Financial Statements and Annual Reports Quiz

Understanding Financial Statements

• A company's annual report includes financial and non-financial information
• The financial information includes a Statement of Financial Position, Statement of Comprehensive Income, Statement of Cash Flow, and Statement of Changes of Equity, and Notes to the Account.
• The non-financial information includes the Auditor's Report, Directors' Report, and further Notes to Account, such as the company's principal activities.
• For publicly listed corporations, there is also a Chairman's Report and Activities Report.
• The first step in reviewing a financial statement is to examine the auditor's unqualified opinion.
• The Directors' Report must be attested to by the company directors, confirming the fairness of the company's financial position and short-term obligations.

Analysis of Statement of Financial Position

• Assets are equal to Liabilities plus Capital
• Assets are the needs of a business, financed by liabilities and capital
• Balance sheets are historical and static in nature
• Assessing the extent of shareholders' financial commitment and its relation to creditors is important
• Assessing the company's short-term solvency is also important
• The funding structure should be appropriate to the company's nature of business

Components of Statement of Financial Position (Assets)

• Current Assets: assets that can be converted to cash within 12 months (e.g., raw materials, finished goods)
• Non-current Assets: assets that cannot be converted to cash within 12 months (e.g., property, plant, and equipment)
• Intangible Assets: non-physical assets (e.g., patents, trademarks, copyrights)
• Preliminary Expenses: expenses capitalized for future write-offs (e.g., R&D expenses)

Components of Statement of Financial Position (Liabilities)

• Current Liabilities: obligations due within 12 months (e.g., accounts payable, short-term loans)
• Long-term Liabilities: obligations not due within 12 months (e.g., long-term loans, deferred taxes)

Components of Statement of Financial Position (Equity)

• Share Capital: equity funds contributed by shareholders
• Ordinary Share Capital: conveys ownership rights with voting rights
• Preference Share Capital: restricted ownership rights, but has preference in dividend and par value upon liquidation
• Reserves: Profit and losses generated and yet to be distributed to investors

Using Financial Ratio to Analyze Statement of Financial Position

• Solvency Ratio: measures a borrower's ability to meet short-term obligations
  • Current Ratio (CR): measures the ability to meet short-term obligations from liquidating current assets (Current Assets/Current Liabilities)
  • Quick Ratio (Acid Test Ratio): a more stringent test than current ratio, excluding stocks (Current Assets−Inventory)/Current Liabilities
  • Gearing Ratio (Debt/Equity Ratio): measures reliance on external debt versus internal equity (Total Liabilities/Total Shareholders’ Equity)
• Debt Service Ratio: assesses a borrower's ability to service their debts.
  • Times Interest Earned Ratio (TIE): measures ability to service interest payments (Earnings Before Interest and Tax/Interest Expense)
  • Debt Service Ratio: (Earnings Before Interest and Tax / (Interest Expense + Principal Repayment))

Using Financial Ratio to Analyze Statement of Comprehensive Income

• Gross Profit Margin (GPM): percentage of sales remaining after subtracting the cost of goods sold (Gross Profit/Sales)
• Net Operating Profit Margin (NOPM): profit margin remaining after operating expenses (Earnings Before Interest and Tax/Sales)
• Return on Assets (ROA): measures how efficiently assets generate profits (Earnings After Tax/Total Assets)
• Return on Equity (ROE): measures profitability relative to equity (Net Profit After Tax/Shareholders' Equity)

Analysis of Statement of Cash Flow

• Cash Flow from Operating Activities (CFO): assesses daily operations (Net Profit After Tax + Non-cash Expenses)
• Cash Flow from Investing Activities (CIN): assessments pertaining to fixed assets (e.g., CapEx, Investment)
• Cash Flow from Financing Activities (CIF): assessments pertaining to funding (e.g., loans, dividends)

Quantitative Analysis of Financial Statements

• This involves analyzing past and future earning capacity, financial position sustainability, and cash flow generation
• Statement of Comprehensive Income and Statement of Financial Position are reviewed
• Quantitative analysis helps make judgements regarding future cash flow

Qualitative Analysis of Financial Statements

• This is an assessment of a business's activities, risks, and future funding needs
• Internal and external factors are assessed, along with business risks and drivers of success for the business
• SWOT analysis can be used for assessing strengths, weaknesses, opportunities, and threats.