see 6.2

585 views
505 views

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
585
On SlideShare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
7
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

see 6.2

  1. 1. A Basic Understanding of Financial Statements A training manual for European Works Council members Produced with support from the European Commission ISBN 2-930139-44-7 Contents Page
  2. 2. 1 Introduction 5 1.1 Foreword 1.2 Acknowledgements 2 Objectives of this training manual 8 2.1 To increase users’ awareness of what information is contained in published financial statements 2.2 To enable users to find information of specific interest to European Works Council members in published financial statements 3 How to use this training manual 11 3.1 As part of a training course with a tutor 3.2 As a self study guide 3.3 As a reference work for specific financial statements 3.4 As a reference work for specific financial terms 4 The European Works Council Directive 13 4.1 Aims of the Directive 4.2 Sources of financial information 4.3 The Annual Report 4.4 The company and the group 5 Definitions of the key financial statements 17 5.1 The balance sheet 5.2 The income statement 5.3 The cash flow statement 6 The balance sheet 19 6.1 Introduction 6.2 Specimen balance sheet 6.3 Dates and currencies 6.4 Contents of the balance sheet 6.5 Format of the balance sheet 6.6 Relationship between headings, subheadings and totals 6.7 Notes to the accounts 6.8 Explanation of selected terms 6.9 Exercises 2
  3. 3. 7 The income statement 39 7.1 Introduction 7.2 Specimen income statement 7.3 Dates and currencies 7.4 Contents of the income statement 7.5 Format of the income statement 7.6 Relationship between headings, subheadings and totals 7.7 Notes to the accounts 7.8 Explanation of selected terms 7.9 Exercises 8 The cash flow statement 51 8.1 Introduction 8.2 Specimen cash flow statement 8.3 Dates and currencies 8.4 Contents of the cash flow statement 8.5 Format of the cash flow statement 8.6 Relationship between headings, subheadings and totals 8.7 Notes to the accounts 8.8 Explanation of selected terms 8.9 Exercises 9 An example of the financial statements of a 58 French multinational company (Lyonnaise des Eaux) 9.1 Introduction 9.2 Specimen financial statements 9.3 Differences in format 9.4 Explanation of selected terms 9.5 Exercises 10 An example of the financial statements of a 71 German multinational company (Volkswagen) 10.1 Introduction 10.2 Specimen financial statements 10.3 Differences in format 10.4 Explanation of selected terms 10.5 Exercises 3
  4. 4. 11 An example of the financial statements of a UK 81 multinational company (Imperial Chemical Industries) 11.1 Introduction 11.2 Specimen financial statements 11.3 Differences in format 11.4 Explanation of selected terms 11.5 Exercises 12 Solutions to exercises 91 Glossary 95 (English, French, German, Italian, Spanish) Index of terms 98 4
  5. 5. 1 Introduction 1.1 Foreword 1.2 Acknowledgements 5
  6. 6. 1 Introduction 1.1 Foreword The European Trade Union College (ETUCO) and the Association for European Training of Workers on the Impact of New Technology (AFETT) have been involved in projects designed to promote effective training for European Works Council members since 1993. ETUCO/AFETT have produced a series of related training materials including a set of transparencies on the EWC Directive, a set of grids describing the systems of workplace representation in each EU member state, and a simulation exercise (FERUCCI simulation, available on-line at http://www.etuc.org/etuco/ewcmat.cfm ) ETUCO/AFETT also run specialised courses for members of European Works Councils, tailoring the training needs to meet the specific needs of each group. In order to further support this work, we have developed this training manual which is designed to help members of European Works Councils understand their company’s financial information so that they may carry out their role more effectively. It may be used as part of a conventional training course, or as a self-study guide, as it contains exercises, the solutions to these, and a glossary of useful terms for reference. We hope that you find it useful, and we would appreciate any feedback from you on your experience of using this material, which is also available on our website at ( http://www.etuc.org/etuco/ewcmat.cfm ). Jeff Bridgford Director ETUCO/AFETT Boulevard Emile Jacqmain 155 B-1210 Brussels Belgium Tel.: +32 2 224 05 30 Fax: +32 3 224 05 33 E-mail: etuco@etuc.org http://www.etuc.org/etuco/ 6
  7. 7. 1.2 Acknowledgements This training manual has been prepared on behalf of the European Trade Union College by John Laidler, lecturer in accounting at the University of Newcastle, and Peter Donaghy, freelance tutor of Business English. The authors are grateful for the information and material they have received from trade union organisations including in particular the TUC, UNISON (United Kingdom) and CC.OO (Spain). They also wish to acknowledge the help and advice received from tutors working with the European Trade Union College, especially Hellmut Gohde, as well as the useful observations made by European Works Council members who studied the material on training courses delivered by the authors. However, ultimately the views expressed in this training manual and the inclusion or exclusion of material herein reflect the decisions of the authors themselves. We are grateful to the following companies for kind permission to reproduce their financial statements: Lyonnaise des Eaux, Procter & Gamble, Imperial Chemical Industries & Volkswagen. No responsibility for loss occasioned to any person acting or refraining from action as a result of material in this training manual can be accepted by the publisher, the European Trade Union College or the authors of the material, P J Donaghy and J Laidler. 7
  8. 8. 2 Objectives of this training manual 2.1 To increase users’ awareness of what information is contained in published financial statements 2.2 To enable users to find information of specific interest to European Works Council members in published financial statements 8
  9. 9. 2.1 The first objective The first objective of this training manual is to enable users to obtain awareness of what information is contained in the financial statements published by multinational companies. At this stage we are concerned with the English language version of the financial statements issued by multinational companies. The principal financial statements published by multinational companies are sometimes referred to using different terminology, depending on the country of origin of the statements and the style of the translation. The names of these statements (with common alternative terms in brackets) are as follows:  the balance sheet (statement of financial position)  the income statement (statement of earnings / profit and loss account)  the cash flow statement • These statements form part of a company’s Annual Report and are publicly available. • These statements contain information, which is of interest to European Works Council members. • These statements are likely to be referred to in European Works Council meetings. As a result of using this training manual European Works Council members should: • know what to expect to find in the balance sheet, income statement and cash flow statement • know where to locate particular items in the balance sheet, income statement and cash flow statement 9
  10. 10. 2.2 The second objective The second objective of this training manual is to enable readers to be able to find information of specific interest to European Works Council members in published financial statements The three basic financial statements which are published by multinational companies (balance sheet, income statement and cash flow statement) contain information about a company’s performance over a year and its financial position at the end of that year. As a result of using this training manual European Works Council members should be able to know where to look for information to answer the following questions about a company: • Has the company made a profit? • How do this year’s results compare to the previous year? • What changes has the company made in its investment in plant? • What was the value of the company’s total sales and how does this compare with the previous year? • How much did the company pay in taxes last year? Information in these financial statements might also be a useful starting point for European Works Council members to ask further questions, such as:  How is the amount spent on equipment distributed among the companies in the group?  How is the wage bill divided between the number of employees in different locations? This training manual is not concerned with analysis and interpretation of financial data. This is considered to be more the work of experts. However, this training manual will help European Works Council members to discuss financial statements with experts with greater confidence. 10
  11. 11. 3 How to use this training manual 3.1 As part of a training course with tutors 3.2 As a self-study guide 3.3 As a reference work for specific financial statements 3.4 As a reference work for specific financial terms 11
  12. 12. 3.1 As part of a training course with tutor A basic understanding of the balance sheet, income statement and cash flow statement provides part of the knowledge that European Works Council members will find useful. It will be very helpful if they are able to receive further explanations and examples drawn from their own sector provided by an experienced tutor. Tutors will select the sections that they consider to be most relevant to the needs of learners. Additional exercises can be prepared to develop a greater understanding of the most relevant aspects. 3.2 As a self-study guide Users should be able to work on their own or with colleagues with this training material in order to obtain a awareness of what information is contained in the balance sheet, the income statement and the cash flow statement. It is recommended that users work through the sections of the training manual in the order in which they appear. The exercises at the end of Sections 6 – 11 can be used in conjunction with the corresponding solutions in Section 12 to assess progress and understanding. 3.3 As a reference work for specific financial statements Users may feel the need to learn more about specific financial statements. It is recommended that such users consult the Contents pages and then they can choose the sections which are of specific interest to them. 3.4 As a reference work for specific financial terms In some cases there may be a need to check the understanding of a specific financial term. The Index of terms enables this training manual to be used for this purpose. Users will be directed to the section where explanations of a specific term are provided. The glossary enables users to identify the translations in French, German, Italian and Spanish of some important terms. 12
  13. 13. 4 The European Works Council Directive (EWC): 4.1 Aims of the Directive 4.2 Sources of financial information 4.3 The annual report 4.4 The company and the group 13
  14. 14. 4.1 Aims of the European Works Council Directive The 1994 European Works Council Directive seeks: “to improve the right to information and to consultation of employees in Community-scale undertakings and Community-scale groups of undertakings” through “the exchange of views and establishment of dialogue between employees’ representatives and central management or any more appropriate level of management.” (Articles 1 & 2) The Appendix to the Directive indicates that: “The European Works Council shall have the right to meet with central management once a year, to be informed and consulted, on the basis of a report drawn up by the central management, of the progress of the business...” and that “the meeting shall relate in particular to the structure, economic and financial situation, the probable development of the business...” The Directive obviously provides very wide terms of reference for European Works Councils and these are reflected in the agreements which have been signed to date between employees’ representatives and the management of multinational companies. Agreements usually include reference to economic, financial, social and employment topics. This training manual is concerned with understanding basic financial information which is provided in published financial statements and which is closely inter-related with these topics. It is also clear from current practice that management will select various documents to form the basis of consultation and discussion. Evidence so far suggests that employees are likely to encounter a vast array of facts, figures and forecasts. This of course can be very confusing. It can be difficult to compare one year with another and one company with another. For these reasons this training manual concentrates on certain specific sources of information. 14
  15. 15. 4.2 Sources of financial information It is difficult to ascertain what would be the most useful sources of financial information for employees. The position is further complicated by sectional and national differences in the way economic and financial information is presented. What may be appropriate for one industry or in one environment may not be so appropriate elsewhere. On the other hand some detailed information which companies may use to monitor performance on a regular basis, such as internal management accounts, may not be readily accessible or may be classified as confidential. There are a large number of reports produced by analysts and experts and produced in trade journals and newspapers. These can often provide useful opinions on the performance and future prospects of a company. These need to be collected and monitored carefully. European Works Council members will benefit from the services of economic and research departments where these are available. 4.3 The annual report One source of information which is open to everyone is the company annual report document. As a result of the harmonisation of European company legislation, all companies are obliged to produce an annual report. This publicly available document includes annual financial statements which are a record of past performances. Although these financial statements are largely directed at shareholders and investors, they nevertheless present a picture which can be extremely useful for EWC members, of how the company has performed under the company’s management. Therefore for the purpose of discussing financial information, it is apparent that reference will be made, either directly or indirectly, to the three key annual financial statements contained in the annual report, namely:  the balance sheet (or statement of financial position),  the income statement (or profit and loss account)  the cash flow statement At the same time the annual report document also contains other reports containing information of interest to European Works Council members such as: • statement from the company chair person • business and operational review • research and development report • health and safety issues 15
  16. 16. • human resources review • environmental issues While these reports and reviews are directed at shareholders rather than employees it is interesting and useful to see if the same messages are being given to the labour force. Material in the annual report document could form the basis of questions that European Works Council members could raise at meetings. However, this current training manual concentrates on obtaining an awareness of the financial information contained in the three key financial statements to be found in the annual report. 4.4 The company and the group European Works Councils are concerned with the business of multinational companies on a group-wide basis rather than on a single country basis. Meetings are expected to look at topics which affect the overall running of the group rather than to look at issues of concern to single companies within the group. It is important therefore to be clear about the composition and nature of the undertaking or entity which is the focus of the European Works Council We need to appreciate the significance of the terms group, parent company, and subsidiary company. Many multinational companies are part of a larger structure. That is to say, they are part of a group of companies which is usually referred to simply as the group (or group company). In order to give a more accurate picture of the financial situation of a company it is necessary to look at the overall situation of the group as a whole. In order to do this the financial statements of all the members of a group are added together. In other words they are consolidated to form what is called group statements or consolidated statements. The group will usually consist of a principal company called the parent company and a number of other companies which are owned by this parent company and which are usually referred to as the subsidiary companies. 16
  17. 17. 5 Definitions 5.1 The balance sheet 5.2 The income statement 5.3 The cash flow statement 17
  18. 18. 5.1 The balance sheet This shows the financial situation of an entity (i.e. a company or a group), at a particular moment in time, usually at the end of the entity’s financial year. It is sometimes referred to as the statement of financial position. 5.2 The income statement This shows how the profit or loss of an entity (i.e. a company or a group), for a particular period of time has been arrived at. It is sometimes referred to as the statement of earnings and in some countries it is called the profit and loss account 5.3 The cash flow statement This shows how an entity’s (i.e. a company’s or a group’s) activities are reflected in the form of cash flowing into and out of the entity over a particular period of time. We are now going to look at each of these financial statements in detail in order to see what they contain and to help us to locate items which may be of interest to European Works Council members. 18
  19. 19. 6 The balance sheet 6.1 Introduction 6.2 Specimen balance sheet 6.3 Dates and currencies 6.4 Contents of the balance sheet 6.5 Format of the balance sheet 6.6 Relationship between headings, subheadings and totals 6.7 Notes to the accounts 6.8 Explanation of selected terms 6.9 Exercises 19
  20. 20. 6.1 Introduction The balance sheet shows the financial situation of an entity (i.e. a company or a group), at a particular moment in time, usually at the end of the entity’s financial year. It is sometimes referred to as the statement of financial position. 6.1.1 The difference between company and group balance sheets The usual structure for a multinational company is that there will be a parent company and a number of subsidiaries. Taken together, the parent company and the subsidiary companies are called the group. Each individual company (i.e. the parent and each subsidiary) will prepare its own balance sheet. In addition, a balance sheet will be prepared for the group as a whole. The balance sheet prepared for the group will be called either the group balance sheet or the consolidated balance sheet. Not all these balance sheets will be publicly available as part of a multinational’s annual report. The balance sheet below the US company Procter and Gamble (see 6.2) is a consolidated balance sheet. Likewise the annual reports for Lyonnaise des Eaux and Volkswagen contain only the group balance sheet as shown below in 9.2 and 10.2. However, in section 11.1 we can see that ICI presents figures under one column for the group and then a separate column of figures for the parent company referred to as the company. European Works Councils are concerned with understanding the position of a multinational business as a whole as opposed to just an individual part of that business. Members of European Works Councils therefore need to look at the group balance sheet (consolidated balance sheet). 6.1.2 Differences in presentation We are going to look at the ways in which the information contained within the balance sheet may be presented. At this stage we are not concerned with the specific meanings of the items in the balance sheet. These will be explained later (see 6.8 Explanation of selected terms). There are several different ways in which the information found in a balance sheet may be presented. These are often referred to as differences in format. 20
  21. 21. The company may be based in the USA in which case the format of the balance sheet will usually reflect the normal US style as seen in the specimen balance sheet in 6.2 below. If the company is based in Europe the specific format of the balance sheet will be according to the legislation of the country concerned and will reflect one of the two formats laid down in an EU Directive on Company law. Examples of balance sheets produced by a French, a German and a UK company are shown in 9.2.1, 10.2.1 and 11.2.1 respectively. The balance sheet may have been translated into English for public relations purposes and its format and language may therefore be influenced by the nature of the readership it is expected to reach or even the background of the translator. This also applies to the other financial statements discussed in this manual, i.e. the income statement (see 7.1) and the cashflow statement (see 8.1). It has to be remembered that there are differences between US and UK English and this applies to accounting terminology as much as in any other area. Members of European Works Councils can expect to handle balance sheets with different styles of presentation according to the country of origin of the company concerned and the policy it has adopted in preparing the financial statements it publishes. As many multinational companies have their head offices in the USA we begin by looking in section 6.2 at a specimen balance sheet which reflects the normal US style. The specimen statements used in section 6.2, 7.2 and 8.2 of this training manual are from the 1997 Annual Report of Procter and Gamble (P&G). P&G is a multinational company with its head offices in the US and, as such, it is subject to US accounting regulations. The company is listed on the New York, Cincinnati, Amsterdam, paris, Basle, Geneva, Lausanne, Zurich, Frankfurt, Antwerp, Brussels and Tokyo stock exchanges. 21
  22. 22. 6.2 Specimen balance sheet The Procter and Gamble company balance sheet from the 1997 annual report. Consolidated Balance Sheets (Amounts in Millions Except Per Share Amounts) June 30 1997 1996 ASSETS Current Assets Cash and cash equivalents $ 2,350 $ 2,074 Investment securities 760 446 Accounts receivable 2,738 2,841 Inventories Materials and supplies 1,131 1,254 Work in process 228 210 Finished goods 1,728 1,666 Deferred income taxes 661 598 Prepaid expenses and other current assets 1,190 1,718 Total Current Assets 10,786 10,807 Property, Plant, and Equipment Buildings 3,409 3,369 Machinery and equipment 14,646 14,174 Land 570 569 18,625 18,112 Less accumulated depreciation 7,249 6,994 Total Property, Plant, and Equipment 11,376 11,118 Goodwill and Other Intangible Assets Goodwill 3,915 4,175 Trademarks and other intangible assets 1,085 1,095 5,000 5,270 Less accumulated amortization 1,051 989 Total Goodwill and Other Intangible Assets 3,949 4,281 Other Non-Current Assets 1,433 1,524 Total Assets $27,544 $27,730 1 Restated for two-for-one stock split effective August 22, 1997. See accompanying Notes to Consolidated Financial Statements. 22
  23. 23. June 30 1997 1996 LIABILITIES AND SHAREHOLDERS'EQUITY Current Liabilities Accounts payable $ 2,203 $ 2,236 Accrued and other liabilities 3,802 3,981 Taxes payable 944 492 Debt due within one year 849 1,116 Total Current Liabilities 7,798 7,825 Long-Term Debt 4,143 4,670 Deferred lncome Taxes 559 638 Other Non-Current Liabilities 2,998 2,875 Total Liabilities 15,498 16,008 Shareholders'Equity1 Convertible Class A preferred stock, stated value $1 per share (600 shares authorized) 1,859 1,886 Non-Voting Class B preferred stock, stated value $1 per share (200 shares authorized; none issued) - - Common stock, stated value $1 per share (2,000 shares authorized; shares outstanding: 1997 - 1,350.8 and 1996 - 1,371.1) 1,351 1,371 Additional paid-in capital 559 294 Currency translation adjustments (819) (418) Reserve for employee stock ownership plan debt retirement (1,634) (1,676) Retained earnings 10,730 10,265 Total Shareholders' Equity 12,046 11,722 Total Liabilities and Shareholders' Equity $27,544 $27,730 23
  24. 24. 6.3 Dates and currencies 6.3.1 Dates It is important to be clear about the period of time which we are referring to. • A balance sheet gives us a picture of the financial situation of a company at a particular moment of time. This is usually at the end of the twelve months period when the company’s year ends which may or may not coincide with the calendar year. • In order to make the figures more meaningful, companies are obliged to provide the comparative figures for at least the preceding year. Therefore you will find further colums in the balance sheets which give you the figure for each item for the previous year. Comparative figures must also be given in the other financial statements discussed in this manual, i.e. the income statement (see 7.3) and the cashflow statement (see 8.3). In the case of the specimen, Proecter & Gamble, shown in 6.2 above, the date 30 June is given on the same line as that of the years 1997 and 1996. This tells us that the balance sheet figures refer to the financial years which ended on the 30 June of both these years. In fact the heading is also plural, consolidated balance sheets, because figures for two years are presented. If we look at the examples in sections 9.2, 10.2 and 11.2 we find the following: 9.2 Lyonnaise des Eaux Consolidated balance sheet 1996 with figures also for 1995 1994- we need to look elsewhere in the finacial statements to see that this is the position on 31 December in each of these years 10.2 Balance sheet of the Volkswagen Group, December 31, 1996 with figures also for 1995 11.2 ICI Balance sheets as at 31 December 1997 with figures also for 1996. There are separate balance sheets for the Group and the Company 6.3.2 Currencies It is important to be clear about the currency we are referring to. The currency in which the accounts are designated is usually indicated somewhere in the headings of the balance sheet by an appropriate symbol or abbreviation. Task 24
  25. 25. Look at the specimen balance sheets in sections 6.2, 9.2, 10.2 and 11.2. Note the currency in which the figures are expressed You will see that they are given as follows: Procter & Gamble $ amounts in millions Lyonnaise des Eaux FRF millions Volkswagen DM million ICI £m 6.4 Contents of the balance sheet Now we can examine what a balance sheet contains ; On the one hand, the balance sheet reflects what a company OWNS, that is, its assets, such as cash, machinery and equipment. On the other hand, the balance sheet reflects what a company OWES, that is, its liabilities, such as money borrowed from third parties and what is due to its shareholders, which we refer to as shareholders’ equity. The balance sheet therefore consists of assets, liabilities and shareholders’ equity which are arranged under different headings and subheadings. All balance sheets contain these three items. The relationship between them can be expressed as: assets minus liabilities equals shareholders’ equity or, as: assets equals liabilities plus shareholders’ equity The specimen Procter and Gamble balance sheet in 6.2 is set out in a way which reflects the latter equation (assets = liabilities + shareholders’ equity). 6.5 Format of the balance sheet Let us consider the overall shape of the balance sheet in order to be able to recognise the different kinds of formats we are likely to meet. Companies present their balance sheets in accordance with the formats permitted under the relevant national legislation. This also applies to the income statement (see 7.5). There are generally two styles of format : horizontal format and vertical format 25
  26. 26. 6.5.1 Horizontal format The Procter & Gamble specimen balance sheet in 6.2 shows assets on the left hand side and liabilities and shareholders’ equity on the right hand side of the balance sheet. This is often referred to as a horizontal format. The two sides of the balance sheet end up with the same final figure, in other words they balance. Total Assets $27,544m Total Liabilities and Shareholders’ Equity $27,544m We can see the same format in the Lyonnaise des Eaux balance sheet in Section 9.2.1 where: the figure for Total Assets on the left hand side is FRF 163,781m and the figure for Total Liabilities on the right hand side is FRF 163,781m Sometimes the same effect is obtained by positioning the two “sides”, that is the assets side and the liabilities and shareholders’ equity side, on the same page, one “side” above the other. This is the case with the balance sheet of the Volkswagen Group as shown in section 10.2 Assets Balance -sheet total DM 94,568m Shareholders’ equity and liabilities Balance-sheet total DM 94,568m 26
  27. 27. 6.5.2 Vertical format On the other hand we may find, especially with companies based in the UK, that a different balance sheet format is used where the items follow one another down the page in a series of relationships . This is referred to as a vertical format. An example of this is shown in the specimen balance sheets of ICI shown in section 11.2. Here in this format you will also find two totals which balance although you may have to look a little more closely to find them. This is clearly a different style of presentation which requires more explanation and this is provided in section 11.1. Please note that at this stage you are not expected to understand these different headings but simply to begin to recognise the way a balance sheet may look and how the total are reached. Remember that there will be a difference in the way the figures are set out because of national legislation and because companies in different industrial sectors may have different kinds of assets and liabilities or companies may use different words to describe them. Task Look at the balance sheet of your company. Does it have a separate total for assets on one side and a separate total for liabilities on the other ? or are the assets and liabilities merged and taken away from each other in a vertical format ? 6.6 Relationship between headings, subheadings and totals. Let us consider some typical examples of headings and subheadings in order to see where the totals appear and how these totals are arrived at. Remember we will explain the meaning of the specific items later on. The Procter & Gamble balance sheet in 6.2 is divided into two main parts: ASSETS and 27
  28. 28. LIABILITIES AND SHAREHOLDERS’ EQUITY Underneath these two headings are a number of main headings as follows: ASSETS Current assets Property, Plant, and Equipment Goodwill and Other Intangible Assets Other Non-Current Assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities Long-term Debt Deferred Income Taxes Other Non-Current Liabilities Shareholders’ Equity Some of these headings are then followed by a number of subheadings with corresponding figures which when totalled represent the total for the main heading. Examples are as follows: Current assets Cash and cash equivalents 2,350 Investment securities 760 Accounts receivable 2,738 Inventories Materials and supplies 1,131 Work in process 228 Finished goods 1,728 Deferred income taxes 661 Prepaid expenses and other current assets 1,190 Total current assets 10,786 28
  29. 29. Current Liabilities Accounts payable 2,203 Accrued and other liabilities 3,802 Taxes payable 944 Debt due within one year 849 Total Current Liabilities 7,798 We can observe the following aspects of the layout: • The headings are followed by a number of sub headings with figures which are then totalled in order to give the overall figure for the item indicated in the heading. • The word total is sometimes then used together with the heading as in Total Current Assets. • A line may also be used to separate the sub totals from the total. Sometimes we may find more lines and even boxes used to separate some of the figures. 6.7 Notes to the accounts The amount of detail which is provided in the balance sheet and the other financial statements will vary. However, in all cases it is impossible to give every detail on the face of the balance sheet itself. For this reason companies provide further details and explanations of certain key items by way of notes to the accounts (which are often just referred to as notes).The extent of information given in the notes is partly determined by the law of the country in which a multinational company has its headquarters and partly by the company voluntarily disclosing further information You will usually find cross- reference to notes either in a separate column or alongside particular items by way of a number. This is illustrated in the specimen French, German and UK financial statements in sections 9.2, 10.2 and 11.2. There are not direct cross- reference numbers in the specimen US style financial statements used in section 6.2, 7.2 and 8.2 although the Procter & Gamble Annual Report does contain a further details and explanations in a section entitled Notes to Consolidated Financial Statements. It is in the notes that many of the details of specific interest to European Works Council representatives will be found. The notes are important also because they 29
  30. 30. facilitate comparisons with the previous year with respect to some of the detailed information. The notes may contain information on such things as the investments which the group has in other undertakings, employee share schemes and details of the shareholdings of directors Task Now look at the specimen sets of balance sheets in sections 9.2, 10.2 and 11.2 and find the references to notes. We have not reproduced a notes to the accounts section in this training manual as the amount of detail contained in the notes is outside the scope of this work. However, here are some examples of the type of items which may be found in the notes (and which expand the information in the balance sheet and income statement) which are of interest to European Works Council representatives: • segmental information including: breakdown of the turnover and profit from the different classes of business within a company and from geographic areas in which the company operates • average number of employees in different sections of the company and their distribution by country • changes in fixed assets • investments in subsidiary undertakings • method of valuation of stock and values of types of stock • breakdown of the amounts borrowed by the company • amounts provided for pensions and for reorganisation costs • details of share option schemes • details of the acquisition of other companies • details of the disposal of parts of the group • breakdown of employee costs: salaries, social security costs and pension costs • directors’ pay • pension fund details • breakdown of the main companies within the group 30
  31. 31. 6.8 Explanation of selected terms 6.8.1 Current assets Current assets are assets which a company possesses but which it does not intend to hold long-term i.e. current assets are assets held by a company on a short-term basis. The definition of short-term for this purpose is usually taken as one year. We will now describe some of the main types of current assets: inventories (6.8.1.1), accounts receivable (6.8.1.2), investments (6.8.1.3), accrued income (6.8.1.4) and prepaid expenses (6.8.1.5). 6.8.1.1 Inventories. An example of a current asset is inventories i.e. the goods a company holds in stock (in UK company accounts the word stock is used rather than the US term inventories). A company may have different types of inventories. For example, we can see from the specimen balance sheet in 6.2 that Procter and Gamble under the heading inventories has three types: • materials and supplies which consist of raw materials and supplies bought in for the manufacture of an end product • work in process which represents goods which are being manufactured but which have not been completed at the balance sheet date • finished goods which are the goods which have been manufactured or bought in and are held in stock at the balance sheet date. 6.8.1.2 Accounts receivable Accounts receivable are the amounts owed by customers to whom a company has granted credit facilities in order to buy the products or services which the company supplies. The company will receive payment some time in the future. They are sometimes simply called receivables. 6.8.1.3 Investments Another example of a current asset is investments or investment securities which the company possesses but which it does not intend holding long-term. 31
  32. 32. If the intention is to have the investment for a temporary period, i.e. for the short- term, then the investment would be classed as a current asset. It might be, for example, that a company has some cash which it does not need until three months time; in which case the company could invest the available cash by putting it on deposit and earning interest or by making some other suitable short-term investment. For investments held on a long-term basis see under fixed assets 6.8.2 below. Two other items which might be included in current assets are accrued income (6.8.1.4) and prepaid expenses (6.8.1.5). 6.8.1.4 Accrued income This item represents sums which have been earned but which have not yet been received. For example, assume that a company placed some money in a bank deposit account on 30 September and that the bank pays the interest on the account on 31 March. Let us also assume that the financial year end of the company is 31 December. When the company draws up its balance sheet on the 31 December, three months worth of interest will have been earned on the deposit account - even though the bank will not pay the interest until the following 31 March. This amount of interest will be included by the company in its balance sheet as a current asset. 6.8.1.5 Prepaid expenses (also called prepayments) These (current assets) represent amounts paid out by a company before its balance sheet date but where the benefit from the payment will not be gained until after the balance sheet date. For example, if a company which draws up its balance sheet to 31 December 1997 has paid a fire insurance premium on 30 September 1997 covering the year ended 30 September 1997, the company will have the benefit of insurance cover until 30 September 1998. If the amount of the premium is $2400, then the company has made a prepayment of $1800 (i.e. 9 months for the period January to September 1998). The company will include this amount as a current asset in its balance sheet drawn up at 31 December 1997. 6.8.2 Property, plant and equipment 6.8.2.1 Classification in balance sheet Assets are, in general, things which a person or a company owns. In the case of a company some of its assets, such as buildings or machinery, will have been acquired with the intention of using them in the business and which will probably be held for a long period of time. They are not intended for resale. These assets may be referred to as fixed assets. Sometimes, such assets as property, plant and equipment are referred to as tangible assets because they are assets which have a physical existence i.e. they can be touched. A company like Procter and Gamble might own assets such as machinery and equipment, land and buildings which are held by the company and used by the 32
  33. 33. company. In the Procter and Gamble balance sheet these three assets are grouped together under the heading property, plant and equipment. This is the classification used by most US companies. 6.8.2.2 Accumulated depreciation One important aspect of the way in which a company accounts for its property, plant and equipment is the charge it makes in its accounts for the wearing out of these assets in the course of their use in the business. This is called the depreciation of the assets. A company will try to spread the cost of an asset over its working life by making charges to each year’s income statement. As an example of this, suppose a company buys a machine on 1 January 1991 for $20,000 and that the machine is expected to have a useful life of ten years. We might make a charge each year to the income statement for its depreciation of $2,000 i.e. $20,000 ÷ by 10 years = $2,000 per year The amounts charged to the income statement in each year will gradually accumulate. The year end totals are referred to as accumulated depreciation When we look at the balance sheet we will see that after three years i.e. 31 December 1993, the value of the machine in the balance sheet will be $20,000 less accumulated depreciation of $6,000 as follows : Cost of machine on 1 January 1991 $20,000 less 3 years accumulated depreciation = 3 X $2000 = $6,000 equals Value of machine on 31 December 1993 $14,000 Further details about depreciation should be given in the notes section of a company’s annual report. 6.8.3 Other non-current assets 33
  34. 34. Items which companies might include under this heading include investments intended to be held on a long-term basis (i.e. investments which are not considered to be current assets). If a parent company has shares in subsidiaries which, for various permissible reasons, are not included in the consolidated figures, the cost of the shares in those subsidiaries may be included under the heading of non-current assets. 6.8.4 Goodwill and other intangible assets We have already seen in 6.8.2 that fixed assets such as property, plant and equipment can be referred to as tangible fixed assets. We need to recognise that companies might own intangible fixed assets i.e. assets which have no physical form therefore we cannot touch them, but they are worth something i.e. if we want an intangible asset we have to pay for it. Some examples are explained below in sections 6.8.4.1 (goodwill) and 6.8.4.2 (other intangible assets). 6.8.4.1 Goodwill Goodwill is an intangible asset. It is represented by the excess of the purchase price of a company over and above the value of the assets less liabilities included in the balance sheet. for example, if the assets less liabilities recorded in the balance sheet have a market value of $10m and a prospective buyer offers $11 the excess of $1m can be referred to as goodwill. Goodwill can arise owing to a number of factors, for example, the company might possess a well-known brand name, or it might be situated in a highly desirable location. Goodwill is built up during the life of a company but the only occasion when a verifiable value can be attributed to the goodwill is when the company is sold,. In such a case we can refer to the goodwill that has been paid for as purchased goodwill. 6.8.4.2 Other intangible assets Items which companies might have under this heading include, patents, trade marks and brand names. We can take patents as an example. Suppose that a company wanted to be able to manufacture a special piece of equipment but that another company had the legal right to manufacture the special equipment. If the first company wanted to acquire the right to be able to make the special equipment, it would have to buy the patent. In other words, the second company owns an assets, the patent,. This asset would be included in its balance sheet as an intangible asset 6.8.4.3 Accumulated amortization Amortization is another word for depreciation. It is often used instead of depreciation when we refer to intangible assets. A company spreads out the cost of its intangible assets over a period of time (just as it spreads out the cost of its tangible assets). The accumulated amortization is therefore equivalent to the accumulated depreciation which is described in detail in 6.8.2.2. 34
  35. 35. 6.8.5 Current liabilities Liabilities are amounts that a company owes to other people or other companies. In such cases we say that a company owes money to third parties. The people or other companies (i.e. the third parties) to whom a company owes money are also referred to as the company’s creditors. A company might owe money in respect of goods which have been supplied or for services which have been provided. Or, the company might have borrowed money which will have to be repaid in due course. The amounts which a company owes to its creditors will usually be due for payment at different times. For example, some of the amounts owing for goods supplied might be due for payment in one month whereas a loan received might not be due for repayment for five years. Liabilities to third parties need to be distinguished between current liabilities and long-term liabilities. Current liabilities represent the part of a company’s total liabilities that is due for payment within the next twelve months. 6.8.5.1 Accounts payable Current liabilities in the Procter and Gamble balance sheet include accounts payable. This represents the amounts owing to suppliers for goods and services supplied on credit and which have not been paid for at the balance sheet date. These amounts are also called trade payables. 6.8.5.2 Accrued liabilities Accrued liabilities are amounts which relate to one accounting period but which are not paid until a subsequent accounting period. An example is the amount for electricity consumed in one accounting period before the balance sheet date (according to a meter reading) but which is not billed by the electricity company and hence, not due to be paid until after the balance sheet date. 35
  36. 36. 6.8.5.3 Debt due within one year Debt represents the amount a company has borrowed from outside sources. For balance sheet presentation the amount of any loan that is due to be repaid within the next twelve months is included under current liabilities as debt due within one year. It is also called debt payable within one year. Any amount due after twelve months is included as long-term debt. 6.8.6 Long-term debt The heading long-term debt covers the amounts which are owed by the company to lenders for monies borrowed where settlement (i.e. repayment) is not due until after one year. 6.8.7 Deferred income taxes This item arises from a technical accounting adjustment and it represents a possible tax liability to be paid at some time in the future. It is not due for payment in the next twelve months and, hence, it is not a current liability. 6.8.8 Other non-current liabilities This item represents amounts set aside to meet a liability that will be incurred at some time in the future but we are not sure what the amount will be or when it will arise. An example is pension liabilities. 6.8.9 Shareholders’ equity (or Stockholders’ equity) We know from our discussion in section 6.4 that the basic relationship that exists in any company balance sheet is: assets minus liabilities equals shareholders’ equity In other words, if we deduct from the assets the amounts we owe to outsiders (i.e. third parties), we will be left with what belongs to the shareholders. We call this amount the shareholders’ equity or the stockholders’ equity. We sometimes come across other terms which are used instead of shareholders’ equity or stockholders’ equity, for example, total shareholders’ funds or capital and reserves. There are two items which make up shareholders’ equity: 36
  37. 37. (1) the amounts brought into the business by the owners, i.e. the shareholders; (2) the reserves of the company. We will now examine each of these in turn. 6.8.9.1 Amounts brought into the business by the owners: shares and additional paid-in capital If a company is set up in the form of a limited company, the owners will contribute the funds required to start the business in the form of shares. For example, if there was a requirement for $10m funding then the prospective owners would be asked, between them, to provide $10m. The total amount will be divided into shares. It could be 10 million shares of $1 each or 20 million shares of 50 cents each or some other convenient subdivision. The amount stated for each share is referred to as the stated value. (Other terms used instead of stated value are nominal value or par value). The total value of the shares may be called capital stock. In the specimen statements, the stated value of the Procter and Gamble common stock is $1 per share. The stated value of a share is likely to be different from its market value. Hence, when a company issues further shares of an existing class, the issue price will be near to the market price. For example, a $1 share might be issued at $1.50. The 50 cents is referred to as additional paid-in capital and is shown in the balance sheet. For example, the Procter and Gamble (see specimen balance sheet in section 6.2) shows additional paid-in capital $559m. In the Procter and Gamble balance sheet of 30 June 1997 there are a number of different types of stock as follows: $m Convertible Class A preferred stock 1,859 Non-voting Class B preferred stock (none issued) - Common stock 1,351. Each type of share carries different rights. Convertible stock carries rights to be converted into common stock Preferred stock carries preferential rights as to dividends and possibly repayment in the event of liquidation. Common stock usually carries rights to the profits remaining after payment of dividends have been made to shares carrying preferential rights and to any surplus available in the event of the company winding up (i.e. coming to the end of its life).. 37
  38. 38. Authorized shares. Each company has to establish in its rules the number of shares it will be authorized to issue. However, the company might not issue all of its authorized shares. For example P&G has no Class B shares in issue. Capital stock is the name given to the total of the different types of shares. An alternative name is share capital. 6.8.9.2 Reserves One way in which reserves can be built up is when the company makes profits which it does not distribute to the shareholders as dividends. In other words, when the company retains the profits for use within its business. This is called retained earnings. The reserves in the Procter and Gamble balance sheet consist of: $m Retained earnings 10,730 Less : currency translation adjustment (819) Less: Reserve for employee stock ownership plan debt retirement (1,634) --------- 8,277 The figure 8227 is not included in the P&G balance sheet but is given here so that, overall, we can see that the shareholders’ equity is made up of: $m Shares issued 3,210 Additional paid-in capital 559 Reserves 8,277 -------- 12,046 There is a great deal of detailed information lying behind this overall summary. For US based multinationals the details are set out in a separate statement called the Consolidated Statement of Shareholders’ (or Stockholders’) Equity. 38
  39. 39. 6.9 Exercises 1. What was the change in the group’s investment in property, plant and equipment for the last financial year? 2. Has there been an increase or decrease in inventories compared with the last financial year? 3. What is the total of retained earnings at 30 June 1997? Answers to questions 1 -3 Summary You should now be able to: (1) recognise most of the main headings in a balance sheet (2) understand how the totals in a balance sheet are arrived at (3) appreciate that there are the different balance sheet formats (4) recognise that further details are available in the form of the notes section of the annual report (5) understand the meaning of some of the main terms found in a balance sheet 39
  40. 40. 7 The income statement 7.1 Introduction 7.2 Specimen income statement 7.3 Dates and currencies 7.4 Contents of the income statement 7.5 Format of the income statement 7.6 Relationship between headings, subheadings and totals 7.7 Notes to the accounts 7.8 Explanation of selected terms 7.9 Exercices 7.1 Introduction 40
  41. 41. The income statement shows how the profit or loss of an entity (i.e. a company or group) for a particular period of time has been arrived at.It is sometimes referred to as the statement of earnings. In some countries it is referred to as the profit and loss account. The income statement (or statement of income) is also known as the statement of earnings (or earnings statement or the profit and loss account. In this section we will use the term income statement to refer to all three possible terms. We are going to look at the ways in which the information contained within the income statement may be presented. At this stage we are not concerned with the specific meanings of the items in the income statement. These will be explained later. There are several different ways in which the information found in an income statement may be presented. Members of European Works Council can expect to handle income statements with different styles of presentation according to the country of origin of the company concerned and the policy it has adopted in preparing the financial statements it publishes If the company is based in Europe the specific format of the income statement will be according to the legislation of the country concerned and will reflect one of the four formats laid down in a EU Directive on Company Law On the other hand the company may be based in the USA in which case the format of the income statement will usually reflect the normal US style. The income statement may have been translated into English for public relations purposes and its format and language may therefore be influenced by the nature of the readership it is expected to reach. This also applies to the two other financial statements discussed in this manual, i.e. the balance sheet (see 6.1) and the cashflow statement (see 8.1). As many multinational companies have their head offices in the USA we begin by looking in section 7.2 at a specimen income statement which reflects the normal US style. This is taken from the Procter and Gamble annual report for 1997. Notice that Procter and Gamble use the term statement of earnings as the title for its income statement Reference will also be made to the statements of multinational companies that have their head offices in France (see section 9), Germany (see section 10) and the UK (see section 11). 7.2 Specimen income statement Consolidated Statements of Earnings 41
  42. 42. (Amounts in Millions Except Per Share Amounts) Years Ended June 30 1997 1996 1995 Net Sales $35,764 $35,284 $33,482 Cost of products sold 20,316 20,762 19,561 Marketing, research, and administrative expenses 9,960 9,707 9,677 Operating Income 5,488 4,815 4,244 Interest expense 457 484 488 Other income, net 218 338 244 Earnings Before Income Taxes 5,249 4,669 4,000 Income taxes 1,834 1,623 1,355 Net Earnings $3,415 $3,046 $2,645 Net Earnings Per Common Share1 $2.43 $2.14 $1.85 Fully Diluted Net Earnings Per Common Share1 $2.28 $2.01 $1.74 Dividends Per Common Share1 $.90 $.80 $.70 Average Common Shares Outstanding 1 1,360.3 1,372.6 1,372.0 1 Restated for two-for-one stock split effective August 22, 1997. See accompanying Notes to Consolidated Financial Statements. The Procter & Gamble Company and Subsidiaries 42
  43. 43. 7.3 Dates and currencies 7.3.1 Dates First of all we need to look at the period of time to which the income statement refers. • An income statement can refer to any particular period of time (for example, three months, six months etc). However, as far as the annual financial statements are concerned, the income statement refers to the business activity which has taken place during the preceding twelve months and this will be stated on the statement itself. • As is the case with the balance sheet, companies are obliged to provide the figures for the previous year for comparative purposes. Therefore we will find a further column in the income statement which gives us the figure for each item for the preceding year. Comparative figures must also be given in the other financial statements discussed in this manual, i.e., the balance sheet (see 6.3) and the cashflow statement (see 8.3). Task Look at the specimen statements of income in sections 7.2, 9.2, 10.2 and 11.2. Note the terms used to describe the statements and identify the periods of time covered by the statements. You will see that they are as follows: 7.2 Procter & Gamble - Consolidated Statements of Earnings: Years Ended June 30 1997: 1996: 1995 9.2 Lyonnaise des Eaux- Consolidated Income Statement : 1996 with the previous two year’s figures for comparison. We need to look elsewhere in the financial statements to see that this is the position on 31 December in each of these years. 10.2 Volkswagen Group- Statement of Earnings for the Fiscal Year Ended December 1996 with the previous year’s figures for comparison. 11.2 ICI Group Profit and Loss Account for the year ended 31 December 1997 with the previous two year’s figures for comparison. 43
  44. 44. 7.3.2 Currencies In each case we also need to note the currency in which the accounts are designated. This information is usually stated in the headings or in the columns of figures in the income statement. Task Look at the specimen statements of income in sections 7.2, 9.2, 10.2 and 11.2. Note the currency in which the figures are expressed You will see that they are as follows: Procter & Gamble $ amounts in millions Lyonnaise des Eaux FRF millions Volkswagen DM million ICI £m 7.4 Contents of the income statement First of all we will examine in general terms what an income statement shows. We will then see in section 7.5 how these features apply to the Procter and Gamble specimen. The income statement usually indicates, for the time period concerned, six important amounts: (1) the amount of income received by the company as a result of the sale of goods and services. This might be called its revenue or its turnover or its sales. (2) the costs incurred in producing the goods or services provided by the company and in running the business. (3) the difference between (1) and (2) i.e. the profit or loss derived from the operating activities of the company. This might be called operating income or trading profit/loss. (4) interest paid and received. (5) how much of the profit is to be paid in taxes. (6) the amount of profits, after deducting taxes, which is available for the company and its shareholders. This may be called net earnings, net income or net profit. 44
  45. 45. 7.5 Format of the income statement Let us consider the overall shape of the statement of income in order to be able to recognise the different kinds of formats we are likely to meet. As previously stated companies present their statements of income in different ways or formats depending on the amount of choice that their national legislation allows. Similarly, the balance sheet (see 6.5) will be drawn up in accordance with the rules laid down in the relevant national legislation. There are generally two style of format : horizontal format and vertical format. 7.5.1 Horizontal format In some countries, we may find only one style of presentation i.e. a horizontal format. Legislation in Spain, for example, permits only the horizontal format. Here the information is presented on two separate sides: on one side: on the other side: under the title of under the title of debit credit costs and profits income and losses (in different forms) (in different forms) 7.5.2 Vertical format Those European companies Procter and Gamble, in common with most US which prefer the vertical type companies, uses a vertical format. choice of one of the of presentation have a two vertical formats which are permitted by the European Union. However, the purpose is the same whatever the style, and we can still identify the same information which is of interest to European Works Council members in the income statement, irrespective of the format. The vertical format is used in the specimen statements found in sections 7.2, 9.2, 10.2, 11.2. 45
  46. 46. 7.6 Relationship between headings, sub headings and totals Unlike the balance sheet, the income statement does not arrive at two sets of figures which have to balance. Instead it moves through a series of stages where figures are added or subtracted in order to show the relationship between the income generated by the business and the costs incurred in running the company. The difference between these is called the results or earnings or profit (or loss) at different stages. We need to consider how totals at each stage have been arrived at. Lines are generally used to indicate subtotals and we need to look carefully to see if the figures have been added or subtracted Thus in the Procter & Gamble Consolidated Statements of Earnings (see section 7.2) we find: 1997 $m Net Sales 35,764 Cost of products sold 20,316 Marketing, research and administrative expenses 9,960 Operating income 5,488 In this example we can see that two figures (20,316 and 9,960) are deducted from the net sales figure to arrive at the figure for operating income. If we look at the Lyonnaise des Eaux Consolidated Income Statement (see section 9.2) we find that the operating income which is referred to as operating results is derived by adding together sales and other operating revenues and then deducting the items which make up operating expenses which have similarly been added together. This, in summary, is as follows: Operating revenues 98,540 Operating expenses 93,180 Operating results 5,360 At other times brackets are used to indicate that a figure needs to be subtracted from the previous figure. Thus in the ICI group profit and loss account (see section 11.2) we find: Turnover 11,062 Operating costs (10,721) 46
  47. 47. This means that the operating costs of 10,721 have to be deducted from the turnover of 11,062. If we look at the Procter and Gamble specimen income statement again (see 7.2), we can see that having arrived at the figure for the operating income ($5,488m), there are two further items before we arrive at a figure for earnings before income taxes. These two items are: (1) interest expense $457m which is deducted from the operating income (2) other income, net $218m which is added to the operating income. In other words: operating income $5488m minus interest expense 457 plus other net income 218 equals earnings before income taxes $5249m The next step is the deduction of income taxes to arrive at the net earnings i.e. earnings before income taxes $5249m minus income taxes 1834 equals net earnings $3415m Below the figure for net earnings, a number of other figures are set out. The various terms used are included in the explanations in section 7.8 below. Earnings is one of the key figures of interest to European Works Council members. Considerable care, however, needs to be exercised here because there are several references to earnings each of which has a different implication. For example, in the Procter and Gamble statement we need to distinguish between earnings before income taxes and net earnings. We also need to appreciate that other terms might be used instead of earnings. Examples are results, income, and profit. Their use depends on the country of origin of the company and it also sometimes depends on how the concept has been translated into English 47
  48. 48. The figure for net earnings ($3,415m in the specimen income statement in section 7.2) is included in the balance sheet. In the specimen balance sheet in section 6.2 it is included within the retained earnings figure of $10,730m 7.7 Notes to the accounts As is the case with the balance sheet, the amount of detail which is provided in the income statement will vary from country to country and from company to company. In all cases, however, it is impossible to give very much detail on the face of the profit and loss account itself. For this reason, many companies are provide further details and explanations of certain key items by way of the notes to the accounts section of the annual report (which are often just referred to as notes). Some companies make reference to notes on the face of the accounts by way of numbers, either in a separate column, or alongside particular items. It is here in the notes that many of the details of specific interest to European Works Council members will be found (see section 6.7 for examples). The notes might contain information on such things the analysis of sales and operating profit according to divisions or sectors or geographical regions. 7.8 Explanation of selected income statement terms 7.8.1 Net sales This is the total amount which a company obtains from the sale of its goods and services. Some companies use the word turnover rather than sales. 7.8.2 Cost of products sold This represents the cost of manufacturing the goods which a company sells. It includes all costs incurred in getting the goods to a state in which they can be sold. Some companies use the terms cost of goods sold. 7.8.3 Operating income The operating income is the balance remaining when a company’s operating expenses are deducted from its net sales. The operating expenses are the expenses incurred during the course of the company’s ordinary business activities. In the Procter & Gamble statement of earnings, the operating expenses consist of the cost of products sold and marketing research and administrative expenses. 48
  49. 49. 7.8.4 Interest expense Companies which borrow money from outside sources have to pay interest on their borrowings. The interest payable which relates to a particular financial year will be charged to that year’s income statement as a separately disclosed item known as interest expense. 7.8.5 Earnings before income taxes This consists of: operating income less interest payable plus interest receivable and other income (i.e. income not derived as a result of operating activities). 7.8.6 Net earnings The final figure in the income statement represents: operating income less interest payable plus interest receivable and other income less income taxes In other words earnings less income taxes. 7.8.7 Net earnings per common share The figure for net earnings per common share is an additional bit of information which some companies include in their annual report, either voluntarily or because of the existence of a specific accounting regulation. Where there is a regulation, this will include the method to be used in the calculation of the figure. The basis of the calculation is: to divide (1) the net earnings which are attributable to the holders of common shares, by (2) the number of shares issued to shareholders. (1) The net earnings attributable to holders of common shares are what remains after any preference dividends have been taken into account. If a company has preference shares in issue they will usually carry the right to a preference dividend (i.e. a dividend paid before any dividends can be paid to the holders of common shares). 49
  50. 50. The preference dividend for Procter and Gamble for the year ended 30 June 1997 is $104m. This figure is given here to enable us to complete the calculation of net earnings per common share (in practice we would find it in other supporting statements within the annual report). The net earnings after preference dividend is $3,311m calculated as follows: Net earnings $3,415m minus preference dividend 104 $3,311m (2) We need to define how we arrive at the number of shares issued to Shareholders. The normal rule is to take the average number of shares held by shareholders during the year. Hence, in the specimen income statement we can arrive at the figure for net earnings per common share, as follows: divide the net earnings after preference dividends, $3,311m by the number of common shares, 1,360.3m Which gives us a figure for net earnings per common share of $2.43 7.8.8 Fully diluted net earnings per common share This is a variation of the item net earnings per common share discussed immediately above (7.8.6). In this case the figure is arrived at by dividing: the net earnings attributable to holders of common shares by the number of common shares in issue plus the number of common shares which a company is contracted to issue. The reason for this item is to show the situation, when, for example, a company has some form of preference or loan stock which carry rights to be converted into common stock, the same amount of net earnings will have to be divided by a greater number of shares once the extra shares are issued. 7.8.9 Dividends per common share This is the amount, expressed in the currency of the company concerned, payable to the holders of common shares as a distribution to them of part of the net earnings. 50
  51. 51. In the case of the specimen company, Procter and Gamble, the dividend for the year ended 30 June 1997 is 90 cents per share. 7.9. Exercises 4. Has the group made a profit for the year ended 30 June 1997? 5. How did the results for the 1997 compare with 1996? 6. What was the value of the group’s sales for 1997 and how did this compare with last year ? 7. What type of expenses have been deducted from the net sales to arrive at a figure for operating income? Answers to questions 4 -7 Summary You should now be able: (1) to recognise the most important headings in an income statement (2) to appreciate that there are different income statement formats (3) to understand how the totals in the income statement have been arrived at (4) to recognise that further details are available in the form of the notes section of the annual report (5) to understand the meaning of selected terms found in the income statement 51
  52. 52. 8 The cash flow statement 8.1 Introduction 8.2 Specimen cash flow statement 8.3 Dates and currencies 8.4 Contents of the cash flow statement 8.5 Format of the cash flow statement 8.6 Relationship between headings, subheadings and totals 8.7 Notes to the accounts 8.8 Explanation of selected terms 8.9 Exercises 52
  53. 53. 8.1 Introduction This shows how an entity’s activities are reflected in the form of cash flowing into and out of the entity over a period of time. In recognition of the vital importance to any company of being able to generate cash and control its cash flows, most companies present a cash flow statement as part of the annual report. A cash flow statement provides shows how the change in cash flow over the year has occurred by highlighting the impact on cash of the various activities undertaken by the company during the year. In cash flow statements the activities of the company are usually analysed into: • operating activities: concerned with how much cash is generated from the company’s usual operations (for example, manufacturing and selling laundry and cleaning products in the case of Procter and Gamble). • financing activities: concerned with how the company is financed, for example, by obtaining funds from shareholders by issuing new shares • investing activities: concerned with how the company has used its available cash, for example, by investing in fixed assets. The cashflow statement may have been translated into English for public relations purposes and its format and language may be influenced by the nature of the readership it is expected to reach or even the background of the translator. This also apllies to the other financial statements discussed in this manual, i.e., the balance sheet (see 6.1.2) and the income statement (see 7.1). 53
  54. 54. 8.2 Specimen cash flow statement Consolidated Statements of Cash Flows (Amounts in Millions) Years Ended June 30 1997 1996 1995 Cash and Cash Equivalents, Beginning of Year $ 2,074 $ 2,028 $ 2,373 Operating Activities Net earnings 3,415 3,046 2,645 Depreciation and amortization 1,487 1,358 1,253 Deferred income taxes (26) 328 181 Change in accounts receivable 8 17 (161) Change in inventories (71) 202 (401) Change in accounts payable, accrued and other liabilities 561 (948) 435 Change in other operating assets and liabilities 503 (134) (449) Other 5 289 65 Total Operating Activities 5,882 4,158 3,568 Investing Activities Capital expenditures (2,129) (2,179) (2,146) Proceeds from asset sales 520 402 310 Acquisitions (150) (358) (623) Change in investment securities (309) (331) 96 Total Investing Activities (2,068) (2,466) (2,363) Financing Activities Dividends to shareholders (1,329) (1,202) (1,062) Change in short-term debt (160) 242 (429) Additions to long-term debt 224 339 449 Reductions of long-term debt (724) (619) (510) Proceeds from stock options 134 89 67 Treasury purchases (1,652) (432) (115) Total Financing Activities (3,507) (1,583) (1,600) Effect of Exchange Rate Changes on Cash and Cash Equivalents (31) (63) 50 Change in Cash and Cash Equivalents 276 46 (345) Cash and Cash Equivalents, End of Year $ 2,350 $ 2,074 $ 2,028 Supplemental Disclosure Cash payments for: Interest, net of amount capitalized $ 449 $ 459 $ 444 Income taxes 1,380 1,339 1,047 Liabilities assumed in acquisitions 42 56 575 See accompanying Notes to Consolidated Financial Statements. The Procter & Gamble Company and Subsidiaries 54
  55. 55. 8.3 Dates and currencies 8.3.1 Dates • A cash flow statement is drawn up for a period of time, and for a company’s annual report this will be the company’s financial year. In the case of the specimen cash flow statement in section 8.2 for Procter and Gamble this is 30 June 1997. • Comparative figures for the previous year will be given. Following the US practice, Procter and Gamble presents details for three years. Comparative figures must also be given in the other financial statements discussed in this manual, i.e., the balance sheet (see 6.3) and the income statement (see 7.3). If we look at the examples in sections 9.2, and 11.2 we find the following: 9.2.3 Lyonnaise des Eaux Consolidated Statement-Cash flow 1996 with figures also for 1995 and 1994- we need to look elsewhere in the financial statements to see that this is the position for the year ended 31 December in each of these years 11.2 ICI Statement of Group cash flow for the year ended 31 December 1997 with figures also for 1996 and 1995. 8.3.2 Currencies It is important to be clear about the currency we are referring to. • The currency in which the accounts are designated is usually indicated somewhere in the headings of the cash flow statement by an appropriate symbol or abbreviation. Task Look at the specimen cash flow statements in sections 6.2, 9.2, and 11.2. Note the currency in which the figures are expressed You will see that they are given as follows: Procter & Gamble $ amounts in millions Lyonnaise des Eaux FRF millions ICI £m 55
  56. 56. 8.4. Contents of the cash flow statement As a minimum we can expect all cash flow statements to contain three key elements: • Opening balances. This is the amount of cash at the beginning of the financial year US based companies express this in terms of cash and cash equivalents. Cash equivalents being items such as certain short-term deposits which can be readily turned into cash. • Cash flows from: operating activities financing activities investment activities • cash balance (or cash and cash equivalents) at the end of the financial year. 8.5 Format of the cash flow statement The manner of presentation of a cash flow statement depends on the regulations of the country in which a multinational has its headquarters. The format in the specimen Procter and Gamble consolidated statement of cash flow (see 8.2) follows US practice. We will consider other formats in sections 9 and 11. 8.6 Relationship between headings, sub headings and totals If we look at the figures in the specimen Procter and Gamble (see 8.2) consolidated statement of cash flow for the year ended 30 June 1997, we can see that the starting point is the opening balance as follows: $m Cash and cash equivalents - Beginning of year 2,074 The totals of the cash flow (in or out) from the three major activities are included as main headings. These are: $m Total Operating Activities (i.e. in this example cash flow in) 5,882 Total Investing Activities (i.e. in this example, cash flow out) (2,068) Total Financing Activities (i.e. in this example, cash flow out) (3,507) 56
  57. 57. We can see that the company’s operating activities have contributed cash of $5882m, but the cash holding has been reduced by cash outflows from investing activities, ($2068m) and financing activities, ($3,507m). Notice how brackets are used around these two sets of figures to indicate amounts flowing out. Details are provided of how the totals for operating activities, investing activities and financing activities are arrived at. For example, with regard to operating activities, we know from the income statement that we already have a figure of $3,415m for earnings. However, it is necessary to make a number of adjustments to determine the effect on cash flow of these activities. Using the total figures we can summarise the cash flow statement as follows: $m cash and cash equivalents, beginning of year 2,074 add: cash inflow from operating activities 5,882 (deduct): cash outflows from investing activities (2,068) financing activities (3,507) effects of exchange rate changes (31) change in cash and cash equivalents 276 cash and cash equivalents, end of year 2,350 8.7 Notes to the accounts Just as in the balance sheet and the income statement, the amount of detail which is provided in the cash flow statement will vary from country to country and from company to company. However, in all cases it is impossible to give very much detail on the face of the cash flow statement itself. For this reason, many companies are provide further details and explanations of certain key items by way of the notes to the accounts section of the annual report (which are often just referred to as notes). Some companies make reference to notes on the face of the accounts by way of numbers, either in a separate column, or alongside particular items. It is here in the notes that many of the details of specific interest to European Works Council members will be found (see section 6.7 for examples) The notes may, for example, contain information on such things as acquisitions, disposals and restructuring within the group. 57
  58. 58. 8.8 Explanation of selected terms 8.8.1 Cash equivalents These are short-term (usually three months or less) investments which can readily be converted into cash. 8.8.2 Treasury purchases This represents the expenditure of cash by the company on buying back its own shares. These shares may be held temporarily by the company before subsequent cancellation or reissue. 8.9 Exercises 8. How much was paid in income taxes this year? 9. How much was received from the proceeds at asset sales during the year ended 30 June 1997 ? 10.With regard to the item “cash and cash equivalents”, how much was generated from the group’s operating activities during the year ended 30 June 1997? Answers to questions 8 -10 Summary You should now be able: (1) to recognise most of the main headings in a cash flow statement (2) to understand how the totals in a cash flow are arrived at (3) to recognise the format that is normally used to present cash flow information (4) to recognise that further details are available in the form of the notes section of the annual report (5)to understand the meaning of some of the main terms found in a cash flow statement 58
  59. 59. 9 An example of the financial statements of a French multinational company (Lyonnaise des Eaux) 9.1 Introduction 9.2 Specimen financial statements 9.3 Differences in format 9.4 Explanation of selected terms 9.5 Exercises 59
  60. 60. 9.1 Introduction Lyonnaise des Eaux (LE) is a multinational company with its head offices in France, and as such, it is subject to French law. It is listed on the Paris and Geneva Stock Exchanges. Its annual report complies with French law. As a member state of the European Union (EU), France has incorporated EU directives concerning financial statements into French law. Hence, the financial statements of a French company can be expected to be similar to financial statements produced by companies from other EU member states. In this training manual we are using the financial statements which are contained in the company’s English language version of its Annual Report 1996. We will find, in practice, that European Works Council members will often handle translated versions of financial statements. However, we need to note that the terms used in these versions might be influenced by the style and background of the translator as well as the philosophy of the company itself. Here, as we shall see, LE uses US accounting terminology, similar to that used in the Procter and Gamble (P&G) financial statements illustrated in sections 6, 7 and 8 above. There are, however, some differences between the formats which are discussed in section 9.3 below. The financial statements included in the annual report consist of a group balance sheet (Consolidated Balance Sheet), a group income statement (Consolidated Income Statement) and a group cash flow statement (Consolidated Statement-Cash Flow). These are the statements reproduced in 9.2 below. The annual report also includes a notes sections. Certain items in the balance sheet, statement of earnings and cash flow statement are crossed referenced, by numbers, to the appropriate notes It is in the notes that many of the details of specific interest to European Works Council representatives will be found. The notes are important also because they facilitate comparisons with the previous year. 9.2Specimen financial statements from the 1997 annual report of Lyonnaise des Eaux The following financial statements are reproduced below: 9.2.1 Consolidated Balance Sheet 9.2.2 Consolidated Income Statement 9.2.3 Consolidated Statement – Cash Flow 60
  61. 61. 9.2.1 Consolidated Balance Sheet CONSOLIDATED BALANCE SHEET (ASSETS) (IN FRF MILLIONS) NOTE Nº 1996 1995 1994 Gross Depreciation Net or provisions Intangible assets 5 8,018 2,591 5,427 6,048 6,194 Goodwill 7 10,906 2,709 8,197 8,693 8,087 Property, plant and equipment 5 96,002 30,928 65,074 53,679 51,403 Other non-current assets (1) 6 9,535 2,359 7,176 8,213 7,758 Investments in companles accounted for under 8 3,466 109 3,357 2,866 2,862 the equity method TOTAL FIXED ASSETS (A) 127,927 38,696 89,231 79,499 76,304 Inventories and work in progress 9 18,633 1,054 17,579 24,416 23,756 Trade receivables and related accounts (2) 28,923 1,575 27,348 27,772 26,290 Other operating receivables (2) 12,437 1,064 11,373 10,690 10,212 Marketable securities 10 6,853 3 6,850 5,646 7,145 Cash and equivalent 7,160 7,160 6,139 7,802 TOTAL CURRENT ASSETS 74,006 3,696 70,310 74,663 75,205 Prepayrnents and deferred charges 11 4,240 4,240 2,727 2,610 TOTAL ASSETS 206,173 42,392 163,781 156,889 154,119 (1) due in less than one year 2,809 802 2,007 1,545 971 (2) due in more one year 2,861 1,119 1,742 1,561 1,341 (A) For further details, see review by sector Lyonnaise des Eaux 1996 61

×