Understanding

the Financial
Statements
Discussion Flow:
I. Three Key Financial Statements
Balance Sheet
Income Statement
Cash Flow Statement
II. Financial Statement Summary Comparison
III. Linking Financial Statements
IV. Users of Financial Statements
V. Advantage and Disadvantage of Financial Statements
VI. Benefits and Contents of the Annual Financial Report
THREE KEY FINANCIAL STATEMENTS
 BALANCE SHEET
(Statement of Financial Position)
Balance Sheet is always on the state of equilibrium
APPLE INC. BALANCE SHEET (in
Millions)
INCOME STATEMENT
(Statement of Profit and Loss)
APPLE INC. INCOME STATEMENT
(in Millions)
STATEMENT OF CASH FLOWS
APPLE INC. CASH FLOW
STATEMENT (in Millions)
APPLE INC. CASH FLOW
STATEMENT (in Millions)
 FS
SUMMARY
COMPARISO
N
LINKING FINANCIAL STATEMENTS
USERS OF FINANCIAL
STATEMENTS
USERS
USE
PROS AND
CONS OF
FINANCIAL
STATEMEN
TS
 BENEFITS
OF
ANNUAL
FINANCIAL
REPORT
CONTENTS OF ANNUAL FINANCIAL REPORT
Analysis of Financial
Statements
Discussion Flow
I. Financial Statement
II. Financial Statement Analysis
III. Analyzing Financial Statements
IV. Three Main Financial Statements
Balance Sheet
Income Statement
Cash Flow Statement
V. Key Takeaways
Financial Statement
•are formal records of
the financial activities
and position of a
business, person, or
other entity.
Financial
Statement
Analysis
IS THE PROCESS OF
ANALYZING A
COMPANY'S
FINANCIAL
STATEMENTS FOR
DECISION-MAKING
PURPOSES.
Analyzing Financial
Statements
Significance of FS Analysis
 it provides useful information on its economic
standing and profit levels
 it helps an investor, a regulator or a
company's top management understand
operating data, evaluate cash receipts and
payments during a period
 Also it appraise owners' investments in the
company
•financial statements are centered around generally
accepted accounting principles (GAAP) in the U.S which
require a company to create and maintain three main
financial statements: the balance sheet, the income
statement, and the cash flow statement.

• Accrual accounting is an accounting method

where revenue or expenses are recorded
when a transaction occurs rather than when
payment is received or made.
• Cash accounting is the other accounting
method, which recognizes transactions only
when payment is exchanged.
 These are:
Three Main
Financial
Statements Balance Sheet
All three statements
are interconnected
and create different
Income Statement
views of a company’s
activities and
performance. Cash Flow Statement
 a report of a company's financial worth in
Balance Sheet terms of book value. It is broken into
three parts to include a company’s assets,
liabilities, and shareholders' equity.
Income Statement
The income statement breaks down the
revenue a company earns against the
expenses involved in its business to provide
a bottom line, net income profit or loss.
The income statement is broken into three parts:
1. Revenue and the direct costs associated with revenue to identify gross profit.
2. Operating profit which subtracts indirect expenses such as marketing costs, general
costs, and depreciation.
3. Net profit which deducts interest and taxes.

Basic analysis of the income statement usually involves the calculation of gross profit
margin, operating profit margin, and net profit margin which each divide profit by
revenue. Profit margin helps to show where company costs are low or high at different
points of the operations.
Cash Flow Statement
The cash flow statement provides an
overview of the company's cash flows from
operating activities, investing activities, and
financing activities. Net income is carried
over to the cash flow statement where it is
included as the top line item for operating
activities.
- Investing activities include cash flows involved with firmwide investments.
- Financing activities section includes cash flow from both debt and equity
financing.

The bottom line shows

how much cash a company
has available.
 Financial statement analysis is used by internal and external
stakeholders to evaluate business performance and value.

KEY Financial accounting calls for all companies to create a

balance sheet, income statement, and cash flow statement
TAKEAWAYS which form the basis for financial statement analysis.

Horizontal, vertical, and ratio analysis are three techniques

analysts use when analyzing financial statements.
CASH FLOW
ANALYSIS
Discussion Flow
I. Philippine Accounting Standard (PAS 7) – Cash Flow Statement
II. Classification of Cash Flow Items
Operating Activities
Investing Activities
Financing Activities
III. Methods of Cash Flow
Direct Method
Indirect Method
IV. Key Takeaways
Philippine The objective of this standard is to require the
provision of information about the historical
Accounting changes in cash and cash equivalents of an
Standard entity by means of a cash flow statement
(PAS 7) – Cash which classifies cash flows during the period
from operating, investing and financing.
Flow Statement

A Cash flow statement is a statement which

shows the sources of cash inflow and uses of
cash out-flow of the business concern during
a particular period of time.
Classification of Cash Flow Items

THE INFLOW (SOURCES)

AND OUTFLOW (USES) 1. OPERATING 2. INVESTING 3. FINANCING
OF CASH ARE CLASSIFIED
INTO THREE:
ACTIVITIES ACTIVITIES ACTIVITIES
Operating Activities
These are the principal revenue-producing
activities of the entity and other activities
that are not considered as investing or
financial activities.
Investing Activities
These are the acquisition and disposal of
long-term assets and short-term and long-
term investments, not included in cash
equivalents. It also involves the buy and sell
of non-current assets.
Financing Activities
Activities that result in changes in all
non-current liabilities accounts, short
term and long-term bank loans and
equity.
 Direct Method
Converts individual cash receipts and cash payments to cash inflows
(sources of cash) and cash outflow (usage of cash).

Methods of
Cash Flow

Indirect Method
Makes the necessary adjustments to net income to arrive at the net
cash flow from operating activities. According to GAAP, it is called
Reconciliation of Net Income to net cash flows of operating activities.
Key Takeaways

A cash flow statement is The cash flow statement

The cash flow statement
a financial statement measures how well a company complements the balance
that summarizes the manages its cash position, sheet and income
amount of cash and meaning how well the statement and is a
cash equivalents company generates cash to mandatory part of a
pay its debt obligations and company's financial
entering and leaving a fund its operating expenses.
company. reports
• The main components of the cash flow statement are cash from operating
activities, cash from investing activities, and cash from financing activities.

• The two methods of calculating cash flow are the direct method
and the indirect method.

• A cash flow statement is a valuable measure of strength, profitability, and the

long-term outlook for a company. It can help determine whether a company has
enough liquidity or cash to pay its expenses.
 • A company can use a cash flow statement to
predict future cash flow, which helps with matters
of budgeting.

• The cash flow statement reflects a company's

financial health since typically the more cash that's
available for business operations, the better.

• Sometimes, a negative cash flow results from a

company's growth strategy in the form of expanding
its operations.
• It is very useful when used in conjunction with the rest of the financial statements,
provides information that enable users to evaluate the changes in net assets of an entity,
its financial structure and its ability to affect the amounts and timing of cash flows in
order to changing circumstances and opportunities.

• By studying the cash flow statement, an investor can get a clear

picture of how much cash a company generates and gain a solid
understanding of the financial well-being of a company.
Operating and
Financial
Leverage
What is LEVERAGE?
In general, leverage means effect of one variable over
another. In financial management, leverage is not much
different; it means change in one element, results in change
in profit. It implies, making use of such asset or source of
funds like debentures for which the company has to pay fixed
cost or financial charges, to get more return. There are three
measures of Leverage i.e. operating leverage, financial
leverage, and combined leverage. The operating
leverage measures the effect of fixed cost whereas
the financial leverage evaluates the effect of interest
expenses.
 
•How responsive a company’s operating income is to change in sales
volume.
•Firm’s ability to use fixed costs (or expenses) to generate better
returns for the firm.
•A cost-accounting formula that measures the degree to which a firm
or project can increase operating income by increasing revenue. A
business that generates sales with a high gross margin and low
variable costs has high operating leverage.

Operating Leverage
Financial
Leverage
 •Employment of fixed cost bearing assets in
the company’s operations is known as
Operating Leverage. Employment of fixed
financial charges bearing funds in a
Differences company’s capital structure is known as
between Financial Leverage.
Operating •The Operating Leverage measures the
Leverage and effect of fixed operating costs, whereas
Financial Financial Leverage measures the effect of
Leverage interest expenses.
•Operating Leverage influences Sales and
EBIT but Financial Leverage affects EBIT and
EPS.
•Operating Leverage arises due to the company’s cost
structure. Conversely, the capital structure of the
company is responsible for Financial Leverage.
•Low operating leverage is preferred because higher
DOL will cause high BEP and low profits. On the other
hand, High DFL is best because a slight rise in EBIT will
cause a greater rise in shareholder earnings, only when
the ROCE is greater than the after-tax cost of debt.
•Operating Leverage creates business risk while
Financial Leverage is the reason for financial risk.
•Firms with large fixed costs have high
operating leverage and so a small
increase in sales can have a big increase
in operating income.
But the opposite is also true:
•A small decrease in sales could have a big
decrease in operating income. Firms with
little fixed costs have low operating
leverage so small increases or decreases
in sales have small impacts on operating
income.
•Operating leverage measures operational
efficiency and operational risk while
financial leverage measures the solvency
of the company and bankruptcy risk.
•Financial leverage is the measure of the amount of borrowed capital present in the capital
structure of the company and therefore the riskiness of the company in terms of its
solvency and ability to meet its obligations related to interest expenses of its borrowings
Higher financial leverage is justified only for those companies that have high growth
prospects and not for small start-ups because interest expenses need to be paid even if the
company is incurring losses and this might not be feasible for such companies. It is better
for them to enter into venture financing or angel investment.
•Operating leverage is a measure of the number of fixed costs of the company such as rent
and office salaries and so on. Greater such costs, greater is the riskiness of the company
because if there are not enough profits, these expenses still need to be paid. Financial
leverage deals with the amount of debt in the capital structure of the company and
therefore the number of interest expenses and whether a company is capable enough to
meet these expenses.