Understanding Financial Statements PDF

Understanding Financial Statements Prepared by Ma. Antonina DC. Santiago Introduction  Financial Statements ✓ represent a formal record of the financial activities of an entity. ✓ These are written reports that quantify the financial strength, perf...

Understanding Financial Statements Prepared by Ma. Antonina DC. Santiago Introduction  Financial Statements ✓ represent a formal record of the financial activities of an entity. ✓ These are written reports that quantify the financial strength, performance and liquidity of a company. ✓ Its reflect the financial effects of business transactions and events on the entity. What are financial statements? The summarized results of your business financial transactions over a designated period of time. ✓ They will show total income, ✓ Expenses ✓ Cash balances, ✓ Assets ✓ Liabilities ✓ Level of debt, and much more. But where does this information come from? Financial Statements Income Statement* Balance Sheet* Statement of Cash Flow Statement of Changes in Equity Source of Financial Statement Accounts Accounts are the categories into which the effects of transactions are recorded, and from which financial reports are created. 5 major account categories: Equity Income Expenses Assets Liabilities Net worth / Proceeds Costs of What you What you level of from sales operation own owe investment Operations Financial Position Chart of Accounts Sample Income accounts Sample Expense accounts Sales revenue Rent Other income Cost of Goods Sold (COGS) Marketing Office supplies Payroll Professional fees Sample Asset accounts Sample Liability Sample Equity Current assets accounts accounts Cash Accounts payable Owner’s equity Inventory Credit card payable Retained earnings Accounts receivable Loan payable Fixed assets Equipment Property Income Statement Income Statement, also known as the Profit and Loss Statement, reports the company's financial performance in terms of net profit or loss over a specified period. Income Statement is composed of the following two elements: Income: What the business has earned over a period (e.g. sales revenue, dividend income, etc) Expense:Expense: The cost incurred by the business over a period (e.g. salaries and wages, depreciation, rental charges, etc) Income Statement / Profit & Loss Statement (P&L) Shows the performance of your My company Income Statement business over a period of time For the month of August 2008 Income Resets at the beginning of each Sales revenue $2,000 new accounting period Summarizes all revenue Expenses generated by the business rent $ 850 Summarizes all expenses utilities 75 incurred by the business (by payroll 400 category) insurance 25 Calculates the net profit or loss, or marketing 250 “bottom line” = Income – Expenses Total expenses 1,600 Tells you how well your business is operated Profit/Loss $400 Income Statement Do this statement first! Reviewing your income statement How is your revenue trending? Month-to-month Against same period last year (considers seasonality) How are your expenses trending? What are your highest categories of expenses? Which expenses are fixed vs. variable? What is your cost of goods sold? How do your expenses (as a % of sales) compare to others in your industry? Reviewing your income statement will tell you… Are you profitable? What’s your profit margin? Profit / Sales What’s your gross profit margin? (Sales – COGS) / Sales 1. Statement of Financial Position Statement of Financial Position, also known as the Balance Sheet, presents the financial position of an entity at a given date. It is comprised of the following three elements: ⮚ Asset ⮚ Liabilities ⮚ Equity Reviewing your balance sheet Debt management What are your total debt obligations? What is your total equity in the business? How leveraged is your company? Debt-to-equity ratio: Total liabilities / Total equity  Balance Sheet Reports assets and claims to assets. Claims of creditors, liabilities. Claims of owners, stockholders’ equity. Assets = Liabilities + Stockholders’ Equity Specific date – one point in time! Balance sheet ✓ Shows a snapshot of your business at a point in time ✓ Accumulates over the lifetime of your business ✓ Shows the net worth of your business ✓ The balance sheet always balances ASSETS – LIABILITIES = EQUITY My company Balance Sheet As of August 31, 2011 Assets: Liabilities: Cash 5,000 Accounts Payable 900 Accounts Receivable 600 Loan Payable 3,500 Inventory 900 Equipment 1,000 Total Liabilities 4,400 Equity: Total Assets 7,500 Owner’s equity 2,700 Retained earnings 400 Total Equity 3,100 Link between balance sheet and income statement Profit or loss is taken from the bottom line of the income statement and recorded on the balance sheet in the Retained Earnings equity account. Retained earnings accumulate over the life of the business. When a business operates at a profit, it increases in equity (is worth more) When a business operates at a loss, it decreases in equity (is worth less) Reviewing your balance sheet Liquidity: Can your company meet its payment obligations? Cash balance Working capital: Current assets – Current liabilities Current ratio: Current assets / Current liabilities Cash flow management How much inventory do you have? How fast are you selling it? Is your inventory on the shelf collecting dust and interest? Are you doing physical inventories monthly, annually, never? ▪ Inventory turns: (COGS / Inventory balance) How high is your accounts receivable balance? How quickly are you collecting it? ▪ Days sales outstanding: (AR / Sales) * # of days in period Balance Sheet From Retained Earnings Statement  Cash Flow Statement Cash Flow Statement, presents the movement in cash and bank balances over a period. The movement in cash flows is classified into the following segments: Operating Activities: Represents the cash flow from primary activities of a business. Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant) Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.  Cash Flow Statement Cash Flow Statement, presents the movement in cash and bank balances over a period. The movement in cash flows is classified into the following segments: Operating Activities: Represents the cash flow from primary activities of a business. Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant) Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.  Statement of Cash Flows Provides information about cash receipts CASH IN and cash payments CASH OUT Summarizes for period: month, quarter, or year. Cash effects of operating, investing, and financing activities.  Statement of Cash Flows Analysis Operating Investing Financing General Explanation Building up pile of cash, 1. + + + Possibly looking for Acquisition 2. + ─ ─ Operating cash flow being Used to buy fixed assets And pay down debt 3. + + ─ Operating cash flow and sale of fixed assets being used to pay down debt. Operating cash flow and borrowed 4. + ─ + money being used to expand  Statement of Cash Flows Analysis Operating Investing Financing General Explanation 5. ─ + + Operating cash flow problems covered by sale of fixed assets, borrowing and owner contributions. 6. Rapid growth, short falls in operating cash ─ ─ + flow; purchase of fixed assets. Sale of fixed assets is financing operating cash flow shortages. 7. ─ + ─ Company is using reserves to finance cash flow 8. ─ ─ ─ short falls.  The Example Company Statement of Cash Flows December 31, 2011 Cash Flows From Operating Activities: Receipts 48 Payments (43) 5 Cash Flows From Investing Activities: Receipts 0 Payments (4) (4) Cash Flows Used By Financing Activities: Receipts 10 Payments (6) 4 Net Cash Flow 5  Cash Flow Statement Cash--Op. Act. $ 973,000 Cash--Inv. Act. (1,188,000) Cash--Fin. Act. 245,000 Net increase $ 30,000 Beg. cash 80,000 End. cash $ 110,000 Balance Sheet 12/31/11 Balance Sheet 12/31/10 Cash $ 110,000 Income Statement Other 4,975,000 Cash $ 80,000 Revenues $12,443,000 Total $5,085,000 Other 4,550,000 Expenses 11,578,400 Total $4,630,000 Net income $ 864,600 Liabilities $2,860,400 Cap. stock 1,000,000 Liabilities $2,970,000 R/E 1,224,600 Cap. stock 900,000 Stmt of Retained Earnings Total $5,085,000 R/E 760,000 R/E 12/31/10 $ 760,000 Total $4,630,000 Net income 864,600 Dividends (400,000) R/E 12/31/11 $1,224,600 Statement of Changes in Equity Statement of Changes in Equity, also known as the Statement of Retained Earnings, details the movement in owners' equity over a period. The movement in owners' equity is derived from the following components: Net Profit or loss during the period as reported in the income statement Share capital issued or repaid during the period Dividend payments Gains or losses recognized directly in equity (e.g. revaluation surpluses) Effects of a change in accounting policyEffects of a change in accounting policy or correction of accounting error Other management reports There are many other management and financial reports you may find useful for managing your business that provide more detail for income statement and balance sheet accounts, such as: Sales revenue by customer Sales revenue by product Unpaid invoices Accounts receivable by customer Accounts receivable aging Expenses by vendor