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CHAPTER 3Financial Statements

Key Financial Statements Balance sheet Income statements Statement of cash flows

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Financial Statements The Financial Statements give a

snapshot of a company’s worth at the end of a particular period, as well as a view of the company’s operations and whether it has made a profit.

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Financial Statements Key group of people who rely on financial

statements Investors: need information to judge whether

or not the company is a good investment. Analysts: need information to develop

analytical reviews for clients considering the company for investments.

Creditors: need information to determine whether to risk lending more money to the company

Competitors: need information to formulate a competitive business strategy.

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Financial Statements Key group of people who rely on

financial statements. Executive and Managers.

They need to know how well they are meeting or exceeding the organization’s target.

Also they need to get information about problems areas of the operations and how to improve.

They need to know how well the company is doing financially

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Financial Statements As well as an annual report, listed

companies need to produce the following: Interim report ( currently at the 6 month

stage) Notification of materials: events such as

major business acquisitions, contracts awarded, major restructuring of business operations, etc.

Notification of major changes in the shareholdings.

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Financial StatementsExample of Notification of materials reports

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The annual report The Basic Parts of an Annual Reports

Chairman statement: A report from the chairman about the progress during the preceding years and prospects for the future.

Operating review: This report is by the key directors of the main divisions of the company, giving management’s view on progress. ie. The finance director and the CFO, write the finance part of the report.

Auditor’s report: a statement by the auditor regarding the findings of their audit of the company’s book

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The annual report The Basic Parts of an Annual

Reports Financial statements: These include the

balance sheet, income statement and the statement of the cash flows.

Notes to the financial statements: The notes give additional information about the contents of the financial statements

Corporate governance report: This report is about how the company applies the principles of good corporate behavior as outlined in the companies act.

List of major shareholders:

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The annual reportBalance sheetprovides a snapshot of a firm’s financial

position at one point in time.Items on firm’s Balance sheet Assets Accounts L-Term assets: are assets that will be held

more than 12 months Land, Buildings, Motor vehicle, Plant &

Machinery, Furniture & fixtures, and etc.

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Balance sheet: Assets

CashA/RInventories

Total CAGross FALess: Dep.

Net FATotal Assets

20097,282

632,1601,287,3601,926,8021,202,950 263,160 939,7902,866,592

200857,600

351,200 715,2001,124,000

491,000 146,200 344,8001,468,800

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The annual reportItems on firm’s Balance sheet S-Term assets: are assets that will be used up in

the next 12 months. Inventory ( or stock) of products a company has available

for sale, or to be used in manufacturing a product. Account receivable Cash in banks or on hand( or petty cash) Marketable securities, shares of other companies

purchase using firm’s excess funds. Intangible assets, assets which have value to the

company but difficult to measures.

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The annual reportItems on firm’s Balance sheet

Intangible assets, assets which have value to the company but difficult to measures.

Goodwill: Arise when a company that purchase another company pays more than the actual value of its assets minus liabilities. The premium paid, which may account for things such as customers loyalty, exceptional workforce, and great location, is listed on the books as goodwill.

Intellectual property: it is a form of copyright and patents, on product or services which the company has been granted exclusive rights.

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Balance sheet: Liabilities and Equity

Accts payableNotes payableAccruals

Total CLLong-term debtCommon stockRetained earnings

Total EquityTotal L & E

2009524,160

636,808 489,6001,650,568

723,432460,000

32,592 492,5922,866,592

2008145,600200,000

136,000481,600323,432460,000

203,768 663,7681,468,800

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The annual reportItems on firm’s Balance sheet Liability accounts S-Term liabilities : include money owed in

the next 12 months. Account payable Notes payable, it includes all the payments to

banks that are due less than a year Accruals

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The annual reportItems on firm’s Balance sheet Liability accounts L-Term liabilities : include money due beyond

the next twelve months Loan payable: This account keep tracks of

mortgages, long term financial loan, commercial papers loan.

Bond payable: This account keep tracks of corporate bonds that have been issued for a term longer than a year. Bonds are a type of debt sold on the market that must be repaid in full with interest.

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Firm’s Long Term Financing

Long Term debt(Bond)

Bond (IOU)

“Coupon interest”

Funds (capital)

Firms Creditors

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The annual reportLong Term debt(Bond certificate sample)

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The annual reportItems on firm’s Balance sheet Equity accounts Share capital. This account reflects the nominal

value of the ordinary share in issue. Each share represents a portion of ownership.

Share premium. If when purchasing shares, the shareholders pay more than the nominal value, then the excess ( or premium ) is recorded in this account.

Preference shares. These shares fall between bonds and ordinary shares in terms of characteristics.

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The annual reportItems on firm’s Balance sheet Equity accounts Retained earnings. These numbers reflect

earnings retained rather than paid out as dividends to shareholders.

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Equity

Shares (ownership)

“Dividend”

Funds (capital)

Firms Shareholders

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The annual report

Income statement summarizes a firm’s revenues and

expenses over a given period of time.Items on firm’s Income statement Sales of goods and services ( Revenue) Cost of goods sold: costs directly related

to the sale of goods or services Purchase discount Purchase returns and allowances

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Income statement

SalesCOGSOther expenses

EBITDADepr. & Amort.

EBITInterest Exp.EBTTaxesNet income

20096,034,000

5,528,000 519,988

(13,988) 116,960(130,948) 136,012(266,960) (106,784) (160,176)

20083,432,0002,864,000 358,672

209,328 18,900

190,428 43,828

146,600 58,640

87,960

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The annual report

Items on firm’s Income statement Expense accounts: Any costs not directly

related to the generating revenue Operating expanse, ie. advertising, insurance,

legal and accounting fees, office expense, utilities, etc

Interest expense, interest paid on company’s debt.

Depreciation expense on tangible goods and Amortization on intangible goods.

Taxes

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The annual report Statement of retained earnings shows how much of the firm’s earnings

were retained, rather than paid out as dividends.

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Statement of Retained Earnings (2009)

Balance of retainedearnings, 12/31/08

Add: Net income, 2009

Less: Dividends paid

Balance of retained earnings, 12/31/09

$203,768

(160,176)

(11,00

0)

$32,592

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Other data

No. of sharesEPSDPSStock price

2009100,000-$1.602

$0.11$2.25

2008100,000

$0.88$0.22$8.50

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The annual reportStatement of cash flows It gives the financial report reader a map of

cash receipt, cash payments, and changes in cash that arise from the operations of the company.

In addition, the statement looks at money that flows into or out of the company through investing and financing activities.

Why we need Statement of cash flows ? Cash is company’s lifeblood Accrual accounting makes it hard to pinpoint exactly

how much cash a company actually hold.

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Statement of Cash Flows (2009)

OPERATING ACTIVITIESNet income

Add (Sources of cash):DepreciationIncrease in A/PIncrease in accruals

Subtract (Uses of cash):Increase in A/RIncrease in inventories

Net cash provided by ops.

(160,176)

116,960378,560353,600

(280,960)(572,160)(164,176)

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Statement of Cash Flows (2009)L-T INVESTING ACTIVITIES

Investment in fixed assets

FINANCING ACTIVITIESIncrease in notes payableIncrease in long-term debtPayment of cash dividendNet cash from financing

NET CHANGE IN CASH

Plus: Cash at beginning of year

Cash at end of year

(711,950)

436,808400,000

(11,000)825,808

(50,318)

57,6007,282

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A/c data for investors and management decision

NOPAT NOWAC FCF EVA MVA

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Net operating after taxes (NOPAT)

NOPAT = EBIT (1 – Tax rate)

NOPAT09 = -$130,948(1 – 0.4)

= -$130,948(0.6)= -$78,569

NOPAT08 = $114,257

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NOWC = Operating - Non-interest

current assets bearing CL

NOWC09 = ($7,282 + $632,160 + $1,287,360) – ($524,160 + $489,600)

= $913,042

NOWC08 = $842,400

What effect did the expansion have on net operating working capital?

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What effect did the expansion have on operating capital?

Operating capital = NOWC + Net Fixed Assets

Operating Capital09 = $913,042 + $939,790

= $1,852,832

Operating Capital08 = $1,187,200

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Economic value added (EVA)

EVA = NOPAT – Annual dollar cost of capital

In order to generate positive EVA, a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital.

EVA takes into account the total cost of capital, which includes the cost of equity.

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Sales xxxCOGS (xxx)Depreciation (xxx)

EBIT xxxInterest Expense (xx)

xxxTax (xx)

Net Income xxx

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What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2008 and 13% in 2009.

EVA05 = NOPAT – (A-T cost of capital) (Capital)

= -$78,569 – (0.13)($1,852,832)= -$78,569 – $240,868= -$319,437

EVA04 = $114,257 – (0.10)($1,187,200)

= $114,257 – $118,720= -$4,463

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Did the expansion increase or decrease MVA?

MVA = Market value __ Equity capital

of equity supplied

During the last year, the stock price has decreased 51%. As a consequence, the market value of equity has declined, and therefore MVA has declined, as well.

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Equity Capital

Shares

Market Value Book Value x xCurrent

priceShares

outstanding Shares

outstanding Initial issue price

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Equity Capital Supplied

Initial capital supplied-IPO (RM)= 4.6/ share

Equity supplied= 100,000 sharesEquity supplied (RM)= 460,000

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Market Value Equity

Market price of share= RM2.25/ share

Equity outstanding= 100,000 sharesMarket value equity= RM225,000

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MVA

MVA= Market value – Equity capital equity supplied

= RM225,000 - RM460,000 = - RM235,000

225,000 – 460,000 = - 0.51 ≈ - 51% 460,000