Financial Statements:

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• Financial Statements
• Definition Interpretation

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Defining some key terms

• Accounting
• Summary analysis of an organizations financial
  condition
• Bookkeeping
• Recording of an organizations financial
  transactions
• Financial accounting
• Accounting performed for reporting purposes

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Overview The financial structure of an
organization

Board of Directors
President
VP Sales
VP Mfg
VP Finance
Treasurer
Controller
Tax Dept
Cost Acctg
Inventory Mgr
Credit Mgr
Financial Acctg
Dir Capital Budgeting
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Overview What financial analysis entails

• Financial statements may be historical or pro
  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

Managers, potential investors, and others analyze
financial statements to form judgments about the
market value of a firm.
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How firms use financial statements

• Reporting to shareholders
• Reporting to creditors
• Certifying accuracy
• Decision support
• Control through auditing

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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

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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 earnings measures the excess of
revenues (net asset inflows) over expenses (net
asset outflows) from sales activities related to
providing goods and services.
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The income statement earnings over a period of
time

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Total
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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

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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).
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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 (PPE)
• Intangible Assets (patents, trademarks,
  goodwill)

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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

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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.
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The balance sheet a frozen moment in time
These sums are in balance
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Overview of financial statements statement of
cash flows

• Reports on the impact of a firms 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

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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

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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

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Total
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Interpreting financial statements using ratios
Ratios help evaluate 4 aspects of financial
status

• Liquidity ability to meet short-term
  obligations
• Efficiency how a firm utilizes its assets
• Financial leverage firms relative use of debt
• Profitability net income relative to various
  size levels

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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

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Ratio analysis some sample ratios
Liquidity Quick Ratio CashMktbl SecAccts
Recv Current Liabilities
Using balance sheet items
Liquidity Current Ratio Current Assets Current
Liabilities
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Ratio analysis some sample ratios continued
Using balance sheet items
Leverage Debt-to-Equity Long-Term Debt Owners
Equity
Using income statement items
Leverage Times Interest Earned Earnings before
Intr Taxes Annual Interest Expense
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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)
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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)

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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

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Market value the ultimate purpose of financial
analysis

• One approach projects the amount of cash flows a
  firm will generate from operating, investing, and
  financing activities 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

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Market value approximation approaches, continued

• Other approaches to approximating a firms market
  value rely on market multiples of 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 shareholders
  equity of similar firms

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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

Management decisions
Marketing decisions
Finance decisions
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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

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• 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