Financial Statements and their interpretation

This page last updated 2013 Oct 01

In Oct 2011 when Prof. Richardson taught this class it was delivered using traditional lecture notes
In Oct 2012 some of the lecture notes + additional web based resources where put into this page created Oct 18th 2012
 

Financial Statements WHY

Report Cards

The information you get from report cards depends on how the teacher uses different "measures", such as  attendance,  mark in the course,  mark in the course compared to others in the class for college and university students there can also be info such as how much money you still owe on your tuition Financial Statements are like company report cards

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Prof. Steve Litt (MBA, Queens) explaining that when you are looking at the info in Financial Statements it depends on whether you are inside the company or outside the company

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Financial Statements What for

Making Decisions

It has been said that business is fundamentally about making decisions - you have the 4Ps you control and the 6Es environments you respond to.  Financial Statements are essentially a tool for people to make decisions about a company, and there are many types of decisions deciding which company to invest in which company is a reliable supplier which company can deliver an important service which company to takeover which company to outsource to which company you can lend money to

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Financial Statements Types

Financial Statements - Types of companies Public  shares listed on the stock exchange Private NPOs - Non Profit Organization Heart and Stroke Foundation, Cancer Society NPOs often obliged to  produce financial statements because often they have funding from some government agencies or are granted the right to issue receipts for tax purposes

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Financial Statements - an introduction

Financial Statements - what influences them The Political - Legal - Regulatory Environment The Competitive Environment The Economic Environment The Technological Environment

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Financial Statements - an introduction

The Political - Legal - Regulatory Environment For publically traded companies, Financial Statements are primarily governed by the regulations within the political jurisdiction they operate within. If a medium-large sized company has their headquarters in Toronto and operates throughout Canada they are bound by the regulations of the OSC Ontario Securities Commission   osc.gov.on.ca/en/SecuritiesLaw_legislation_index.htm  and the rules imposed by the TSX Toronto Stock Exchange tmx.com. Federal Dept. of Finance  www.fin.gc.ca/act/index-eng.asp

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Financial Statements - an introduction

The Political - Legal - Regulatory Environment - Sarbanes-Oaxley Act  Canadian companies that operate in the U.S. may also be bound by U.S. regulations such as the 2002 Sarbanes-Oaxley Act - a law designed to offer more corporate accountability and transparency. At the time Sarbanes-Oaxley was being discussed in the U.S., "The Toronto Stock Exchange, the British Columbia Securities Commission, and Canadian business executives have protested the implementation of such draconian measures, arguing that the Enron, Worldcom, and Adelphia corporate scandals have not happened in Canada.  However, observers of the Northern Telecom profit restatement fiasco would argue otherwise." Barry Shaw, BRS Management Consulting   In order to give confidence to their clients, several of the large accounting / management consulting firms (the big 4) have sections on their website in which they offer educational information on the Sarbanes-Oxley Act and how it will effect compliance by Canadian firms.  http://www.deloitte.com/view/en_CA/ca/services/corporategovernanc e/87dd85ed081fb110VgnVCM100000ba42f00aRCRD.htm Sarbanes-Oaxley Section 302 As Barry Shaw explains "Section 302 requires CEO’s and CFO’s to sign off on the accuracy of their financial statements, obligating them to accept personal liability for those statements; a new and frightening responsibility."   As we have seeen in recent years in the United States, state and federal prosecutors have been very enthusiastic about taking CEO's to court for various situations related to how companies may have operated contrary to some law. Section 302 makes some CEO's very nervous about taking on the role of heading a pubically traded company because it means, basically, that they could go to jail if ....

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Financial Statements - an introduction

The Competitive Environment Most companies in the second decade of the new millenium of 2K face an increasing competitive environment, locally, regionally and internationally. For publically traded companies, the competition is intense to maintain the support from existing shareholders and attract new shareholders - without confidence from shareholders, the stock price will decline, and the market capitalization of the company will drop so low that they will not have the finances to sustain operations, and ultimately they will have to suspend operations. Investors Investors, who have many options to chose from, put a lot of pressure on companies to provide detailed financial statements in order to make stock buy/sell decisions as accurately as possible. This accuracy is increasingly important for large institutional investors who are buying/selling stock as part of giant mutual fund portfolios for pension funds, etc. . Suppliers Competition also challenges companies not just from investors but also medium and large scale suppliers. For example, in the automotive and consumer electronics industry suppliers need to carefully plan their sales to large customers and in the planning process they not only want to make a sale, they want to sell to a company who is going to be in business for a long period of time - so customers also look at a company's financial statements to guage whether or not they should supply to them because such a decision might leave a company vulnerable if they shipped a lot of product and did not get paid.

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Financial Statements - an introduction

The Economic Environment   currency exchange rate considerations inflation household purchasing power as it effects consumer buying power federal debt - effects government support for business

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Financial Statements - an introduction

The Technological Environment Technology, particular as it applies to software and hardware utlized to manage data, influences how companies assemble the information that is put into a financial statement. Technology also influences how the financial statement itself is communicated to stakeholders, shareholders, regulatory agencies, media (newspapers, TV, radio and online). - text based - audio, video clips - web based One important consideration that investors take into account is the speed with which companies communicate information in financial statements. Information that is very timely can be used to make quick decisions that can result in investors making or losing millions of dollars so "these days" the format of the information and the technology used to deliver it are very important. - tweets - blogs - website updates etc.

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NPOs Non Profit Organizations

Financial Statements are not only for companies that trade their shares on the stock maket, but also for non-profit organizations that need to reveal their financial details to stakeholders such as government agencies, faith-based groups, volunteer organizations etc. People who serve as members of the Board of Directors of non-profit organizations are often in a position to read all or part of detailed financial statements in order to vote on some motion, or authorize some activity. There are a number of resources to help NPO directors read and understand financial statements. The Chartered Accountants of Canada have speakers series in which different finance topics are discussed. In November 2012 in Toronto there is a breakfast session discussing this topic see  http://www.cica.ca/focus-on-practice-areas/ governance-strategy-and-risk/not-for-profit-director-series/item64269.aspx

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Annual Reports A significant component of Annual Reports are the Financial Statements. Students going for a job interview with a medium or large sized company, especially a publicly traded company, are well advised to scan the Annual Report. Things to look for would include the speech given by the CEO which outlines most of the important things the company is doing, as well as explaining how they will del with pressing problems. It can be very "convincing" if a students answers a question on a job interview with a line beginning such as "according to what your CEO said in her/his speech at the AGM, as listed in your annual report, the company will need more people with..."

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Financial Statements - what is in them

How Financial Statements are put together The raw data is assembled by the accounting department - traditionally this task is done by the person designated as the bookkeeper. The degree to which the sales figures are automated and compiled using the latest technology is critical to how the information can subsequently be analyzed. The bookkeeper sorts through register tapes (in small companies)(large companies are usually computerized) sales invoices supplier invoices payroll service contracts real estate information From the compiled information assembled by the bookkeeper, the facts are "classified and summarized into financial reports for a business so that a financial statement can then be prepared." "Financial statements are customarily prepared on a quarterly, biannual or annual basis. The date of a financial statement is of considerable importance. Most are usually drawn up on a yearly (fiscal) basis. Statements provided that are outside of the fiscal closing are known as interim statements." http://www.dnb.ca/understanding-financial-statements.html

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Financial Statements - what is in them

Financial Statements - Balance Sheet And Profit And Loss Statement The balance sheet  - basically, how the company is doing at an exact moment in time - for companies operating in an intense competitive environment, or in a fast paced technological environment, or big changes in the economic environment, the balance sheet may not be very helpful if the reader is several months from the date the sheet was compiled. Dates Dec 31st is popular April 30th is also popular - companies pick a date matching the regulatory requirements in their jurisdiction so that their data can be compared to other companies releasing statements at the same time - this helps investors compare more easily. - many seasonal businesses issue their statements after their main selling season, because their condition is most favorable at that time. Balance sheets show  the dollar amount of assets (what the business owns)  and liabilities (what a business owes) in relation to net worth or owner's equity (what the owner, principals or stockholders own).  "Balance sheets are presented with assets on the left side of a page and liabilities and equity on the right. Totals of both left and right sides must balance, since total assets must equal total liabilities plus net worth." "The income or profit and loss statement is a detailed computation of the money a business makes or loses over a specific time period. Sales or service income is offset against expenses-operating and production costs. You will most often see year-end statements reflecting income and expenses for a particular calendar year."  some parts from http://www.dnb.ca/understanding-financial-statements.html

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Financial Statements - what is in them

Financial Statements - Balance Sheet - Assets The balance sheet reports the company's assets, liabilities and networth. Assests represent all resources - money, inventory, real estate, anything of value that indicates "how much the company is worth", particularly if it had to be sold ...   One of the challenges about ascertaining assets is that some types decrease or increase over time. Example - equipment (such as trucks or machinery) may lose value as it gets older so the value decreases, real estate may increase over time as the value of the property at a particular location, rises as the real estate market rises. "Assets are listed in liquidity order - ease of converting into cash. Typical assets include: cash, accounts receivable, inventory, fixed assets and a number of miscellaneous assets we have classified as other. Liabilities include what a company owes: accounts and notes payable, bank loans, deferred credits and miscellaneous other. All businesses divide assets and liabilities into two groups: current (convertible to cash within a year) and noncurrent. Net worth is the owner's investment (in the case of a proprietorship or partnership) or capital stock (original investment) plus earned surplus (earnings retained in the business) in the case of a corporation. "-  some parts from http://www.dnb.ca/understanding-financial-statements.html

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Financial Statements - what is in them

Financial Statements - Balance Sheet - Assets Current Assets cash incoming cheques not yet deposited the balance (if positive) in the chequing account including any stocks or bonds held by the company some large companies may even have a stash of precious metals in bullion trade / accounts receivables  things you sold and have not been paid for yet inventory product about to be sold "Finished goods value varies greatly according to circumstances. If they are popular products in good condition that can be easily sold, then the value shown might be justified. If the goods are questionable in salability, the value may be carried too high" or unassembled parts in the process of being assembled or raw materials not yet in the manufacturing process raw materials are most valuable because they can be sold to other manufacturers based on the commodity pricing in the market some parts from http://www.dnb.ca/understanding-financial-statements.html

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Financial Statements - what is in them

Financial Statements - Balance Sheet - Assets Current Assets - Marketable Securities "Marketable securities are found on many balance sheets. Marketable securities can include: government bonds and notes, commercial paper, and/or stock and bond investments in public corporations. Marketable securities are usually listed at cost or market price, whichever is lower. Accountants will frequently list securities at cost with a footnote indicating market price on the balance sheet date. (When marketable securities appear on a statement, it frequently indicates investment of excess cash.)"   some parts from http://www.dnb.ca/understanding-financial-statements.html

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Financial Statements - what is in them

Financial Statements - Balance Sheet - Assets Current Assets - Accounts Receivable Money it has not yet collected from customers. Sometimes this money is long overdue and will most likely not be collected. Sometimes the money is due from companies who have gone into bankruptcy and you are waiting to see if you get anything. Sometimes the money is not collected due to bad management practices or failure to be enthusiastic about contacting the delinquent accounts. "Usually a business will set aside an estimated allowance for these uncollectible or doubtful accounts. This allowance called "bad debt" is deducted from the total receivables shown on the balance sheet. Frequently a footnote identifying the amount deducted will be found in the statements."  some parts from http://www.dnb.ca/understanding-financial-statements.html

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Financial Statements - what is in them

Financial Statements - Balance Sheet - Assets Noncurrent Assets - Fixed Assets Fixed assets are  "...materials, goods, services and land used in the production of a company's goods. Examples include: real estate, buildings, plant equipment, tools and machinery, furniture, fixtures, office or store equipment and transportation equipment. All of these would be used in producing products for a company's customers. Land, equipment or buildings not used in the production of customer goods would be listed as other noncurrent assets or investments. Fixed assets are carried on the company's accounting books at the price they cost at the time of purchase." some parts from http://www.dnb.ca/understanding-financial-statements.html

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Financial Statements - what is in them

Financial Statements - Balance Sheet - Assets Noncurrent Assets - Other assets   In recent years in the IT sector, there have been a number of high profile cases were companies like R.I.M. suffered greatly from litigation by companies holding patents and claiming patent infringement. Leading some people to suggest that holding certain patents used in IT may be considered an asset of the company.

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sign image came from
http://www.scienceofstrategy.com/science_of_decisions.htm

some of the material on this page was found in
 http://www.dnb.ca/understanding-financial-statements.html
 http://www.itprojecttemplates.com/WP_SEC_BillC198.htm
 

 

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