Financial
Statements
• Financial
statements are written reports of financial affairs of a company.
• Such companies’
reports communicate the result of its business operations for a particular
period of time and its financial position at the end of that period.
• Financial
Statements
• Financial
statements of the company include:
• Balance Sheet
• Profit &
Loss Account
• Trading Account
• Cash Flow
Statement
• Profit &
Loss Appropriation Account
Users of
Financial Statements
•
Owners and managers
•
Employees
•
Prospective investors
•
Financial institutions
•
Government
•
Creditors
• Others
Objectives of
Financial Statements
•
To
provide financial information to users.
•
To
provide useful financial information for predicting, comparing and evaluating
potential cash flow of a business.
•
To
help in knowing earning power of a company.
•
To
help in judging management’s ability to utilize resources effectively.
•
To
provide statement of financial position of the company concerning the assets
and liabilities of the business.
•
To
provide the financial statement in periodic basis so that the comparisons of
progress can be made.
•
To
compare with competitors.
•
To
provide necessary information for financial forecasting.
•
To
provide required data for research.
Balance Sheet
• The balance
sheet is a snapshot of the firm’s assets and liabilities at a given point in
time
• Assets are
listed in order of liquidity
• Ease of
conversion to cash
• Without
significant loss of value
• Balance Sheet
Identity
• Assets =
Liabilities + Stockholders’ Equity
•
Net
Working Capital
• Current Assets –
Current Liabilities
• Positive when
the cash that will be received over the next 12 months exceeds the cash that
will be paid out
• Usually positive
in a healthy firm
•
Liquidity
• Ability to
convert to cash quickly without a significant loss in value
• Liquid firms are
less likely to experience financial distress
• But liquid
assets earn a lower return
• Trade-off to
find balance between liquid and illiquid assets
Market Vs. Book
Value
• The balance
sheet provides the book value of the assets, liabilities and equity.
• Market value is
the price at which the assets, liabilities or equity can actually be bought or
sold.
• Market value and
book value are often very different. Why?
• Which is more
important to the decision-making process?
Income Statement
• The income
statement is more like a video of the firm’s operations for a specified period
of time.
• You generally
report revenues first and then deduct any expenses for the period
• Matching
principle –shows revenue when it accrues and match the expenses required to
generate the revenue
Statement of
Cash Flows
• Is used to help
answer questions such as:
• Is the firm
generating enough cash to purchase the additional assets required for growth?
• Is the firm
generating any extra cash that can be used to repay debt or to invest in new
products?
• Such information
is useful both for managers and investors
Statement of
Retained Earnings
• Shows how much of the firm’s earnings were retained,
rather than paid out as dividends
• A positive
number in the retained earnings account indicates only that in the past the
firm earned some income
Statement of
Cash Flows
• Summarizes the
changes in a company’s cash position
• The statement
separates activities into three categories, plus a summary section:
• Operating
activities
• Investment
activities
• Financing
activities
• Operating
activities
• Includes:
• net income,
• depreciation,
• changes in
current assets and liabilities other than cash,
• short-term
investments and
•
short
term debt
• Investing
activities
• Includes:
• investments in
fixed assets
• or sales of
fixed assets
• Financing
activities
• Includes:
• Raising cash by
selling short-term investments or by issuing short-term debt
• Long term debt,
or stock
• Also because
both dividends paid and cash used to buy back outstanding stock or bonds reduce
the company’s cash, such transactions are included here
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