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Financial Statements

What they are, their use and limitations

Christopher Jeffries

on 21 October 2013

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Transcript of Financial Statements


What are financial statements?
How are financial statements used?
What are the limitations of financial statements?
selections of financial data from recorded transactions
The Income Statement
The Balance Sheet
Statement of Cashflows
The inflows and outflows of resources accrued over a set period of time
A snapshot of resources and obligations accrued since the beginning of the business up to a specific date
where money came from and went to over a period of time
Total revenue - total expenses = net income
revenues earned
Sales revenue
expenses incurred
Cost of sales
Rent & rates
Also interest payments and taxation
(assets - liabilities) + accumulated investment = net assets
The Balance sheet can help in determining the level of risk of a business and is also known as the Statement of Financial Position.
Fixed assets (longer than 1 year lifespan)
Current assets (likely to be realised within 12 months)
Current liabilities (likely to be repaid within 12 months
Long-term liability (longer than 1 year for repayment)
Working capital = current assets - current liabilities
Capital account = Net assets
represents ownership breakdown
also known as Capital reserves / Capital employed Equity / Shareholder's funds
cashflow = cash inflows - cash outflows
operating activities
income before interest & tax
investment returns / servicing finance
interest received or paid
capital expenditure
acquisition or disposal of fixed assets
financing activities
Financial statements
Three basic types:
Income Statement
Balance Sheet
Cashflow Statement
To communicate the success and financial soundness of a company
Based on:
income statement
current balance sheet
previous year's balance sheet
Adapted from Accounting theory and practice. M.W.E. Glautier, D. Morris, B. Underdown. 8th ed. 2011. Pearson Education Ltd. pp. 51, 57-61.
Also known as P&L or Statement of Profit or Loss
Who reads financial statements?

Managers & Owners
Make business decisions
Bargaining tools
Internal Users
External Users
Insitutional Investors
Investment decision
Financial Institution
Lending decision
Tax payments
Decision to extend credit terms
General Public & Media
Various uses
People who need financial information about a company
Based on double entry bookkeeping method
credit / debit
Assets = Liabilties + Equity
ASSETS are owned resources.
Accounts receivable
Fixed assets
Prepaid expenses
Other assets
LIABILITIES are claims against the company assets:
Accounts payable
Payroll liabilities
Short term notes payable
Long term notes payable
EQUITY (or net assets) represent the total investment in a business by the owners and demonstrates their claim to the corporate assets:
Retained earnings
Paid in capital
Only financial measurements are included

Financial statements can be window-dressed

Recorded financial transactions are historical

Reliability of data < > Usefulness of data
The income statement, balance sheet and the statement of cashflow are all interlinked
Operating cash flow
reflects items from the income statement
reveals the purchase and sale of long term assets
shows cash of paying off or getting loans, and equity such as selling shares or dividends
Income statement
Balance sheet
Cashflow statement
Shows the maximum cashflows possible: the book profit earned
Indicates the actual cash flows received and paid by the company
Shows the difference between the income statement and the cashflow statement
cash that was not collected
cash owing but not yet paid
Financial statements aim to help investors to make a decision. However, their effectiveness in this respect is questionable. Consider the following and discuss:
Investors 'read' the financial statements to assess the financial health of a company
For example
Does the business have enough cash to meet its day to day operating costs?
Working capital = current assets - current liabilities

Is the company operating efficiently?
Is the amount of working capital too high?
Working capital
Working capital = current assets - current liabilities
What does working capital actually tell us?

Why are only current assets considered?

Why might there be a zero or negative value for working capital? What would the possible consequences be?

Who is responsible for ensuring sufficient levels of working capital?

What measures could be taken to increase working capital? Would there be any knock-on effects?
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