After the analyst understands the company's business environment, financial statement information can be studied. This analysis consists of three steps: (1) read the audit report, (2) identify significant transactions and the company's important segments, and (3) read the income statement, balance sheet, statement of cash flows, statement of shareholders' equity, and footnotes.

The Audit Report

The audit report serves as the accounting profession's “seal of approval,” stating whether, and to what extent, the information in the financial statements fairly reflects the financial position and operations of the company.

After reviewing the financial records of a company, the auditor usually renders a standard audit report stating that the financial statements fairly reflect the financial position and operations of the company and the internal control system is reasonably effective. Such a report also states that all necessary tests were conducted in concluding that a company's financial statements conform to generally accepted accounting principles.3 In such cases, the reader can be reasonably assured that the information in the statements is credible and that the company in question is in reasonable financial health.

3. Examples of the standard audit report can be found in Chapter 1 of this text and in Appendix C, where excerpts from NIKE's SEC Report 10-K is located.

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