Introduction to financial statements


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Introduction to financial statements

  1. 1. Introduction to Financial Statements
  2. 2. Learning Objectives <ul><li>Different types of statements </li></ul><ul><li>Purpose of each </li></ul><ul><li>How they work together </li></ul><ul><li>Why they are all important </li></ul><ul><li>What we can learn from them </li></ul>
  3. 3. Financial Statements <ul><li>The financial statements are windows into a company's performance and health. </li></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Income Statement ~ Statement of Operations ~ Profit & Loss Statement (P&L) </li></ul></ul><ul><ul><li>Statement of Cash Flows </li></ul></ul><ul><li>All three of these statements are found in a firm's annual report, 10-K, and 10-Q filings </li></ul>
  4. 4. “ GAAP” G enerally A ccepted A ccounting P rincipals <ul><li>GAAP starts with a conceptual framework of standards that anchor financial reports to a set of principles (such as materiality- the degree to which the transaction is big enough to matter) and verifiability (the degree to which different people agree on how to measure the transaction). </li></ul><ul><li>The basic goal is to provide users – equity investors, creditors, regulators and the public - with &quot;relevant, reliable and useful&quot; information for making good decisions. </li></ul><ul><li>Sitting on top of the “simple” framework is a growing pile of literally hundreds of accounting standards. </li></ul>
  5. 5. The Balance Sheet ~ What is it? <ul><li>The balance sheet represents a record of a company's assets , liabilities and equity at a particular point in time. The balance sheet is named by the fact that a business’s financial structure balances in the following manner: </li></ul><ul><li>Assets = Liabilities + Shareholders' Equity </li></ul><ul><li>Assets represent the resources that the business owns or controls at a given point in time. This includes items such as cash, inventory, machinery and buildings. </li></ul><ul><li>The other side of the equation represents the total value of the financing the company has used to acquire those assets. Liabilities represent debt, while equity represents the total value of money that the owners have contributed to the business - including retained earnings, which is the profit made in previous years. </li></ul>
  6. 6. The Balance Sheet ASSETS Cash Inventory Land/Bldgs Equipment Accts Rcvbl Securities = + LIABILITIES Accts Payable Wages Payable Taxes Payable Notes Payable Short term Long Term EQUITY Pref Stock Common Stk APIC Retained Earnings
  7. 7. The Balance Sheet
  8. 8. The Balance Sheet ~ Why do I care? <ul><li>The balance sheet provides investors with a snapshot of a company's health as of the date provided on the financial statement. </li></ul><ul><li>Generally, if a company assets are large relative to liabilities, it's in good shape. Conversely, just as you would be cautious loaning money to a friend who is burdened with large debts, a company with a large amount of liabilities relative to assets should be scrutinized more carefully. </li></ul>
  9. 9. The Income Statement ~ What is it? <ul><li>The income statement measures a company's performance over a specific time frame and presents information about the revenues, expenses and profit that was generated as a result of the business' operations for that period. </li></ul><ul><li>Components of the Income Statement include: </li></ul><ul><ul><li>Revenue (how much the company earned) </li></ul></ul><ul><ul><li>Expenses (how much the company has spent, sort of) </li></ul></ul><ul><ul><li>Net Income before and after Tax (the profits of the company) </li></ul></ul><ul><li>This statement contains the information you'll most often see mentioned in the press or in financial reports - figures such as total revenue , net income , or earnings per share . </li></ul>
  10. 10. The Income Statement
  11. 11. The Income Statement ~ Why do I care? <ul><li>The income statement answers the question, &quot;How well is the company's business performing?&quot; Basically, &quot;Is it making money?&quot; </li></ul><ul><li>Firms with low expenses and high profits relative to revenues are typically more desirable for investment because bringing in more dollars directly benefits you as a shareholder. </li></ul>
  12. 12. The Statement of Cash Flows ~ What is it? <ul><li>The statement of cash flows represents a record of a business' cash inflows and outflows over a period of time. It is the most intuitive of the statements and focuses on the following cash-related activities: </li></ul><ul><ul><li>Operating Cash Flow: Cash generated from day-to-day business operations. </li></ul></ul><ul><ul><li>Cash from Investing: Cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment or long-term assets </li></ul></ul><ul><ul><li>Cash from financing: Cash paid or received from the issuing and borrowing of funds </li></ul></ul><ul><li>The cash flow statement is important because it's very difficult for a business to manipulate its cash situation. Earnings can be manipulated, but it's tough to “fake” cash in the bank. For this reason some investors use the cash flow statement as a more conservative measure of a company's performance. </li></ul>
  13. 13. Accrual Accounting <ul><li>The accrual method is required by GAAP and measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur. </li></ul><ul><li>The general idea is that economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made (or received). </li></ul><ul><li>This method allows the current cash inflows/outflows to be combined with future expected cash inflows/outflows to give a more accurate picture of a company's current financial condition. </li></ul><ul><li>Sitting on top of the “simple” framework is a growing pile of literally hundreds of accounting standards. </li></ul>
  14. 14. The Statement of Cash Flows
  15. 15. The Statement of Cash Flows ~ Why do I care? <ul><li>The statement of cash flows is very important to investors because it shows how much actual cash a company has generated. The income statement includes non-cash revenues or expenses, which the statement of cash flows excludes. </li></ul><ul><li>One of the most important traits to look for is the firm's ability to generate cash. Many companies have shown “profits” on the income statement but struggled later because of insufficient cash flows. </li></ul>
  16. 16. Analysis of Profitability  <ul><li>Profitability is a subtle and complex concept.  “Doing well” may be measured by different standards.  Three concepts of profitability are given by: </li></ul><ul><ul><li>Return on assets </li></ul></ul><ul><ul><li>Return on common equity </li></ul></ul><ul><ul><li>Earnings per common share  </li></ul></ul>
  17. 17. Earnings Per Share or EPS <ul><li>Most income statements include a calculation of earnings per share or EPS. This calculation tells you how much money shareholders would receive for each share of stock they own if the company distributed all of its net income for the period. </li></ul><ul><li>To calculate EPS, you take the total net income and divide it by the number of outstanding shares of the company. </li></ul>
  18. 18. Read the Footnotes <ul><li>A horse called “Read The Footnotes” ran in the 2004 Kentucky Derby. He finished seventh, but if he had won, it would have </li></ul><ul><li>been a victory for financial </li></ul><ul><li>literacy proponents everywhere. </li></ul><ul><li>It’s so important to read the </li></ul><ul><li>footnotes . The footnotes to </li></ul><ul><li>financial statements are packed with information that assist in reading and understanding the financial statements. </li></ul>
  19. 19. Bringing It All Together <ul><li>The three financial statements we have discussed are all related. </li></ul><ul><li>The changes in assets and liabilities that you see on the balance sheet are also reflected in the revenues and expenses that you see on the income statement, which result in the company’s gains or losses. </li></ul><ul><li>Cash flows provide more information about cash assets listed on a balance sheet and are related, but not equivalent, to net income shown on the income statement. Therefore, no one financial statement tells the complete story. </li></ul>