1 / 30

Financial Statements: Definition & Interpretation

Financial Statements: Definition & Interpretation. Defining some key terms. Accounting: Summary & analysis of an organization’s financial condition Bookkeeping: Recording of an organization’s financial transactions Financial accounting: Accounting performed for reporting purposes.

shaine-sanders
Download Presentation

Financial Statements: Definition & Interpretation

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Financial Statements: Definition & Interpretation

  2. Defining some key terms • Accounting: • Summary & analysis of an organization’s financial condition • Bookkeeping: • Recording of an organization’s financial transactions • Financial accounting: • Accounting performed for reporting purposes

  3. Overview: The financial structure of an organization Board of Directors President VP Sales VP Mfg VP Finance Treasurer Controller Credit Mgr Inventory Mgr Cost Acctg Tax Dept Dir Capital Budgeting Financial Acctg

  4. Overview: What financial analysis entails Managers, potential investors, and others analyze financial statements to form judgments about the market value of a firm. • Financial statements may be historical orpro forma • Pro forma financial statements are those produced for periods in the future, prepared under a particular set of assumptions • The usefulness of pro forma financial statements depends on the accuracy of those assumptions

  5. How firms use financial statements • Reporting to shareholders • Reporting to creditors • Certifying accuracy • Decision support • Control through auditing

  6. Financial statement distinctions • Income statement • Reports costs, revenue, & earnings over a specified period Balance sheet • Reports book value of assets, liabilities, & owners’ equity at a given point in time Cash flow statement • Reports impact of operating, investing, & financing activities on cash flow over a period

  7. The income statement: where analysis typically begins The income statement measures the profitability of a firm over a specific time frame. Revenue – Expenses = Net Income Net income or earningsmeasures the excess of revenues (net asset inflows) over expenses (net asset outflows) from sales activities related to providing goods and services.

  8. The income statement: earnings over a period of time + - Total

  9. Approaches to income statement analysis • Common-size analysis involves expressing each expense as a percentage of revenue • Time series analysis compares common-size income statements over two or more periods in order to reveal trends • Cross section analysis involves using common-size income statements to compare two or more organizations and provides insight about different strategies they follow

  10. Overview of financial statements: the balance sheet The basis of all accounting systems is the balance sheet equation: Assets = Liabilities + Owners’ Equity The balance sheet is a statement of financial position and provides a constant equality between total assets and total equities (liabilities plus owners’ equity).

  11. The balance sheet, continued An asset is a resource the firm owns or has the right to use that has present or probable future value. Examples include: • Cash • Marketable (short-term) Securities • Accounts Receivable • Inventory • Prepaid Expenses • Property, Plant, & Equipment (PP&E) • Intangible Assets (patents, trademarks, & goodwill)

  12. The balance sheet, continued A liability is a resource that requires a probable future sacrifice of resources (cash or otherwise). Examples include: • Accounts Payable (to suppliers and other creditors) • Notes Payable (amounts owed that are represented by a formal agreement) • Dividends Payable • Accrued Liabilities (i.e., interest expense) • Taxes Payable • Long-term Debt

  13. The balance sheet, continued Owners’ equity is the difference between what owners own and what they owe to others. Examples include: • Common Stock issued by the company • Paid-in Capital • Retained Earnings Sole proprietorships or partnerships do not make a distinction between contributed capital and retained earnings.

  14. The balance sheet: a frozen moment in time These sums are in balance

  15. Overview of financial statements: statement of cash flows • Reports on the impact of a firm’s operating, investing, & financing activities on cash flows during an accounting period • Explains the reasons for the change in cash between balance sheet dates • Classifies reasons for change into categories of operating, investing, & financing activities

  16. Overview of financial statements: statement of cash flows, continued Typical operating activities: • Sales to customers • Collections on accounts receivable • Purchase of inventory • Payments on accounts payable • Payment of operating expenses • Payment of tax expense

  17. Overview of financial statements: statement of cash flows, continued Typical investing activities: • Purchase of property, plant, & equipment • Sale of property, plant, & equipment • Investments in stock of other firms • Sale of investment in stock of other firms Typical financing activities: • Borrowing money or repaying loans • Issuing stock • Repurchasing of stock • Paying dividends on stock

  18. + - + Total

  19. Interpreting financial statements: usingratios Ratios help evaluate 4 aspects of financial status: Liquidity:ability to meet short-term obligations Efficiency:how a firm utilizes its assets Financial leverage:firm’s relative use of debt Profitability:net income relative to various size levels

  20. Ratio analysis • Definition • An evaluation of relationships between financial statement variables • Comparison may be made based on: • Goals • Industry standards • Lender requirements • Other data obtained from various sources

  21. Ratio analysis: somesample ratios Using balance sheet items Liquidity: Quick Ratio Cash+Mktbl Sec+Accts Recv Current Liabilities Liquidity: Current Ratio Current Assets Current Liabilities

  22. Ratio analysis: some sample ratioscontinued Using balance sheet items Leverage: Debt-to-Equity Long-Term Debt Owner’s Equity Using income statement items Leverage: Times Interest Earned Earnings before Intr & Taxes Annual Interest Expense

  23. Ratio analysis: some sample ratios continued Using balance sheet (BS) and income statement (IS) items Efficiency: Inventory Turnover Cost of Goods Sold (IS) Inventory (BS) Efficiency: Assets Turnover Cost of Goods Sold (IS) Assets (BS)

  24. Ratio analysis, continued Issues related to comparison with industry averages: • Can be difficult as firms operate in more than one industry; distortion can occur • Accounting practices vary among firms • Firms with seasonal swings show deviations (less if annual figures are used)

  25. Ratio analysis, continued Sources for industry data • “Annual Statement Studies” by Robert Morris Associates: http://www.bmatters.com/rma.htm • Dun & Bradstreet: http://www.dnb.com • BizMiner: http://www.bizminer.com • Financial Times: http://surveys.ft.com • Search at http://www.google.com

  26. Market value: the ultimate purpose of financial analysis • One approach projects the amount ofcash flowsa firm will generate fromoperating, investing, and financingactivities over some number of years in the future • The net amount is then discounted using an appropriate rate to reflect the time value of money, to find the present value of these future cash flows

  27. Market value approximation approaches, continued • Other approachesto approximating a firm’s market value rely onmarket multiplesof certain financial statement items for similar firms in the market: • Market price of shares to multiples of earnings (P/E) • Market value to book value of shareholder’s equity of similar firms

  28. Relationship among strategies • Management, marketing, & finance decisions lead to strategies • For best results, decisions in one area are made only after considering information from one or more of the other areas Marketing decisions Management decisions Finance decisions

  29. Introduction to Financial analysis: some parting thoughts • Financial analysis is a crucial aspect of managerial decision-making • Financial decisions are influenced by, and have influence on, decisions in other areas of the firm • Understanding these relationships is of key importance in effective leadership and strategic business planning

  30. References • Financial Accounting: A User Perspective (1997). Robert E. Hoskin, New York: John Wiley & Sons, Inc. • Financial Accounting: An Introduction to Concepts, Methods, & Uses (2000). LeBronne C. Harris & James E. Moon, Fort Worth: The Drydon Press. • Financial Management: Theory and Practice (1999). Eugene F. Brigham, Louis C. Gapenski and Michael C. Ehrhardt, Stamford, CT: The Dryden Press • The Essentials of Financial Management (1998). Omer L. Carey, PhD and Musa M.H. Essayyad, PhD., Piscataway, NJ: Research and Education Association

More Related