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Essentials of financial reporting
- 1. ESSENTIALS OF FINANCIAL REPORTING BY MANISH GUPTA
- 3. SECTION 1 OVERVIEW OF FINANCIAL STATEMENTS
- 4. OVERVIEW OF FINANCIAL STATEMENTS • Brief Introduction • Financial Statements gives the detailed information about the performance of the company to all the stakeholders • Who might be interested in financial statements • Shareholders and prospective shareholders • Company’s directors and managers • Banks, Suppliers and prospective suppliers • Customers and prospective customers • Employees and prospective employees
- 5. OVERVIEW OF FINANCIAL STATEMENTS • Objectives • What do you think -- What are the objectives of financial reporting package?? • Why stakeholder would be interested • Check investment is safe and performing well • Check company performance and their own • Check company is good credit risk • Check company can and will pay on time • Check company can deliver • Check long term career prospects
- 6. BASIC ACCOUNTING CONCEPTS • Debit & credit (Left side vs Right Side) • Type of accounts • Income Accounts • Expense accounts • Assets • Cash • Non Cash • Liabilities • Equity & Profits • Others
- 7. OVERVIEW OF FINANCIAL STATEMENTS • KEY Assumptions in preparing financial statements • Consistency • Going Concern • Accrual Accounting • Prudency • Format of Financial Statements & Fundamental Requirements • No specific format, however • Show “true and fair view” • Prepared in accordance with: • Generally Accepted Accounting Principles • Financial Reporting Standards
- 8. OVERVIEW OF FINANCIAL STATEMENTS • Elements & Contents • Balance Sheet (Statement of financial position) – We will Learn • Statement of Profit & Loss – We will Learn • Statement of changes in Equity – Just for info • Statement of Cash Flow – We will learn • Notes and Significant Accounting Policies – Just for Info
- 12. SECTION 2 STATEMENT OF FINANCIAL POSITION (BALANCE SHEET)
- 13. STATEMENT OF FINANCIAL POSITION (BALANCE SHEET) • Objective of Balance Sheet • Lets look at the Sample • Major Contents • Date • Assets • Liabilities • Signatories
- 14. STATEMENT OF FINANCIAL STATEMENT (BALANCE SHEET) • Assets • Fixed Assets & Intangible Assets • Investments • Loans and Advances • Current Assets • Inventories • Cash & Cash Equivalents
- 15. STATEMENT OF FINANCIAL STATEMENT (BALANCE SHEET) • Liabilities • Shareholder’s / Owner’s Equity • Reserves & Surplus • Borrowings (i.e. loan taken) • Current Liabilities and Provisions
- 16. STATEMENT OF FINANCIAL STATEMENT (BALANCE SHEET) • Control Aspects • Common Pitfalls and things to be cared • Accounting policies give a subjective view • Stock • Long term contracts • Research and development costs (Records the cost as expense but not the value of learnings) • Valuation of intangible assets (Subjective) • Depreciation (imaginary and various methi
- 17. STATEMENT OF FINANCIAL STATEMENT (BALANCE SHEET) • Whats not in the Balance Sheet • Customer lists and goodwill in the business • Future earning capability of the business • Management talent and workforce skills • Good industrial relations • Real economic value of fixed assets • Brands, logos and trademarks built up in the business • Copyrights and patents built up in the business • Some of these items are covered in Annual Report though !!
- 18. SECTION 3 STATEMENT OF PROFIT & LOSS
- 19. STATEMENT OF PROFIT & LOSS • Measurement Basis • Matching concept • Frequency • Major Contents • Total Revenue • Cost of Sales • Expenses • Comprehensive Income / expenses
- 20. STATEMENT OF PROFIT & LOSS • Income • Direct Income • Indirect Income • Expenses • Direct • Payroll • Cost of Sales • Indirect
- 21. STATEMENT OF PROFIT & LOSS • Depreciation • Taxes • EBIDTA • Other Comprehensive income • Analysis in terms of % and Trends • Control Aspects
- 22. STATEMENT OF PROFIT & LOSS • Pitfalls • Collectability of sales • Different operating models may lead to different % to sales and trends. • Under-recognizing of expenses and extraordinary expenses • Difference in utilization of capacity • The presence of any of the following five factors increases the probability of earnings manipulation: • Growing sales without increase in net profits coupled with Increasing days sales in receivables, coupled with average collection • Deteriorating gross margins. • Decreasing rates of depreciation. • Decreasing asset quality (defined as the ratio of noncurrent assets other than property, plant, and equipment to total assets).
- 23. RATIO ANALYSIS • Current Ratio & Acid Test Ratio • Debt Equity Ratio • Average collection period • Average Inventory Holding Period • Gross Operating Profit Margin Ratio • EBIDTA • Earnings Per Share (EPS) • Return on Equity • Return on assets employed
- 24. RATIO ANALYSIS • GOP % comparability for efficeiency - • Elusive as it depends on how expenses are recognized against revenue • Ratio of Fixed vs Variable costs • Revenue Growth Trends – • Can come from internal growth vs tapping / creating additional opportunities • Is growth in revenue is attributed to increased spending which may not be sustainable • Net profit vs EBIDTA for • valuation and • credit analysis
- 25. STATEMENT OF CASH FLOW • Why do we prepare Cash Flow • Identify the life-cycle categories and enrich the analysis of companies encountering risks and opportunities. • Best tool for measuring Financial flexibility. • A cash flow cushion can enable a company to sustain essential long-term investment spending when competitors are forced to cut back • Will the company survive downturns of business (fight bankruptcy). • Template
- 26. STATEMENT OF CASH FLOW • Type of Activities • Cash from Operations • Investing Activities • Financing Activities • Method of Calculations • Direct Method • Indirect Method
- 27. BUSINESS PERFORMANCE CONTROLS BALANCED SCORE CARD • How do we measure business is performance well? • Budgets & Previous Years • Trends Analysis • Industry Peers • What is Balance Score Card • Balanced Scorecard is a carefully selected set of quantifiable measures derived from an organization’s strategy. Which serves as a tool to communicate outcomes & performance drivers which will help to achieve its mission and strategic objectives. • HOW Balanced Score Card is important tool.
- 29. STEPS IN MAKING A BALANCED SCORE CARD • Select the Organization Unit (Profit Center) • How different profit centers are linked to each other and also to corporate in total • Interview Stakeholders to understand what is important for achieving goals • Summaries and Harmonize • Executive Workshop to fine tune and get support form executive leadership • Roll out to various teams and implement
- 30. MANAGEMENT INFORMATION SYSTEM • Lets look at the breakdown of MIS • Management • Information • System • Characteristics of Good MIS • Timely • Relevant • Short and to the point
- 31. MANAGEMENT INFORMATION SYSTEM • Few Types of MIS Reports are • Financial Reporting Package • Daily Sales Reports • Debtors Ageing Report • Cash Collection Reports • Supplier Ageing Reports • Price comparison Reports • Market insights generated through newspapers / social media etc
Editor's Notes
- Welcome – 15 Mins Hello and Mingalabar, First of all thank you very much for subscribing to this “Essentials of Financial Reporting” – course. I Would also thanks to Myanmar Institute of Finance for arranging this together. I would like to introduce my teaching assistant (_______) who will be helping me out through out the course and translating in case some technical words are not understood. Before we start – some quick things. Silent your phones to let other enjoy the class. Please take notes – Brief Handouts are provided; However, we will not be learning it verbatim. Handouts are only for future reference. I will try as much as possible to fill the contents with practical examples and scenarios. You can note down the questions ask during question and answer sessions. You may please use your phones as calculators while calculating. If you already understand the contents, please let others learn it, do not help them by telling answers or solutions. Now brief objective of the course Lets look at course objectives and contents in brief. Course Objectives are to: Understand Financial Reporting standards. We will be learning only the framework of financial reporting and what it contains. Dive into contents of financial reporting and understand: Balance Sheet (Statement of financial position) – We will Learn Statement of Profit & Loss – We will Learn Statement of changes in Equity – Just for info Statement of Cash Flow – We will learn Notes and Significant Accounting Policies – Just for Info Key Ratios Analysis Study Ratio analysis with real examples of Samsung Electronics & Compare with Apple Business Performance (KPIs) Management Information System. We are using Balance sheet of Reliance Industries Limited, Largest Business house in India for the purpose of this course.
- Explain the various parts of financial statements including audit report, board of directors report & analysis. why do you think a so much detailed report is prepared by them? We prepare financial statement to provide financial information about the entity which is useful to a. existing and potential investors regarding, buying, selling or holding equity b. lenders and other creditors in making decisions about providing resources to the entity debt instruments, and providing loans. Ask Question - Why you need to understand Financial Reports.. Help Stakeholder Analyze Financial Standing of the company, Analyse Profitability Make Investment Decisions Capital Budgeting and Finance modeling Are these reporting reliable? Can there be a fraud via financial reporting – Yes – Enron, Satyam computers FS Fraud cases as follows: by COSO Revenue recognition in 61% of cases Overstated assets in 51% Understated liabilities/expenses in 31% Misappropriation of assets in 14% Other techniques in 20%
- Explain the various parts of financial statements including audit report, board of directors report & analysis. why do you think a so much detailed report is prepared by them? We prepare financial statement to provide financial information about the entity which is useful to a. existing and potential investors regarding, buying, selling or holding equity b. lenders and other creditors in making decisions about providing resources to the entity debt instruments, and providing loans. Ask Question - Why you need to understand Financial Reports.. Help Stakeholder Analyze Financial Standing of the company, Analyse Profitability Make Investment Decisions Capital Budgeting and Finance modeling Are these reporting reliable? Can there be a fraud via financial reporting – Yes – Enron, Satyam computers FS Fraud cases as follows: by COSO Revenue recognition in 61% of cases Overstated assets in 51% Understated liabilities/expenses in 31% Misappropriation of assets in 14% Other techniques in 20%
- Going Concern - Entity will survive forever and will continue in operations for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations Accrual Basis – All Income and expenses, Assets and Liabilities are recorded in the period of their occurrence irrespective of whether they are paid of not. Consistency – Accounting principals and guidelines are consistently applied over the year to provide comparability to the financial statement. Prudence – Accounting assumptions and estimate are made with prudence to present a true and fair view of financial position and transactions. Is there any Specific Format – No !! there is no specific format for presenting the financial statements, however usually regulators provide specific format in which they want to see the information. There are financial reporting standards such as US GAAP - United States Generally Accepted Accounting Principles, IFRS - International Financial Reporting Standards, MFRS –Myanmar Financial Reporting Standards IGAAP - Indian Generally Accepted Accounting Principles IND AS – Indian Accounting Standards (converged version of IFRS Countries Company Laws also prescribe additional information to be provided to shareholders. Financial Reporting Packages usually contain all information into one document usually called “Annual Reports”
- The Balance Sheet presents true and fair view of listing of a business’s assets and the liabilities and owners’ equity, as on a given date. Assets - represent those items owned by the business; Fixed (tangible / Intangible) Current Assets Liabilities represent the claims to the assets by outsiders, and owners’ equity represents the claims of the owners to the assets.
- Fixed Assets (Property Plan & Equipments) This grouping of accounts includes owned Land; Buildings; Furnishings and Equipment; the cost of Leaseholds and Leasehold Improvements; and Construction in Progress. It also includes similar assets held under capital leases. It is reduced by accumulated Depreciation. Depreciation is a method of allocating the net cost (after reduction for expected salvage value) of the individual assets or classes of assets to operations over their anticipated useful lives. Investments Investments generally include debt or equity securities, whether or not they are traded in recognized markets, and ownership interests that are expected to be held on a long-term basis (more than 12 months). Loans / Advances (Given) Amount given as advance to suppliers or employees as loan is grouped in this category. (if entity is financial institution or bank as loan is grouped in this category). Current Assets Debtors - This line item groups Accounts Receivable and Notes Receivable. Accounts not expected to be collected within the next 12 months are included under Non-current Receivables. Cash & Bank - Cash and Cash Equivalents include Cash in Hand, Cash at Bank, Temporary Cash Investments. Temporary Cash Investments are those investments of a demand nature or that have maturities within 90 days at the time of purchase. Inventories - Inventories includes the cost of merchandise held for sale and the cost of supplies used in operating the property. The cost of merchandise held for sale. Cash & Cash Equivalents – Cash, Bank and short term investments which can be liquidated on demand are termed as cash & cash Equivalents Intangible Assets - Intangible assets are assets that lack physical substance. Many intangible assets are readily identifiable, such as patents, trademarks, customer lists, etc. Goodwill is an unidentifiable intangible asset. -
- Shareholder’s / Owner’s Equity This is just an Initial Investment and Further new injection of capital from outside. Re Investment of profits is part of reserves. – Page 33 Reserves and Surplus Accumulated amount of Profits of previous years which is not distributed to owners yet and is re-invested into the business - Page 35 Borrowings (i.e. Long Term Loans (Taken & Other Liabilities) This category includes mortgage notes, (e.g. Bonds), other notes, and similar liabilities and obligations under capital leases that are not payable during the next 12 months. Page 36 Current Liabilities and Provisions – Page 39-40 Current Liabilities are liabilities which are determined and due to vendors / suppliers within 12 months Provisions are expenses accrued which are measurable and has some determined amount but is not demanded at the time of balance sheet date.
- What are control points – Fixed Assets – Fixed Asset Register with details Debtors – Ageing Report and Balance Confirmation letters. Cash & Bank – Cash Count and Balance Sheet Reconciliation. Inventory – Inventory List / Slow Moving Reports. Valuation Issues related to Assets, good will, patents investments as all these are reflected on historical cost and subject to subjective amortization.
- Key Pitfalls and controlling aspects Historical Valuations In-correct Measurements No in Time Lack of Accuracy Lack of Details
- Measurement Basis – Cash & Accrual Accounting Accounting can be done based on cash payment system where amount which is received / paid is considered as income or expenses respectively or can be done on accrual system where even though the cash is not paid income / expenses is recorded based on commitment in the period when they occur. Examples. Electricity bill, salaries, cost of sales. Frequency Ideally should be every month to compare with previous year same month and last month results. Should compare month on month results to identify trends and take necessary actions.
- Type of Income (direct / Indirect, ordinary/ Extraordinary) Direct income is generated in normal course of business or incidental to business activities Indirect income is not resulting from business operations such as interest on fixed deposit / sale of fixed asset etc. as its not Extra Ordinary Income – Revenue which arises only once and are not likely to be repeated in known future with certainty. Type of Expenses (direct / Indirect, ordinary/ Extraordinary) why it matters Direct Expenses are cost expenses which are arising from cost of sales and necessary to generate products and services. Indirect expenses are general expenses in running business such as marketing, administration, maintenance. These expenses though are necessary to run business & important to generate revenue are not directly attributable to a product or service. – Page 46 Extra Ordinary expenses are spend which are not related to business or arise only once in while without certain probability of repeating nature. It is important to segregate expenses and revenue to establish a trend and know true profitability of business and attain correct valuation.
- Depreciation & Amortization – Depreciation and amortization refers to charging the cost of assets to P&L account on a systematic basis in order to create a reserve for replacing such assets in future. Depreciation is usually charged based on life of assets however in certain countries rates are defined by tax authorities as well in which case depreciation as per tax records and as per books is usually different. Such difference creates deferred tax assets & liabilities. Interest – Interest on borrowings taken by entity. Please note that interest earned on savings is not offset against this expenses as the nature is different. To assess the liquidity of company usually we use interest coverage ratio to check if entity is able to generate enough cash to covers its interest payments. Tax – Tax payable on net income. Usually there are certain expenses which are not allowed as per tax rules or are allowed in different periods. Expenses which are dis-allowed are not considered while creating a tax provision. Expenses which are allowed in different time zone, are considered to create deferred tax assets or liabilities. Earnings Before Interest, Tax, Depreciation & Amortization (EBITDA) – This Term is very commonly used to compare the profitability of different companies. Each company may have different asset base, loans and tax rates hence net profit ratios does not give a fair comparison of business performance. Business may have assets which are not producing any revenue hence net profits are low due to depreciation. Items to be recognize in Other Comprehensive Income & Expenses Comprehensive Income refers to net income plus “other comprehensive income,” which includes certain revenues, expenses, gains, and losses that are reported as separate components of equity instead of net income. Other comprehensive income currently includes: Unrealized gains and losses. Foreign currency translation adjustments.
- What are General controls Pre numbered vouchers and Invoices Preparation and Checker Collector and recorder Income Controls & Analysis Segmentation Product wise – Quantity & Price if variable Comparison with Competitors Expenses Controls and Analysis Variance as compared to revenue Variance vs Budgets & Trends
- Current Ratio - The most common liquidity ratio is the current ratio, which is the ratio of total current assets to total current liabilities. Current Ratio = Current Assets / Current Liabilities. In ideal situations any number of more than 1 is sound. Ideal value is 2 Acid Test Ratio (Quick Ratio) - The acid-test ratio measures a property’s liquidity by considering only “quick assets”—current assets minus inventories and prepaid expenses: Acid-Test Ratio = Quick Assets / Current Liabilities. Should be more than 1 Debt Equity Ratio - One of the most common solvency ratios is the debt-equity ratio, which compares the total debt of the operation to the total investment in the operation by the owners: Debt Equity Ratio = Total Debts / Total Equity. Should not be more than 2 Average Collection Period - This ratio reveals the number of days required to collect the average accounts receivable. Receivables Turnover = Credit Sales / Average Receivables Collection Period = 365 / Receivable Turnover Lower Collection period means we collect our outstanding fast enough which is good for cash flow, however too much variance from industry standard may make business less flexible Average Inventory Holding Period - This ratio measures the number of times inventory turns over during the period. Generally, the greater the number of times the better Inventory Turnover = Cost of Goods Sold / Average Inventory Inventory Holding Period = 365 / Inventory Turnover High holding period is not good for business Gross Operating Profit Margin Ratio - This ratio is measure of management’s overall ability to produce profits by generating sales and controlling the operating expenses over which they have the most direct control. It is calculated by dividing gross operating profit by total operating revenue GOP Ratio – Gross Operating profit (Rev-direct & indirect exp) / Sales EBIDTA - This ratio is another measure of management’s overall ability to produce profits by generating sales and controlling the operating expenses over which they have the most direct control. It is calculated by dividing Net profit before deducting depreciation and taxes and interest by total operating revenue EBIDTA – Net Profit + Taxes + Depreciation + Interest/ Total Revenue EBIDTA is a better way to compare profitability of different entities as compared to Net profit as some entities may have different capital structure model Earnings per share (EPS)- EPS is the portion of a company's profit allocated to each outstanding equity share. EPS serves as an indicator of a company's profitability. EPS is calculated as: EPS = Net Profit - Dividends on Preference shares) / Number of Outstanding Shares. Return on Equity - This ratio measure enterprise’s profitability in terms of capital employed into business by equity partners Return on Equity– Net Profit / Total Equity Return of equity can not be compared between different companies due to differences in debt. ROE would be high for companies which has high debt ratio. This ratio is usually used for comparing market interest rates and risk factors in running the business. Return on Assets Deployed - This ratio measure enterprise’s profitability in terms of Assets used in business which is also equal to (Total equity plus Total long term debt) Return on Assets– Net Profit / Total Equity + Long term debt (Assets employed) Return of Assets can be better used for comparison between different companies however due care need to given if entity hold assets for non-business use
- Sound financial analysis involves more than just calculating numbers—good analysis requires that certain qualitative factors be considered when evaluating a company. These factors, as summarized by the American Association of Individual Investors (AAII), include the following: Are the company’s revenues tied to one key customer? If so, the company’s performance may decline dramatically if the customer goes elsewhere. 2. To what extent are the company’s revenues tied to one key product? Companies that rely on a single product may be more efficient and focused, but a lack of diversification increases risk. To what extent does the company rely on a single supplier? Depending on a single supplier may lead to unanticipated shortages and thus to lower profits. What percentage of the company’s business is generated overseas? Companies with a large percentage of overseas business are often able to realize higher growth and larger profit margins. However, firms with large overseas operations also find that the value of their operations depends in large part on the value of the local currency. Thus, fluctuations in currency markets create additional risks for firms with large overseas operations. In addition, the political stability of the region is important. What about the competition? It is important to consider both the likely actions of the current competition and the likelihood of new competitors in the future. What are the company’s future prospects? Does the company invest heavily in research and development? If so, its future prospects may depend critically on the success of products currently in the pipeline. How does the legal and regulatory environment affect the company? It is crucial to factor in the effects of proposed regulations and pending or likely lawsuits.
- Why Cash Flow Statement – It tells where cash is coming from and how its spent. Are operations generating enough cash? How much cash is spent on investment activities. Is cash balance sufficient for future operations.
- Operating Activities – The principal revenue-generating activities of an organization. These are normal business activities of the entity such as sales, purchase, salaries, other expenses. Investment Activities This section covers activities such as buying & selling long term assets New Investments which would be able to generate income in future Finance Activities New capital injections Loans taken or given.. (except advances or credit due to normal business activities) Dividend, Interest
- The Balanced Scorecard assists organizations in overcoming three key issues: Financial KPIs - effective organizational performance measurement, Non Financial KPIs - the rise of intangible assets (employees, customers), and the challenge of implementing strategy. Balanced Scorecard is a carefully selected set of quantifiable measures derived from an organization’s strategy. The measures selected for the Scorecard represent a tool for leaders to use in communicating to employees and external stakeholders the outcomes and performance drivers by which the organization will achieve its mission and strategic objectives.
- Four Prospective of Balanced Score Card Customer, Internal Processes, Employee Learning and Growth, and Financial.