Part 3

Understanding
Financial
Statements and
Reports
Slide Contents

• Learning Objectives
1. An Overview of the Firm’s Financial Statements
2. The Income Statement/Statement of Profits and
Loss
3. The Balance Sheet/Statement of Financial
Position
4. The Cash Flow Statement
• Key Terms

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Learning Objectives

1. Describe the content of the basic financial

statements and discuss the importance of financial
statement analysis to the financial manager.
2. Evaluate firm profitability using the income
statement.
3. Use the balance sheet or the statement of financial
position to describe a firm’s investments in assets
and the way it has financed them.
4. Identify the sources and uses of cash for a firm
using the firm’s cash flow statement.

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 3.1 AN OVERVIEW OF THE
FIRM’S FINANCIAL
STATEMENTS

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Basic Financial Statements

Financial statements are written records that convey

the business activities and the financial performance
of a company. Financial statements are often audited
by government agencies, accountants, firms, etc. to
ensure accuracy and for tax, financing, or investing
purposes. Financial statements include:
• Balance sheet/Statement of Financial Position
• Income statement/Statement of Profit & Loss
• Cash flow statement

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Basic Financial Statements

• Using Financial Statement Information

• Investors and financial analysts rely on financial
data to analyze the performance of a company
and make predictions about its future direction of
the company's stock price. One of the most
important resources of reliable and audited
financial data is the annual report, which contains
the firm's financial statements.

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INCOME STATEMENT/STATEMENT OF
PROFIT AND LOSS

The Income Statement is one of a company’s

core financial statements that shows
their profit and loss over a period of
time. The profit or loss is determined by
taking all revenues and subtracting all
expenses from both operating and non-
operating activities.

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 Income Statement

Revenues
• The following are covered in the income
statement, though its format may vary
depending upon the local regulatory
requirements, the diversified scope of the
business and the associated operating
activities:
Expenses
• The cost for a business to continue operation and
turn a profit is known as an expense.

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INCOME STATEMENT/STATEMENT OF
PROFIT AND LOSS

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Balance Sheet/Statement of
Financial Position

A balance sheet gives a statement of a business’s

assets, liabilities and shareholders equity at a
specific point in time. They offer a snapshot of what
your business owns and what it owes as well as the
amount invested by its owners, reported on a single
day. A balance sheet tells you a business’s worth at
a given time, so you can better understand its
financial position.

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Balance Sheet/Statement of
Financial Position

The assets section of the balance sheet breaks

down what your business owns of value that can be
converted into cash. Your balance sheet will list your
assets in order of liquidity; that is, it reports assets in
order of how easily they can be converted to cash.
There are two main categories of assets included on
your balance sheet:

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Balance Sheet/Statement of
Financial Position

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Balance Sheet/Statement of
Financial Position

The assets section of the balance sheet breaks

down what your business owns of value that can be
converted into cash. Your balance sheet will list your
assets in order of liquidity; that is, it reports assets in
order of how easily they can be converted to cash.
There are two main categories of assets included on
your balance sheet:

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Balance Sheet/Statement of
Financial Position

• The first subcategory lists the current assets in

order of their liquidity. Here’s a list of the most
common accounts in the current section:
• Current
• Cash
• Accounts Receivable
• Prepaid Expenses
• Inventory
• Due from Affiliates

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Balance Sheet/Statement of
Financial Position

• AIRCON P20,000 /20 years = 1,000

• 2018-2038
Balance Sheet: Dec 2020
Equipment 20,000
Acc.Dep 2,000
Net Asset 18,000

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Balance Sheet/Statement of
Financial Position
• The second subcategory lists the long-term assets. This
section is slightly different than the current section because
many long-term assets are depreciated over time. Thus,
the assets are typically listed with a total accumulated
depreciation amount subtracted from them. Here’s a list of
the most common long-term accounts in this section:
• Long-term
• Equipment AIRCON = P20,000
• Leasehold Improvements
• Buildings
• Vehicles
• Long-term Notes Receivable
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Basic Financial Statements

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Basic Financial Statements

• The current liabilities section is always reported first and includes debt
and other obligations that will become due in the current period. This
usually includes trade debt and short-term loans, but it can also include
the portion of long-term loans that are due in the current period. The
current debts are always listed by due dates starting with accounts
payable. Here’s a list of the most common current liabilities in order of
how they appear:
• Current Liabilities
• Accounts Payable
• Accrued Expenses
• Unearned Revenue
• Lines of Credit
• Current Portion of Long-term Debt

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Basic Financial Statements

• The current liabilities section is always reported first and includes debt
and other obligations that will become due in the current period. This
usually includes trade debt and short-term loans, but it can also include
the portion of long-term loans that are due in the current period. The
current debts are always listed by due dates starting with accounts
payable. Here’s a list of the most common current liabilities in order of
how they appear:
• Current Liabilities
• Accounts Payable
• Accrued Expenses
• Unearned Revenue
• Lines of Credit
• Current Portion of Long-term Debt

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Basic Financial Statements

• The second liabilities section lists the obligations

that will become due in more than one year. Often
times all of the long-term debt is simply grouped into
one general listing, but it can be listed in detail. Here
are some examples:
• Long-term Liabilities-BONDS
• Mortgage Payable
• Notes Payable- BANKS
• Loans Payable

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Basic Financial Statements

• Equity Section
• Unlike the asset and liability sections, the equity
section changes depending on the type of entity.
For example, corporations list the common stock,
preferred stock, retained earnings, and treasury
stock. Partnerships list the members’ capital and
sole proprietorships list the owner’s capital.

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The Balance Sheet

• The stockholder’s equity includes the

following: Par value of common stock + Paid
in Capital + Retained Earnings.
• Authorized Capital= 200Mpaid in capital ¼
200Mx 4= 800M
• We can also express stockholders’ equity as
follows:

Shareholders' equity = Total Assets – Total

Liabilities

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Analyze

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RECAP

Income Statement ( Statement of Profit and

Loss) – summarizes a firm’s financial
transactions over an interval of time, like
revenues and expenses. (performance)

Balance Sheet (Statement of financial

position)- is a snapshot of firm’s financial
resources and obligations at a single point of
time
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Basic Financial Statements

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 THE CASH FLOW STATEMENT

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The Cash Flow Statement

The Cash Flow Statement is used by firms

to explain changes in their cash balances over
a period of time by identifying all of the
sources and uses of cash for the period
spanned by the statement.

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Sources and Uses of Cash

• A source of cash is any activity that brings

cash into the firm. For example, sale of
equipment. Sales, borrowings (bonds,
stock)

• A use of cash is any activity that causes

cash to leave the firm. For example,
payment of taxes.

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• The cash flow statement includes ONLY
inflows and outflows of cash and cash
equivalents; it excludes transactions that do
not directly affects cash receipts and
payments.
• The cash flow is a cash basis report on three
types of financial activities; operating,
investing and financing activities.
• Non-cash activities are usually reported in
footnotes.

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What is the importance of cash
flow statement?

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The Statement of Cash Flow provides
valuable information about company’s gross
payments and receipts and allows insights
into it’s future income needs.
As an analytical tool, the statement of CF is
useful in determining the short-term viability
of a company, particularly its ability to pay
bills.

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Cash Flow Statement

The basic format for a cash flow statement is

as follows:
Beginning Cash Balance
Plus: Cash Flow from Operating
Activities
Plus: Cash Flow from Investing
Activities
Plus: Cash Flow from Financing
Activities
Equals: Ending Cash Balance
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Cash Flow Statement

• Operating activities represent the company’s

core business (meaning regular business
activities), including sales and expenses.

• Investing activities include the cash flows

that arise out of the purchase and sale of
long-term assets such as plant and
equipment. It includes purchases of physical
assets, investments in securities, or the sale
of securities or assets.

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Cash Flow Statement

Financing activities represent changes in the

firm’s use of debt and equity such as issue of
new shares, the repurchase of outstanding
shares, and the payment of dividends.
It shows the net flows of cash that are used to
fund the company.

It include transactions involving debt, equity,

and dividends.

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Sample Cash Flow:

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Cash Flow Analysis

Why did the cash balance decline by $4.50m?.

See table 3.1 and table below:
Sources of Cash Uses of Cash
Increase in Accounts Increase in Accounts
Payable = $4.50 Receivable $22.50

Increase in long-term debt Increase in inventory =

=$51.75 $148.50
Increase in retained Increase in net plant and
earnings = $159.75 equipment = $40.50

Decrease in short-term
notes = $9
Total Sources of cash = Total Uses of cash =
$216.00 $220.50

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Cash flow from Investing Activities

• Below are a few examples of cash flows from

investing activities along with whether the items
generate negative or positive cash flow.
• Purchase of fixed assets–cash flow negative
• Purchase of investments such as stocks or
securities–cash flow negative
• Lending money–cash flow negative
• Sale of fixed assets–cash flow positive
• Sale of investment securities–cash flow positive
• Collection of loans and insurance proceeds–cash
flow positive

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Cash Flow Analysis

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The Importance of the Cash Flow Statement

• The cash flow statement is the financial statement that

presents the cash inflows and outflows of a business during
a given period of time. It is equally as important as the
income statement and balance sheet for cash flow
analysis. Without a cash flow statement, it may be difficult
to have an accurate picture of a company’s performance.
The income statement will tell you how much interest you
paid on a loan and the balance sheet will tell you how much
you owe, but only the cash flow statement will tell you how
much cash was consumed servicing that loan. The income
statement will record sales and profits but it’s the cash flow
statement that will alert you if those sales aren’t generating
enough cash to cover expenses.
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End of Presentation

“You only live once, but if you do

it right, once is enough.” — Mae
West

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