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Section 4

Analytical income statement and


balance sheet

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Learning objectives

After studying this chapter, you will understand

• Elements of the published financial reports


• How published financial reports confuse core activities
with financial activities
• How to adjust published financial reports so that core
activities can be isolated from financial activities
• How to create analytical income statement and balance
sheet

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Elements of financial reports
Beginning Flows Ending
stocks stocks
Statement of Cash Flows
Cash from operations
Beginning Ending
Cash from investing
Balance Sheet Balance Sheet
Cash from financing
Cash = Net change in cash Cash

+ Other Assets Statement of + Other Assets


Shareholders’ Equity
Total Assets Total Assets
+ Investments by owners
- Dividends
- Liabilities - Liabilities
+ Earnings

= Equity = Net change in Equity = Equity

Income Statement
Revenues
- Expenses
= Net income
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Understanding accrual accounting
• Accrual accounting decouples measured earnings (net
income) from the amount of cash generated from
operations
• Accrual accounting revenues generally do not
correspond to cash receipts for the period, nor do
accrual expenses always correspond to cash outlays for
the period
• Accrual accounting can produce large discrepancies
between measured earnings and the amount of cash
generated from operations
• Accrual earnings is a more accurate measure of the
value creation during the period than is operating cash
flow

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Income statement
• Income statement reports the accumulation of costs and
revenues during the fiscal year
• Must contain as minimum information (IAS 1.82)
– Revenues (Sales)
– Finance costs
– Share of the profit or loss of associates and joint ventures
– Tax expense
– Total of discontinuing operations
• Statement of profit or loss and other comprehensive
income
• Income attributable to controlling and non-controlling
owners

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Case (cont.): Statement of income, Kone
2013
Case (cont.): Statement of comprehensive
income, Kone 2013
Some firms report IFRS and non-IFRS
numbers: Nokia 2015/Q2
Some firms report IFRS and non-IFRS
numbers: Nokia 2015/Q2
“2. Non-IFRS to reported reconciliation (unaudited)

In addition to information on our reported IFRS results, we provide certain


information on a non-IFRS, or underlying business performance, basis.
Non-IFRS results exclude certain non-recurring items (special items)
for all periods. In addition, non-IFRS results exclude intangible asset
amortization and other purchase price accounting related items
arising from business acquisitions. We believe that our non-IFRS
results provide meaningful supplemental information to both
management and investors regarding Nokia’s underlying business
performance by excluding the above-described items that may not be
indicative of Nokia’s business operating results. These non-IFRS
financial measures should not be viewed in isolation or as substitutes to
the equivalent IFRS measure(s), but should be used in conjunction with
the most directly comparable IFRS measure(s) in the reported results.”
Some firms report IFRS and non-IFRS
numbers: Nokia 2015/Q2

521 - 508 = 13
Balance sheet information

Rates of return ROA and ROCE

Capital structure Debt vs. Equity


ASSETS
Helps
Liquidity Cash conversion
LIABILITIES assess
+
Solvency Ability to pay debt
EQUITY

Working capital Efficiency


Balance Sheet

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Case: Balance sheet of Kone (Consolidated
statement of financial position)

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Case: Balance sheet of Kone (Consolidated
statement of financial position)

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Case: Balance sheet of Kone (Consolidated
statement of financial position)

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Statement of cash flows
Cash inflows and outflows from
Operating Activities transactions and events that affect
operating income

Cash inflows and outflows from


loaning money to others, investing in
Investing Activities
securities, or in assets (e.g.,
equipment) used to produce goods
and services.

Cash inflows and outflows from


Financing Activities borrowing money, selling stock,
and paying dividends

Δ Cash

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Case: Statement of cash flows of Kone

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Case: Statement of cash flows of Kone

873,4 - 774,6 = 98,8

These two numbers


must be the same.

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Case: Statement of cash flows of Kone

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Statement of the changes in equity

• Describes how equity and its component have changed


during the fiscal year
• These changes occur e.g. due to
– Earnings generated during the fiscal year
– Profit distribution (dividends)
– Purchases of own shares
– Option-based compensation

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Case: Statement of the changes in equity
of Kone

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Footnotes and other small-printed facts

• Footnotes are an integral part of companies’ financial


reports.
• These “notes” help users better understand and
interpret the numbers presented in the body of the
financial statements.
• Important notes include:
1. Summary of significant accounting policies
2. Subsequent event disclosures
3. Related party transactions

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Analytical income statement and balance
sheet

• Ability of the firm to generate value is the main issue


• We need to reformat balance sheet and income statement
to highlight the distinction between
– Operating items
– Financial items
• For non-financial companies, operating activities are the
source of value, not financial activities!
– That is, ordinary firms do not create value from financial activities
We need to focus on operating activities, because they
create value

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Analytical income statement and balance
sheet
• We need to reformate I/S and B/S to separate operating
activities from financing activities
• This distinction is not always easy to make due to several
factors
– The definition of operations is not clear-cut
– The specifications in the income statement and the balance sheet
do not clearly distinguish between operating and financing activities
– The notes are not sufficiently informative
• Reformation depends on the business model and the
characteristics of the firm
– Items that are sometimes categorised as belonging to ‘operations’
may at other times be classified as belonging to ‘financing’

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Analytical income statement
• Adjust non-operating items, if needed
– Do these adjustements consistenty for all firms you are
analyzing
• Focus on Net Operating Profit After Taxes (NOPAT)
– Distinguish between profit from operations and financial income
• Taxes are deducted from EBIT
– Taxes are calculated using the corporate tax rate or the effective
tax rate of a given company

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Reported vs. analytical income statement

Reported I/S Reformatted I/S


Sales (Revenues) Sales (Revenues)
− Cost of sales − Cost of sales
= EBITDA = EBITDA
− Depreciations and amortizations − Depreciations and amortizations
= EBIT = EBIT Operating taxes:
− Financial expenses, net − Operating taxes - Effective tax rate?
- Corporate tax rate?
= Earnings before taxes = NOPAT
− Taxes − Financial expenses, net
= Net earnings + Tax savings from debt financing
= Net earnings

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Case: Analytical income statement of
Kone, 2013
SALES 6 932,6
+ Other income of business 55,9 See next slide
- Materials and services -3 416,4 See next slide: 2839 + 577,4
- Wages and salaries -1 983,8 See next slide
- Other expences -584,8 See next slide: 95,5 + 489,3
+Share of associated companies' income 1,1 See I/S
+/- Increase / decrease of inventory 28,6 See next slide
EBITDA 1 033,2
- Depreciation and amortization -78,5 See next slide
EBIT (OPERATING PROFIT) 954,7
- Taxes on operating profit -233,9 = 0.245×954,7
NOPAT 720,8
-/+ Net financial costs/income 5,9 See I/S: 36,8-42,7 = 5,9
-/+ Taxes on net financial costs/income -1,5 = 0.245×5,9
-/+ Net financial costs/income after taxes 4,4 = 5,9 -1,5 = 4,4
NET INCOME 725,2 Note: corporate and effective
tax rates are different

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Case: Analytical income statement of
Kone, 2013

This was reported


in income statement

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Reported balance sheet

Assets Liabilities and Equity


Non-current (fixed) assets Equity
 Intangible assets
 Tangible assets Non-current liabilities
 Financial assets, long maturity  Debt, interest-bearing
 Non-interest bearing
Current assets
 Inventories Current liabilities
 Receivables  Non-interest bearing
 Financial assets, short maturity • Financial liabilities
 Cash, operating and excess • Accounts payable
• Tax liabilities
 Interest-bearing

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Reported balance sheet
1st step: Remove non-operating items
Assets Liabilities and Equity
Non-current (fixed) assets Equity
 Intangible assets
 Tangible assets Non-current liabilities
 Financial assets, long maturity  Debt, interest-bearing
 Non-interest bearing
Current assets
 Inventories Current liabilities
 Receivables  Non-interest bearing
 Financial assets, short maturity • Financial liabilities
 Cash, operating and excess • Accounts payable
• Tax liabilities
 Interest-bearing

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Reformatted balance sheet
1st step: Remove non-operating items
Assets Liabilities and Equity
Non-current (fixed) assets Equity
 Intangible assets
 Tangible assets Non-current liabilities
 Debt, interest-bearing
 Non-interest bearing
Current assets
 Inventories Current liabilities
 Receivables  Interest-bearing
 Cash, operating

Note: This balance sheet is NOT in balance!!!

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Reformatted balance sheet
2nd step: Deduct items from the other side
Net Operating Assets Invested Capital
Non-current assets: Equity
• Tangible and intangible
+ Current assets: – Interesting bearing net debt:
• Inventories + Non-current liabilities, interest-
bearing
• Receivables
+ Current liabilities, interest-bearing
• Cash, operating – Financial assets, all maturities
– Current liabilities, non-interest – Cash, excess
bearing
– Non-current liabilities, non- = Invested capital
interest-bearing = Net Operating Assets
= Net Operating Assets
= Invested capital Working capital (net)

Note: This balance sheet is (again) in balance!!!


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Example: Outotec, Interim report Q2/2015

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Case: Creating the analytical balance
sheet of Kone
Analytical Balance
Sheet:
Intangible assets 1332,5
Tangible assets 269,6
Investments in associated
companies 4,3
Deferred tax asset 218,9
NON-CURRENT ASSETS 1825,2

Analytical Balance
Sheet:
Inventories 1103,9
Receivables 1410,6
CURRENT ASSETS 2514,5

FINANCIAL ASSETS 1003,7

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Case: Creating the analytical balance
sheet of Kone

Analytical Balance
Sheet:

EQUITY 1724,6

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Case: Creating the analytical balance
sheet of Kone
Analytical Balance
Sheet:
Deferred tax liabilities 191,3
Accounts payable 511,2
Provisions 139,4
Advanced payments 1397,5
Other non-interest-
bearing liabilities 1105,5
NON-INTEREST-
BEARING DEBT 3344,9

Analytical Balance
Sheet:
Long-term liabilities 155,8
Current liabilities 118,1
INTEREST-BEARING
DEBT 273,9

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Case: Analytical balance sheet of Kone

NET OPERATING ASSETS INVESTED CAPITAL


Intangible assets 1332,5 (A), EQUITY 1724,6
Tangible assets 269,5
Investments in associated companies 4,3 Long-term liabilities 155,8
Deferred tax asset 218,9 Current liabilities 118,1
(A), NON-CURRENT ASSETS 1825,2 (B), INTEREST-BEARING DEBT 273,9

Inventories 1103,9 (C), FINANCIAL ASSETS 1003,7


Receivables 1410,6
(B), CURRENT ASSETS 2514,5 (B-C), INTEREST-BEARING
NET DEBT -729,8
Deferred tax liabilities 191,3
Trade payables 511,2 (A+B-C), INVESTED CAPITAL 994,6
Provisions 139,4
Advances received 1397,5
Other non-interest-bearing liabilities 1105,5
(C), NON-INTEREST-BEARING DEBT 3344,9

(A+B-C), NET OPERATING ASSETS 994,6

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Case: Analytical balance sheet of Kone

SUMMARY 2012 2013 Average


(A), EQUITY 1833,7 1 724,6 1779,2
(B), INTEREST-BEARING DEBT 305,7 273,9
(C), FINANCIAL ASSETS 1019,4 1 003,7

(B-C), INTEREST-BEARING NET DEBT -713,7 -729,8 -721,8


(A+B-C), INVESTED CAPITAL 1120,0 994,6 1057,3

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Summary

• Statement of cash flows links the cash in the opening


balance sheet to the cash in the closing balance sheet
• Statement of the changes in equity links the equity in the
opening balance sheet to the equity in the closing
balance sheet
• Accrual accounting items generally do not correspond to
cash receipts and outlays for the period
• Analytical income statement and balance sheet
distinguishes operating and financial items in the
reported income statement and balance sheet

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