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Financial statements
Financial statements and reporting

• Of the various reports corporation issues to their

stockholders, the annual report probably is the most important.
• Two types of information are given in this report:
• FIRST: a verbal section, often presented as a letter from the
chairman, describes the firms operating results during the past year
and then discusses new developments that will affect future
operations.
• SECOND: the annual report presents four basic financial
statements:-
• (A)- The income statement.
• (B)- The balance sheet.
• (C)- The statement of retained earnings.
• (D)- The statement of cash flows.
• Together, these statements give an accounting picture of the
firm’s operations and financial position.
• Detailed data are provided for the two most recent years,
along with historical summaries of key operating statistics for the
past five or ten years.
The Income statement

• In the example net sales are shown at the top of each

statement, after which various costs, including income taxes,
are subtracted to obtain the net income available to common
stockholders.
• A report on earnings per share and dividend per share is
given at the bottom of the statement.
• In corporate finance , earnings per share (EPS) is called
“the bottom line ” denoting that , of all the items on the income
statement, EPS is the most important .
• The company earned $2.48 per share in 2008, down from
$2.52 in 2007, but it still raised the per share dividend (DPS)
from$1.08 to $1.17
• It is important to remember that not all the amounts shown
on the income statement present cash flows.
• For most operations, the income statement is generated using
accrual methods of accounting this means revenues are
recognized when they are earned, not when The cash is
received , and expenses are realized when they are incurred,
not when the cash is paid
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X company
comparative income statements for years ending December
31(millions of dollar, except per share data)
2007 2008
Net sales $1500 $1435
Cost of goods sold (1220) (1175)
Gross profit $280 $260
Fixed operating expenses except depreciation (90) (85)
depreciation (50) (40)
Earnings before interest and taxes (EBIT) $140 $135
interest (36) (30)
Earnings before taxes $104 $105
Taxes (40%) (42) (42)
Net income $62 $63
Preferred dividend (0) (0)
Earnings available to common stockholders $62 $63
Common stocks dividend (29) (27)
Addition to retained earnings $33 $36
PER- SHARE DATA:-
Common stock price $23 $24
earnings per share (EPS) $2.48 $2.52
Dividend per share (DPS) $1.17 $1.08

The balance sheet

• The balance sheet shows the finical position of a firm at a specific

point in time. This financial statement indicates the investments made
by the firm in the form of assets and the means by which the assets
were financed- whether the fund were raised by borrowing
(liabilities) or by selling ownership shares (equity).
• The top portion (normally referred to as the left -hand side) of the
balance sheet shows the total assets, while the bottom portion
(normally referred to as the right -hand side) shows the liabilities and
equity, or the claims against these assets.
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• The assets are listed in order of their “liquidity” or the length of

time it typically takes to convert them to cash.
• The claims are listed in the order in which they must be paid:-
accounts payable generally must be paid within 30-60 days, accruals
are payable within 60-90 day, and so on , down to stockholders’
equity accounts, which represent ownership and need never be “ paid
of”

The balance sheet :Cash versus other assets

• Some additional points about the balance sheet are worth
noting:

1- Cash versus other assets :

• Although the assets are stated in terms of dollar, only cash

represents actual money.
• Receivables are bills others owe the company,
• inventories show the dollars the company has invested in
raw materials, work-in- process, and finished goods available for
sale;
• and net fixed assets reflect the amount of money the
company paid for its plant and equipment when it acquired those
assets less the amount that has been written off ( (depreciated )
since the acquisition of those assets.
• The company can write checks at present for a total of $20
million (versus current liabilities of $130 million due within a
year).
• The non cash assets should produce cash over time, but they
do not represent cash in hand and the amount of cash they would
bring if they were sold today could be higher or lower than the
values at which they are carried on the books (their book values).
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The balance sheet :Liabilities versus stockholders' equity

2- Liabilities versus stockholders‘ equity:

The claims against assets are of two types- liabilities (or money the
company owes) and the stockholders' ownership position.
• The balance sheet must balance, so the common
stockholders‘ equity, or net worth, is a residual that represents the
amount stockholders would receive if all the firm‘s assets could be
sold at their book values and all the liabilities could be paid at their
book values.
• The company‘s 2008 net worth is:
• Assets-Liabilities=Stockholders' equity
• $850 million-$423 million=$427 million
• Suppose assets decline in value-for example, suppose some
of the accounts receivable are written off as bad debts. If liabilities
remain constant, the value of the stockholders‘ equity must decline
• Therefore, the risk of assets value fluctuations is borne by
the stockholders.
• Note, however, that if assets values rise (perhaps because of
inflation), these benefits will accrue exclusively to the
stockholders.
• The change in the firm‘s net worth is reflected by changes
in the retained earning account, if bad debts are written off on the
assets (Left-hand) side of the balance sheet ,the retained earnings
balance is reduced on the liabilities and equity (right-hand) side.

Cash flow statement

• In financial accounting, a cash flow statement, also known

as statement of cash flows or funds flow statement is a financial
statement that shows how changes in balance sheet and income
accounts affect cash and cash equivalents, and breaks the analysis
down to operating, investing, and financing activities. The
statement captures both the current operating results and the
accompanying changes in the balance sheet.
• As an analytical tool, the statement of cash flows is useful
in determining the short-term viability of a company, particularly
its ability to pay bills. People and groups interested in cash flow
statements include:
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• •Accounting personnel, who need to know whether the

organization will be able to cover payroll and other immediate
expenses
• •Potential lenders or creditors, who want a clear picture of a
company's ability to repay.
• •Potential investors, who need to judge whether the company
is financially sound
• •Potential employees or contractors, who need to know
whether the company will be able to afford compensation

Cash flow statement usefulness

• The cash flow statement is intended to:-

1-Provide information on a firm's liquidity and solvency and its

ability to change cash flows in future circumstances .

2-Provide additional information for evaluating changes in assets,

liabilities and equity.

3- Improve the comparability of different firms' operating

performance by eliminating the effects of different accounting
methods.

4- Indicate the amount, timing and probability of future cash flows.

The cash flow statement has been adopted as a standard financial

statement because it eliminates allocations, which might be derived
from different accounting methods, such as various timeframes for
depreciating fixed assets.

Cash flow activities

• The cash flow statement is partitioned into three segments, namely:
cash flow resulting from operating activities, cash flow resulting from
investing activities, and cash flow resulting from financing activities.
The money coming into the business is called cash inflow, and money
going out from the business is called cash outflow.
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Operating activities

• Operating activities include the production, sales and

delivery of the company's product as well as collecting payment
from its customers. This could include purchasing raw materials,
building inventory, advertising, and shipping the product.
• Under IAS 7, operating cash flows include:
• •Receipts from the sale of goods or services
• •Receipts for the sale of loans, debt or equity instruments in
a trading portfolio
• •Interest received on loans
• •Dividends received on equity securities

Cash flow activities

Payments to suppliers for goods and services

• Payments to employees or on behalf of employees

• Interest payments (alternatively, this can be reported under
financing activities in IAS 7, and US GAAP)
• Items which are added back to [or subtracted from, as
appropriate] the net income figure (which is found on the Income
Statement) to arrive at cash flows from operations generally
include:
• Depreciation (loss of tangible asset value over time)
• Deferred tax
• Amortization (loss of intangible asset value over time)
• Any gains or losses associated with the sale of a non-current
asset, because associated cash flows do not belong in the operating
section. (unrealized gains/losses are also added back from the
income statement)

Investing activities

• Examples of Investing activities are

• •Purchase of an asset (assets can be land, building,
equipment, marketable securities, etc.)
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• •Loans made to suppliers or customers

Financing activities

• Financing activities include the inflow of cash from

investors such as banks and shareholders, as well as the
outflow of cash to shareholders as dividends as the
company generates income. Other activities which impact
the long-term liabilities and equity of the company are also
listed in the financing activities section of the cash flow
statement.
• Under IAS 7,
• •Proceeds from issuing short-term or long-term debt
• •Payments of dividends
• •Payments for repurchase of company shares
• •Repayment of debt principal, including capital
leases
• •For non-profit organizations, receipts of donor-
restricted cash that is limited to long-term purposes
• Items under the financing activities section include:
• •Dividends paid
• •Sale or repurchase of the company's stock
• •Net borrowings
• •Payment of dividend tax
• Disclosure of noncash activities
• Under IAS 7, noncash investing and financing
activities are disclosed in footnotes to the financial
statements. Under US GAAP, noncash activities may be
disclosed in a footnote or within the cash flow statement
itself. Noncash financing activities may include[14]
•Leasing to purchase an asset
•Converting debt to equity
•Exchanging noncash assets or liabilities for other noncash
assets or liabilities
•Issuing shares in exchange for assets
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Statements of retained earnings

Statements of retained earnings

• The statement of retained earnings is one of the basic

financial statements as per Generally Accepted
Accounting Principles, and it explains the changes in a
company's retained earnings over the reporting period.
• It breaks down changes affecting the account, such
as profits or losses from operations, dividends paid, and
any other items charged or credited to retained earnings. A
retained earnings statement is required by Generally
Accepted Accounting Principles (GAAP) whenever
comparative balance sheets and income statements are
presented.
• It may appear in the balance sheet, in a combined
income statement and changes in retained earnings
statement, or as a separate schedule