Financial statements Analysis

Financial statements

Financial Statements

Where the Where the Where the

Company Has Company is Company is
Been Currently Going

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 Financial statements
Financial statements
 provide insight into the company’s current status
 lead to the development of policies and strategies for the
future
 are prepared by management
 Provide useful information for those having reasonable
understanding of business for decision making

Analysis should begin with the financial statements and the

notes to financial statements.

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 Financial statements
Other resources include:
 Proxy statement
 Auditor’s report
 Management discussion and analysis
 Supplementary schedules
 Form 10-K and Form 10-Q
 Other sources

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Elements of Financial Statements
• Assets
– Probable future economic benefits obtained or controlled
as a result of past business transactions
• Liabilities
– Obligations to transfer assets or provide services in the
future as a result of past business transactions
• Equity
– The residual interest in the assets after deducting liabilities
• Investments by owners
– Increases in the equity due to transfers of value to obtain
or increase ownership interests (or equity) in it
Elements of Financial Statements
• Distribution to owners
– Decrease in equity resulting from transferring assets,
rendering services, or incurrence of liabilities by the
enterprise to owners

• Comprehensive income
– The change in equity during a period due to transactions,
events, and circumstances from non-owner sources
Elements of Financial Statements
• Revenues
– Inflows and other enhancements of assets or settlements of
liabilities from delivering or providing goods, rendering
services, or carrying out other activities related to the central
operations
• Expenses
– Outflows or consumption of assets or incurrence of liabilities
from delivering or providing goods, rendering services, or
carrying out other activities related to the central operations
• Gains
– Increases in equity from peripheral or incidental transactions
of an entity
• Losses
– Decreases in equity from peripheral or incidental
transactions of an entity
 Concepts and Principles
 Business entity
The concept of separate entity means that the business
or entity for which the financial statements are prepared is
separate and distinct from the owners of the entity.
 Going concern
The financial statements are prepared with the assumption
that a company will continue in operation for the foreseeable
future.
 Time period
To assess the success or failure of an entity, the life of an
entity is divided into equal time intervals to accumulate all
transactions relate to a particular period and facilitate the
measurement of firm performance.
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 Concepts and Principles
 The accruals concept
Transactions (revenues and expenses) are recorded in
the accounting system and reported in the financial
statements of the related period on the bases of
occurrence and not on the bases of cash collection or
payment.
 Materiality
The materiality concept involves the relative size and
importance of an item to a firm. Immaterial items might be
handled in the most economical and practical manner.

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 Concepts and Principles
 Consistency
Measuring and reporting transactions similarly within each
accounting period and from one period to the next. It is
described in IASB framework as an aspect of comparability.

 Matching principle
Matching the revenues generated in a particular period
against the expenses incurred during the same period.

 The revenue recognition

Revenues or gains are realized when the service is delivered
or the assets are transferred and readily convertible to known
cash or claims.
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 Assumptions of Accounting
Model
• Business Entity • Matching
• Going Concern or • Consistency
Continuity • Full Disclosure
• Time Period • Materiality
• Monetary Unit • Industry Practices
• Historical Cost • Transaction Approach
• Conservatism • Cash Basis
• Realization • Accrual Basis

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 The financial statements

 Income statement / Statement of comprehensive

income

 Statement of owners equity changes

 Statement of financial position / Balance sheet

 Statement of Cash flow

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 The financial statements
The financial statements:

 Form basis for understanding the financial position of a

firm.

 Allow users to assess historical and future financial

performance.

 Present picture of firm’s financial health, leading to better

business decisions.

 Financial statements are the first and often the best

source of information about a company’s past
performance, current health, and prospects for the future.
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 The financial statements
The financial statements Users:
 Shareholders and investors Investment decisions

Performance assessment
 Managers and employees Compensation contracts
Company-sponsored pension
plans
 Lenders and suppliers Lending decisions
Covenant compliance
Seller’s health
 Customers Repeat purchases
Warranties and support

Mandatory reporting
 Government and regulators Taxing authorities
Regulated industries 14
 The financial statements
Identification of the financial statements:

 Name of the reporting entity

 Whether a single entity or a group

 Date at the end of the reporting period or the period

covered

 Presentation currency used

 Level of rounding (e.g. $000 or $m)

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 The financial statements
Income statement for the year ended December 31 2013
($ in millions) 2013
Net Sales 3,957
Cost of goods sold 1,364
Gross profit 2,593
Selling, general and admin expenses 1,093
Income from continuing operations before tax 1500
Income tax expense 406
Income from continuing operations 1094
Discontinued operations
Income from operation of discontinued business, net of tax 203
Gain on disposal of discontinued business, net of tax 98
Income before extraordinary item and change in accounting principle 1,395
Extraordinary loss, not of tax benefit 170
Cumulative effect of changes in accounting principle, net of tax 118
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Net income 1,107
 The financial statements
Income statement /Statement of comprehensive income
(Cont.)
Other comprehensive income and expense:
Exchange differences on translating foreign operations
Available-for-sale financial assets
Cash flow hedges
Gains on property revaluation
Actuarial gains (losses) on defined benefit pension plans
Share of other recognised income and expense of associates
Income tax relating to components of other recognised
income and expense

Other comprehensive income and expense for the year,

net of tax

Total comprehensive income and expense for the year 17

 The financial statements
Statement of financial position
Formerly referred to in the standards as the ‘balance
sheet’ and it consists of the assets, liabilities and owners
equity.

An asset is a current asset if it satisfies any of the

following criteria:
(a) It is expected to be realized within the entity's normal
operating cycle;
(b) It is held for the purpose of being traded;
(c) It is expected to be realized within 12 months of the end of
the reporting period;
(d) It is cash or a cash equivalent as defined by IAS7.
All other assets are non-current assets. 18
 The financial statements
Statement of financial position (Cont.)
A liability is a current liability if it satisfies any of the
following criteria:
(a) It is expected to be settled within the entity's normal
operating cycle;
(b) It is held for the purpose of being traded;
(c) It is due to be settled within 12 months of the end of the
reporting period;
(d) The entity does not have the right to defer settlement for
at least 12 months after the end of the reporting period.

All other liabilities are non-current liabilities

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 Concepts and Principles
Provisions are a cost charged to profit and loss account and credited to
provision under long-term liabilities in anticipation of an expense
expected to occur in the future.

Reserves are funds, formally belonging to the owners, which represent

value retained in business for some purpose. The four main types of
reserve are:
1. Profit reserve,
2. Share premium account,
3. Revaluation reserve, and
4. Other reserves.

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 The financial statements
Statement of financial position (Cont.)

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 The financial statements
Statement of financial position (Cont.)

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 The financial statements
Statement of changes in equity
• Shows how each component of equity has changed
during an accounting period
• Items presented include
─ total comprehensive income for the period
─ effects of any changes in accounting policies
─ share issues
─ dividends paid
• Provides a reconciliation of the opening and closing
balance on each component of equity

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 The financial statements
Statement of changes in equity

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 The financial statements
Statement of cash flow
The statement of cash flows consists of three main
section
 Operating activities:
Cash earned from what we are in the business of doing
 Investing activities:
Buying and selling long term assets and investments

 Financing activities:
− Borrowing and repaying loans
− Selling shares and paying dividends

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 The financial statements
Statement of cash flow

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Purpose of statements analysis
 Absolute figures are of little value.

 Identification of a trend.

 Compare it with the company's plan.

 Compare with those of other companies in the same

industry

 Compare with industrial average

Ratio’s only a starting point

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 Tools and Techniques
 Common-size and trend analysis

 Key financial ratios

 Structural analysis

 Industry comparisons

 Common sense and judgment

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 Common size & trend analysis
Common-size financial statements

 Express each account on the balance sheet as a

percentage of total assets

 Express each account on the income statement as a

percentage of net sales

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Common size (Horizontal analysis)

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Trend analysis (Vertical analysis)

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 Auditor’s Opinion
Auditor’s Report
 Contains the expression of opinion as to the fairness
of the financial statement presentation

 Can be:
– Unqualified opinion
– Qualified opinion
– Adverse opinion
– Disclaimer of opinion

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 Unqualified Opinion
 The financial statements present fairly
 The financial position
 Results of operations
 Cash flows

 In conformity with generally accepted accounting

principles

 For the user: the highest degree of reliability

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 Qualified Opinion
 Except for the matter to which the exception relates
(suggests careful evaluation be made)

 The financial statements present fairly

 The financial position
 Results of operations
 Cash flows
 In conformity with generally accepted accounting
principles

 For the user: determine the significance of the

exception
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 Adverse Opinion
 The financial statements do not present fairly
 The financial position
 Results of operations
 Cash flows

 In conformity with generally accepted accounting

principles

 For the user: reliability of financial statements need

to be seriously questioned

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 Disclaimer of Opinion
 The auditor does not express an opinion

 Auditor
 Has not preformed an audit sufficient in scope to
form an opinion or
 Is not independent

 For the user: auditor’s statement conveys no

indication of financial statement reliability

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