Welcome to your first lesson in the Financial Modeling course. Your goal of achieving the proficiency of a CFA analyst is ambitious and rewarding, and this course is designed to build that expertise from the ground up. We begin our journey with the bedrock of all financial analysis: financial accounting.
This lesson addresses the fundamental "why" and "what" of this field. We will define the purpose of financial accounting and introduce the three core financial statements that form the universal language of business and investment. Mastering this foundation is the first and most critical step toward the sophisticated modeling and analysis techniques we will cover later.
The Purpose of Financial Accounting
At its heart, financial accounting is the system through which a company communicates its financial story. But what does that process entail? A concise video from Accounting Stuff provides a clear definition.
ACCOUNTING BASICS: a Guide to (Almost) Everything
Watch this very short clip to get a formal definition of financial accounting.
Please watch the segment from the beginning.
As you just saw, financial accounting is the process of identifying, recording, summarizing, and analyzing an entity's financial transactions and reporting them. The output of this process is a set of standardized reports called financial statements.
But recording and reporting numbers is not the end goal. The true purpose is to provide information that is useful for decision-making. This is where we transition from accounting to financial analysis. Financial analysis takes the data provided by accountants and uses it to evaluate a company's performance and prospects, ultimately to make economic decisions.
The following video from AnalystPrep, a resource for CFA candidates, directly explains the role and objective of financial statement analysis from an analyst's perspective.
Introduction to Financial Statement Analysis (2025 CFA® Level I Exam – FSA – Learning Module 1)
This video explains the core objective of financial analysis and who uses this information.
First, watch the section that defines financial analysis and its primary goal. Pay close attention to the emphasis on evaluation and the ultimate aim of identifying overvalued and undervalued securities. Next, broaden your understanding by watching the segment that discusses the various users of financial analysis. This will help you see why this skill is so crucial for different stakeholders, from investors to creditors and those involved in mergers and acquisitions.
To summarize, the core purpose of financial accounting is to provide reliable information that enables financial analysis. This analysis serves a wide range of crucial functions for different stakeholders:
- Equity Investors: Use financial statements to decide whether to buy, hold, or sell shares in a company. They are looking for businesses that are undervalued by the market or have strong future growth prospects.
- Creditors (e.g., Banks, Bondholders): Analyze a company's financial health to assess its ability to repay debt. They are primarily concerned with creditworthiness and risk.
- Company Management: Use their own financial statements to assess performance, make strategic decisions, and benchmark against competitors.
- Mergers & Acquisitions (M&A) Teams: Scrutinize the financials of target companies to determine a fair valuation and identify potential synergies.
For an aspiring analyst, this process of evaluation is paramount. Your ability to interpret financial statements will be the key to making sound investment recommendations and strategic business decisions.
The Three Core Financial Statements
Now that we understand the purpose of financial accounting, let's identify the three principal reports that convey this financial information. These are the documents you will spend your career analyzing and, in this course, building from scratch.
The video from Accounting Stuff provides a straightforward introduction to each of the three core financial statements.
ACCOUNTING BASICS: a Guide to (Almost) Everything
First, let's get a high-level overview of the three statements.
Watch this short clip that introduces the reports as a group.
As the video mentioned, the three main financial statements are the Balance Sheet, the Income Statement, and the Cash Flow Statement. Let's briefly look at the specific role of each.
1. The Balance Sheet
The Balance Sheet presents a snapshot of a company's financial position at a single point in time. It tells you what a company owns (its assets) and what it owes (its liabilities and equity).
ACCOUNTING BASICS: a Guide to (Almost) Everything
This clip explains the concept of the Balance Sheet.
Watch the description of the Balance Sheet. Notice the key phrase "at a single point in time."
Think of it like a personal statement of net worth on a specific day. It doesn't show performance over the year; it shows where the company stands financially at that exact moment.
2. The Income Statement
The Income Statement, also known as the Profit and Loss (P&L) statement, shows a company's financial performance over a specific period (e.g., a quarter or a year). It tells you how profitable a company was by summarizing its revenues and subtracting its expenses.
ACCOUNTING BASICS: a Guide to (Almost) Everything
Now, let's look at the Income Statement.
Watch this segment's description of the Income Statement. Note the emphasis on performance "over a period of time."
If the Balance Sheet is a snapshot, the Income Statement is a video. It records the story of a company's operations from the beginning to the end of a period, culminating in the "bottom line": net income or net loss.
3. The Cash Flow Statement
The Cash Flow Statement bridges the gap between the Income Statement and the Balance Sheet. It reports the cash generated and used by a company over the same period as the Income Statement. It specifically tracks the movement of cash, showing how money flowed into and out of the business.
ACCOUNTING BASICS: a Guide to (Almost) Everything
Finally, let's examine the Cash Flow Statement.
Watch the brief explanation of the Cash Flow Statement.
Profitability (from the Income Statement) is not the same as cash flow. A company can be profitable but still run out of cash. This statement is vital for assessing a company's ability to pay its bills, fund operations, and make investments.
Conclusion
In this introductory lesson, we have established the foundational concepts for your journey into financial modeling.
Key Takeaways:
- Financial Accounting is the systematic process of recording and reporting a company's financial transactions.
- The Purpose of Financial Accounting is to provide accurate and useful information for Financial Analysis, which involves evaluating a company to make economic decisions (e.g., investing, lending).
- The three core financial statements are the primary outputs of the accounting process:
- The Balance Sheet: A snapshot of what a company owns and owes at a single point in time.
- The Income Statement: A summary of revenues and expenses, showing profitability over a period of time.
- The Cash Flow Statement: A report of cash inflows and outflows over a period of time.
These three statements are the language of business. Every financial model, valuation, and analysis you will perform as an analyst begins with understanding and interpreting them.
In our next lesson, we will explore a crucial accounting principle that governs how these statements are prepared: the difference between accrual and cash basis accounting. This concept is key to understanding why reported profit and actual cash flow can differ, a critical insight for any serious financial analyst.