This synopsis covers the key elements of balance sheet analysis and the relevance of financial statements in understanding a firm's financial risks.

Continuing our series of recording a synopsis of The Chartered Institute for Securities & Investment (The CISI) module of Managing Operational Risk in Financial Institutions.

Chapter Two: Fundamentals of Financial Risk in Financial Institutions

This chapter delves into the importance of understanding financial statements for assessing the financial health and stability of an organization, particularly in the context of managing operational risks.

1. Balance Sheet Analysis

1.1 Introduction

• Importance of Financial Statements: Financial statements are essential tools for assessing the financial and economic activities of a business. Understanding these statements is crucial in evaluating the financial stability and operational risk impacts of a firm. Operational risk events, such as regulatory fines or client losses, can directly affect an organization’s financial resources and capital.
• Accounting Definition: Accounting is the process of recording, measuring, and reporting economic events in a usable form for interested parties. It involves providing clear financial information on a company's activities.
• Annual Report and Financial Disclosures: Company directors are required to prepare and disclose financial statements as part of an annual report. These statements present the company’s financial performance during a specific accounting period, typically 12 months.

Major Financial Statements:

1. Statement of Financial Position (Balance Sheet): This statement provides a snapshot of the company’s financial standing at a specific point in time. It shows the assets owned by the company and how they are financed (liabilities and equity). While officially called the statement of financial position under the Revised Accounting Standards (IAS 1), it is still commonly referred to as the balance sheet.
2. Statement of Comprehensive Income (Income Statement or Profit and Loss Report): This statement summarizes the income or revenue earned over the accounting period. It is a reflection of the company’s trading activities, indicating the company’s profitability or losses during the year.
3. Statement of Cashflows: The cashflow statement details the cash generated and spent by the company during the accounting period. It tracks cash inflows and outflows, providing a clear picture of the company’s liquidity and ability to meet short-term obligations.