →

The Financial Statement Analysis formula sheet: the key formulas explained

Common mistakes

• Getting the sign wrong in the indirect method. An increase in receivables or inventory is subtracted from net income, an increase in payables is added, and a gain on an asset sale is subtracted because the cash proceeds belong in investing.
• Using the ending LIFO reserve instead of the change in the reserve when converting cost of sales from LIFO to FIFO.
• Including out-of-the-money options or other antidilutive securities in diluted EPS. If a security would increase EPS, it is left out.
• Adding back after-tax interest to FCFF when an IFRS reporter has already put interest paid in financing activities, so CFO was never reduced by it.
• Applying the double-declining rate to cost minus residual value, or ignoring the residual value floor in the final years.
• Assuming inventory write-downs can be reversed under US GAAP. IFRS allows reversals up to the original write-down; US GAAP does not.
• Treating capitalisation as neutral for cash flow. Capitalising a cost moves the outflow from operating to investing, so CFO looks higher and investing outflows larger, even though total cash is the same.

How to study it

• For every accounting choice, ask how it moves income, assets, equity, cash flow from operations and the key ratios. Many questions are really asking for one of those directions.
• Keep a one-page list of IFRS vs US GAAP differences and revise it often. The same ten or so differences account for most of the questions.
• Rebuild a cash flow statement from two balance sheets and an income statement until you can do it without notes. It ties the three statements together and underpins free cash flow and quality questions.
• In table questions, find the line items you need before you calculate, and check whether the question wants averages or year-end figures.
• Learn each ratio's numerator and denominator by writing them out. Most wrong answers use revenue where cost of sales belongs, or the other way round.

Try 3 Financial Statement Analysis questions

Practise and prove Financial Statement Analysis

The question bank and the mock exams are the practice half of CheapMocks Academy. Try the free sample questions, see the topic weights for the whole exam and the latest Level I pass rates.

Financial Statement Analysis FAQ