basic-understanding-of-a-companys-financials.pdf
- 1. Basic understanding of a company’s financial statements September 2020
- 2. 2 PwC | Basic Understanding of a Company's Financials Table of contents What are financial statements? 3 Balance sheet 5 Income statement 16 Cashflow statement 24 2
- 3. What are financial statements? 3 PwC | Basic Understanding of a Company's Financials
- 4. 4 PwC | Basic Understanding of a Company's Financials Financial statements are written records that illustrates the business activities and the financial performance of a company. In most cases they are audited to ensure accuracy for tax, financing, or investing purposes. A methodically work through of the three financial statements in order to assess the Financial health of a company. Balance Sheet Income Statement Statement of Cash Flows The financial statements • Statement of financial position • Statement of operation/profit and loss Balance Sheet is a snapshot at a point in time. On the top half you have the company’s assets and on the bottom half its liabilities and Shareholders’ Equity (or Net Worth). The assets and liabilities are typically listed in order of liquidity and separated between current and non-current. The income statement covers a period of time, such as a quarter or year. It illustrates the profitability of the company from an accounting (accrual and matching) perspective. It starts with the revenue line and after deducting expenses derives net income. The cash flow statement look at the cash position of the company . It answers it answers the questions ; How much of the organisation’s cash goes to its creditors and shareholders? Does it keep enough for its own investment and growth? has 3 components cash from operations, cash used in investing, and cash from financing. It “undoes” all of the accounting principles and shows the cash flows of the business. Source CFI
- 5. Balance sheet 5 PwC | Basic Understanding of a Company's Financials
- 6. 6 PwC | Basic Understanding of a Company's Financials Simplified Balance Sheet Assets Current assets Cash 20,000 Accounts receivable 3,000 Inventory 60,000 Prepaid expenses 11,000 Total current assets 94,000 Non current assets Property plant & equipment 110,000 Intangible assets 10,000 Total non current assets 120,000 Total assets 214,000 Liabilities Current liabilities Accounts payable 2,000 Accrued expenses 1,000 Total current liabilities 3,000 Non current liabilities 11,000 Bank loan 100,000 Shareholder equity Common shares 89,000 Retained Earnings 11,000 Total liabilities and shareholders equity 214,000 Current vs non-current Current Assets Balance sheet The Balance sheet has 3 main categories: Assets Liabilities Equity Assets • Expected to be converted into cash in less than 1 year • Accounts receivable, inventory Liabilities • Will be paid in less than 1 year • Trade accounts payable Non-current Assets • Expected to be held greater than 1 year • Property, plant, and equipment Liabilities • Repayment terms longer than 1 year • Loan repayable over a 5 year period Source CFI
- 7. 7 PwC | Basic Understanding of a Company's Financials See accompanying notes. Illustrative balance sheet (assets ) Current Assets • Expected to be converted into cash in less than 1 year • Accounts receivable, inventory Non-current Assets • Expected to be held greater than 1 year • Property, plant, and equipment
- 8. 8 PwC | Basic Understanding of a Company's Financials 8 Cash and Investments • Investments in equity or debt instruments to be held for capital gain and/or income Cash and investments A company will hold external investments for two reasons: • Excess cash • Accumulating cash to make a large purchase A company can also make internal investments • (less than year) Internal investments Long term Short term External investments • (more than year) • Investment in subsidiaries, associates and joint ventures 8 Source CFI
- 9. 9 PwC | Basic Understanding of a Company's Financials Intangible Asset Intangible assets are items of value that are used to generate revenues and have no physical substance. Unearned/Differed Revenue Unearned revenue arises when a company sells something it has not yet delivered e.g. licenses, subscriptions 12 month subscription sold for $1,200 in January: Goodwill • Non-current asset • Company has intangible Value e.g. brand, customers,intellectual capital If a company is purchased for more than the fair value of net assets (assets less liabilities): Purchase price X Fair value of net assets acquired (X) Goodwill X Earned: $100 $300 $600 $900 $1,200 Jan Mar Jun Sep Dec Unearned $1,100 $900 $600 $300 $0 Other assets Trademarks Patents Copyrights Source CFI
- 10. 10 PwC | Basic Understanding of a Company's Financials Current Liabilities • Will be paid in less than 1 year • Trade accounts payable Non-current Liabilities • Repayment terms longer than 1 year • Loan repayable over a 5 year period Illustrative balance sheet (liabilities) See accompanying notes.
- 11. 11 PwC | Basic Understanding of a Company's Financials New buildings Building improvements Leasehold improvements Other liabilities Commitments Commitments are future obligations that a company agrees to. Contingencies Contingencies are liabilities that may or may not happen, depending on circumstance. e.g. lawsuit The liability must be recorded if: 1.A loss will be suffered in the future 2.The loss amount can be reasonably estimated If not, just disclose a note. Contingent gains are never recorded in financial statements. Source CFI
- 12. 12 PwC | Basic Understanding of a Company's Financials Illustrative balance sheet (statement of shareholder’s equity) See accompanying notes.
- 13. 13 PwC | Basic Understanding of a Company's Financials Common shares • Allow for participation in the profits of the company – Comes in the form of a dividend • Allow for voting rights in a company – One vote for every share held • If dissolved, any residual amount after everyone else is paid would go to the common shareholders Preferred shares Authorised shares • The total number of shares a company can sell Common vs preferred shares Outstanding (Issued) shares • The total number of shares a company has sold/issued • Offer investors a fixed dividend – It may not be paid annually • Will accumulate/pay before common share dividends • Most businesses don’t issue because they are viewed as debt with a tax disadvantage – Dividends do not reduce taxable income See accompanying notes. Source CFI
- 14. 14 PwC | Basic Understanding of a Company's Financials Aspects of the Equity Par Receives Contributed surplus Paid-up share capital (180,000 x 25¢) $45,000 Contributed surplus (180,000 x 15¢) $27,000 e.g. 180,000 shares 40¢/each 25¢/par Aspects of the equity Contributed Surplus Other comprehensive income Other comprehensive income (OCI): • certain company gains and losses that are not always recorded through the income statement e.g. unrealised gains and losses on investments and hedging instruments Source CFI
- 15. Understanding the income statement and cash flow 15 PwC | Basic Understanding of a Company's Financials
- 16. Income statement 16 PwC | Basic Understanding of a Company's Financials
- 17. 17 PwC | Basic Understanding of a Company's Financials The Income statement has 3 main sections: Income Statement Revenues Expenses Profit or loss
- 18. 18 PwC | Basic Understanding of a Company's Financials VS Single step vs multi-step income statements Single Step Multiple Step Source CFI
- 19. 19 PwC | Basic Understanding of a Company's Financials Operating Profit EPS –Investor Ratio Net Operating Profit OCI-other gains and losses The Illustrative income statement
- 20. 20 PwC | Basic Understanding of a Company's Financials (e.g. materials used in manufacturing) Cost of goods sold or Cost of sales: • May be shown as summarised line item • May be broken Down to its expense items Direct Materials Direct Labor Direct overhead (e.g. professional services delivered) (to the production of the goods or services) Cost of sales Source CFI
- 21. 21 PwC | Basic Understanding of a Company's Financials Advertising and promotion cost Legal, Insurance and accounting expenses. Office supplies Other related expenses. Selling, general and administrative expenses. Selling, general and administrative, or SG&A contains a large number of expense items such as: Source CFI
- 22. 22 PwC | Basic Understanding of a Company's Financials Gains and losses Gains and losses may appear separately or grouped after all operating items under “other income or expenses”. They are related to activities that are incidental to operations such as: Sale of Investments Foreign exchange translations Financial Instrument transactions Source CFI
- 23. 23 PwC | Basic Understanding of a Company's Financials Other aspects of the Income Statement Other comprehensive income (OCI): • certain company gains and losses that are not always recorded through the income statement e.g. unrealised gains and losses on investments and hedging instruments Other comprehensive income Source CFI
- 24. Cashflow statement 24 PwC | Basic Understanding of a Company's Financials
- 25. 25 PwC | Basic Understanding of a Company's Financials The cash flow statement Day-to-day business operations; Revenues and expenses that have been collected and paid during the year Depreciation and amortisation are not included. Non-current assets that support the business: • Property, plant and equipment • Business acquisitions Transactions regarding shares or debt. Company raises funds by either borrowing or issuing shares. Statement of cash flows demonstrates: • Where cash is being generated • Where cash is being used in the business Operating Investing Financing Source CFI
- 26. 26 PwC | Basic Understanding of a Company's Financials Statement of Cash Flows The transactions are sorted by activity type: Operating Investing Financing The closing cash balance All cash transactions The opening cash balance Source CFI
- 27. 27 PwC | Basic Understanding of a Company's Financials Direct method Direct method of cash flow starts with cash transactions. (Transactions are separated into cash received and cash paid.) Indirect method Indirect method of cash flow starts with net income. (Non-cash adjustments are then added.) Direct method vs Indirect method Source CFI
- 28. 28 PwC | Basic Understanding of a Company's Financials Net cash provided by operating activities Changes in working capital PPE Investment Financing requirement/surplus Represents operating ‘lifeblood’ of business after paying necessary outgoings for financing and tax Shows whether business is absorbing funds for working capital or releasing them. Trend may indicate ether financial stress or loose control over working capital Companies must invest in PPE to maintain their productive capacity. A downward trend may indicate a declining company. Identify the necessary sustainable level of expenditure. Shows whether internally generated funds are sufficient to cover investments made in fixed assets and businesses. Continuous deficits indicate that growth depends on regular injections of external finance. Key elements in a cash flow statement Source CFI
- 29. 29 PwC | Basic Understanding of a Company's Financials See accompanying notes. For full disclosure: Notes are provided to allow the reader of the financial statements to understand and make judgements of financial activities of the company. The Full Disclosure Principle
- 30. 30 PwC | Basic Understanding of a Company's Financials Indirect Information Company accounting standards How inventory & investments are valued Financial instruments Revenue is recognized Property, plant & equipment is amortized Any other policies A breakdown of the types of investments Debt and financial instruments What is included in: Inventory Intangible assets PP&E Income taxes Notes of indirect information: • Help provide the entire financial picture of an organisation • Not related to the numbers in the financial statements Commitments Contingencies Stock based compensation plans Three Key Financial Statements Notes Significant Accounting Policies Direct Information Indirect Information Source CFI
- 31. 31 PwC | Basic Understanding of a Company's Financials Performance Ratio • Net Profit margin, • return on assets (ROA) • return on equity(ROE) • return on capital employed (ROCE), • gross margin ratios • Efficiency ( • Solvency Ratios • Current ratio= Current assets/Current liabilities • Leverage or Gearing • Operating cash flow/Interest paid • Operating cash flow/Dividends paid • Operating cash flow/Operating profit • Dividend yield, • P/E ratio, • earnings per share (EPS), • dividend payout ratio Ratio Analysis The Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement. Ratio analysis is a cornerstone of fundamental equity analysis. Solvency Ratios Investor Ratios
- 32. 32 PwC | Basic Understanding of a Company's Financials The benefits of an annual report The annual report contains a significant amount of information: Financial • Management discussion & analysis(MD&A) • Financial statements • Notes to financial statements • Messages from the Chair, CEO • Corporate profile • MD&A • Risk and control processes and analysis Non-financial Operational performance Financial performance Strategic direction Source CFI
- 33. 33 PwC | Basic Understanding of a Company's Financials Letters to the shareholders 01. Business description 02. Management’s Discussion and Analysis (MD&A) 03. Reporting on internal controls 04. Audit report 05. Balance sheet, Income Statement and Statement of Cash Flows 06. Notes to the financial statements 07. Earnings per share 08. Earnings per share Listing of directors of the company 09. Contents of an annual report The annual report will always include: Source CFI
- 34. 34 PwC | Basic Understanding of a Company's Financials Acts as sort of variance analysis Explains company performance Lists future actions to be taken Identifies the key risk facing the organization Management discussion and analysis MD&A provides information regarding past performance and future strategic direction
- 35. pwc.com/jm Thank you © 2020 PricewaterhouseCoopers. All rights reserved. PwC refers to the Jamaica member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.