Transcript Document

Financial Statement & Analysis
Dr. Prakash Singh
Finance & Accounting Area
IIM, Lucknow
Why Financial Statements
• In any markets, the participants need to value the
assets to facilitate buy and sell
• Price discovery is possible only if we have
information about the asset (full, reliable and
consistent)
• Companies report their performance in a structured
format to the markets
• Markets analyze the information and “discover” the
fair value
Two Main Parts
• Accounting Statements: Construction and
Analysis
– The Balance Sheet
– The Profit & Loss Account
– The Cash Flow Statement
• Accounting Policies: Standards, practices and
the impact on the statements
Financial Statement Users
Internal Users
External Users
Managerial
accounting
Financial accounting
•Managers
•Lenders
•Executives
•Investors
The Basic Accounting Elements
Asset
– Has future benefit to the entity
Liability
– Obligation to transfer assets in the future
Owners’ Equity
– Owners’ interest in the company
Revenue
– Increase in economic resources resulting from normal
operations of the company
Expense
– Decrease in economic resources resulting from normal
operations of the company
The Balance Sheet
Presents the financial position of a company at a particular
point in time.
• Three
categories:
– Assets
– Liabilities
– Owners’
Equity
The Quick Corporation
Balance Sheet
December 31, 2004
Assets
Cash
Account Receivable
Inventories
Land
Plant and equip.
$40,000
5,000
90,000
10,000
125,000
$270,000
Diamond Chapter 2
Liabilities
Accounts Payable
Notes Payable
Total Liabilities
Stockholders' Equity
Capital Stock
Retained Earnings
Total Stockholders'
Equity
Total Liabilites and
Stockholders' Equity
$80,000
20,000
$100,000
$145,000
25,000
170,000
$270,000
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Balance Sheet Format:

Sources of Funds

 Shareholders Funds
 Loan Funds
Application of Funds
 Net Block (Gross Block – Accumulated Depn.)
 Investments
 Net Current Assets (Current Assets, Loans and
Advances – Current Liabilities & Provisions)
 Misc. Expenditure (to the extent not yet written off)
Income Statement
• Reports the economic results of a company over a time
period. It shows the derivation of earnings or losses.
Income Statement of XXX Corp. – year 2000
+ Revenues
- Cost of Revenue (product cost or COGS)
= Gross Margin
- Sales and Marketing
- General and Administrative
- Research & Development
- Depreciation and Amortization
= Operating Income (EBIT)
+ Interest Income(expense) net
= Net Income before Taxes
- Income Tax Provision
- Extraordinary Items
= Net Income
$
% Rev.
The Statement of Cash Flows
• Classifies individual cash
flows according to three
main activities:
– Operating activities
– Investing activities
– Financing activities
The Quick Corporation
Statement of Cash Flows
For the Year Ended December 31, 2004
Cash flows from Operations
Cash revenues
Less cash expenses
Net cash provided by operating activities
$535,000
(485,000)
$50,000
Cash flows from Investing Activities
Purchase of land
Sale of equipment
Net cash used by investing activities
(30,000)
10,000
Cash flows from Financing Activities
Issuance of capital stock
Issuance of dividends
Net cash used by financing activities
10,000
(15,000)
Net increase in cash
Cash Balance January 1, 2004
Cash Balance December 31, 2004
Diamond Chapter 2
(20,000)
(5,000)
25,000
15,000
$40,000
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Contentious Issues
Recognition issue
Valuation issue
Classification issue
• These issues underlie almost every major
decision in financial accounting.
• Measurement issues are controversial.
Recognition
• Recognition means the recording of a
transaction.
• Refers to the difficulty of deciding when a
business transaction occurred.
• Point of recognition is important because it
affects the financial statements.
Classification
• Classification is the process of assigning
transactions to the appropriate accounts
• Proper classification depends on
– Correctly analyzing the effect of each transaction
on the business
– Maintaining a system of accounts that reflects that
effect
Valuation
• Focuses on assigning a monetary value to a
transaction.
• Most controversial issue in accounting.
• According to GAAP, use original cost
– Also called historical cost.
• Practice of recording transactions at cost
follows the cost principle.
How Does It All Add Up
When you get paid
for a product or
service…
Income
When you buy
something…
Assets
The value of
anything you own…
Expenses
Assets
often
generate
income
Liabilities
Liabilities
often
generate
expenses
The value of
anything you
borrow…
Contemporary Issues
• IFRS/Accounting Standards (GAAP) / Companies Act e.g. AS 28
• Interpretation of Accounting Policies: Fair Value / Income
Recognition
• Contingent Liabilities: The Bottom line in the Sub prime
Mortgage Crisis (report and relax)
• Recapitalization/ Write offs/ Selective Bailouts: Why Lehman
was not saved ?
• Role of the Auditors: The Satyam fiasco
• Role of Independent Directors
• Corporate Governance: Disclosure is the buzz word
• Compensation to the Directors and other top management
professionals: Obscene bonuses