Financial Reporting Theory Presentation: Virtues of Balance Sheet

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Financial Reporting Theory Presentation Virtues
of Balance Sheet

• Presented by Dennis Kwok
• Nicolas Wong
• Wilson Wong

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Agenda

• What is financial statement?
• Balance sheet items
• Users investors, creditors, management
• Problems
• Conclusion

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HKSSAP 2.101
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Elements of Balance Sheet

• Asset
• resource controlled by the enterprise
• future economic benefits are expected to flow to
  the enterprise
•  
• Liability
• present obligation
• arising from past events
• expected to result in an outflow from the
  enterprise of resources
• Equity
• residual interest in the assets of the enterprise
  after deducting all its liabilities.

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Users

• Investors
• Creditors
• Management
• Government
• Public
• Employees

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Users

• Investors
• Creditors
• Management
• Government
• Public
• Employees

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Usefulness to investors

• Worthwhile to invest in the company
• Prospective of the company

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Investor

• Net asset
• to determine the value of the company
• ? assess the worthwhile to invest in the
• company

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Investor

• Risk of insolvency
• debt ratio total liabilities / total assets
• assess the ability of settling the debt in long
  term
• debt/equity ratio total liabilities / total
  equities
• determine the composition of financing of the
  company

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Creditors

• Money lender
• Bond holder
• Goods or services seller

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Usefulness to creditors

• Whether the borrowers are able to pay?
• Return in terms of what?

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Risk

• Liquidity
• Whether assets can cover liabilities?
• How to determine?
• Ratio analysis
• Current ratio, quick ratio, long-term debt ratio,
  total debt ratio, cash ratio

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Risk

• Current ratio current assets / current
  liabilities
• Quick ratio (current assets - inventory)
  /current liabilities
• Long-term debt ratio long-term debt /
  (long-term debt total equity)
• Total debt ratio total liabilities / total
  assets
• Cash ratio cash / current liabilities

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Risk

• Debt Structure
• long term liabilities vs. short term liabilities
• is it too rely on short-term debt to finance
  fixed assets?

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Risk

• Assets structure
• fixed assets vs. current assets
• are the assets easily convertible to cash?

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Risk

• The sequence of repay when bankrupt
• 1. Guaranteed bond holders
• 2. Non-guaranteed bond holders
• 3. Trade creditors

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Return

• As a money lender
• floating or fixed interest rate
• any changes in the interest rate

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Return

• As a bond holder
• Use the coupon rate to consider the cost of the
  bond
• For convertible bond holders
• compare the net asset value with share price to
  consider whether to convert the bonds to shares
  when the bonds mature

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Return

• As a goods or services seller
• to see the Accounts Payable account
• proportion of the creditor
• the term of credit granted

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Management

• Financial Position
• What are remaining in the company
• Trend Analysis
• Perform analysis, compare with the industrys
  competitors and last years figure
• Determine the position in the industry life cycle
• To determine the direction of the company in the
  future

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Problems

• Unclear disclosure of portfolio investment
• Window-dressing
• Consolidation
• Off-balance sheet financing

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Off-balance sheet financing

• Enron
• Other companies

Company Item not on Balance Sheet Estimated Exposure (Billion)
United Airline Inc. Plane leases 12.7
American Airline Inc. Plane leases 7.9
J.P.Morgan Chase Liability for trading units 1.0
Electronic Data Systems Payments for customers computers 0.5
Data source Standard Poors, Company reports Data source Standard Poors, Company reports Data source Standard Poors, Company reports
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Conclusion

• Cannot just rely on the balance sheet (especially
  for investors). Make use of income statement and
  cash flow statement.
• The information provided by the balance sheet may
  not be the true picture of the company.

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Conclusion

• Users of the financial statement should focus
  more on the relevant information with own
  judgment.
• More requirements on the disclosures on the
  financial statements are needed.

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The End

• Thank You

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Q A