Understanding Financial Statements

(Financial Management 1)
3rd Trimester, AY 2020-2021
 Understanding Financial Statements
Learning Outcomes:
1. Understand how business activities are reported through the
financial statements
2. Appreciate the general objectives of financial statements
3. Enumerate and identify the needs of various users that demand
financial accounting information
4. Enumerate the sources of information about a business enterprise
5. Understand the benefits and costs of supplying accounting
information
6. Identify the required financial statements and know how they are
interconnected .
7. Know the nature and significance of the
• Statement of Financial Position or Balance Sheet Statement
• Statement of Comprehensive Income
• Statement of Stockholder’s Equity, and
• Statement of Cash Flows
 Understanding Financial Statements
How Business Activities are Reported - through financial
statements

Financial statements
• reports on a company’s performance and financial
condition
• serves the needs of different users
• provide crucial input for strategic planning
General Objectives of Financial Statements
1. Providing Information for Economic Decisions
Users of financial statements help them evaluate a
business’ ability to generate cash and cash equivalents, its ability
to pay its employees and suppliers, meet interest payments,
repay loans and make distributions to its owners.
2. Providing Information About Financial Position
The financial position of an enterprise is affected by the
economic resources such as:
- Information about the economic resources controlled by
the enterprise
- Information about financial structure is useful in predicting
future funding needs
- Information is useful in predicting success of the business
- Information about liquidity and solvency
General Objectives of Financial Statements
3. Providing Information About Performance of an
Enterprise
In particular its profitability which is required to assess
potential changes in the economic resources that are likely to
control the future.
4. Providing Information About Changes in Financial
Position
This is useful to assess it investing, financing and
operating activities during the reporting period – cashflows.
 Demand for Financial
Accounting Information
The broad classes of users that demand financial accounting
information include the following:
1. Managers and Employees –for their own well being and
prospective earnings.
2. Investors and Analysts – to decide whether to buy or sell
equity shares.
3. Creditors and Suppliers – for lenders, to determine credit
to extend the company, and for suppliers to determine their
long term commitment to supply-chain relations.
4. Shareholders and Directors – to assess it profitability and
risks, evaluate managerial performance and to help to make
leadership decisions.
 Demand for Financial
Accounting Information
5. Regulatory and Tax Agencies – SEC, BIR, BSP and other
legal institutions to monitor compliance.
6. Customers and Potential Strategic Partners – to
evaluate a company’s ability to provide products and
services as agreed.
7. Other decision makers – for varied purposes like
assessing damages for environmental abuses & making
policy decisions involving economic, social, taxation and
other initiatives.
 Sources of Information
In the Philippines, publicly listed companies must file
financial accounting information with the Securities and
Exchange Commission (SEC) as follows:
1. The audited Annual Report that includes four (4)
financial statements – balance sheet, income
statement, statement of stockholders’ equity and
statement of cash flow.
2. The unaudited quarterly or interim reports that
include summary versions of the 4 financial statements
as mentioned above and limited additional disclosure.
All other registered corporations and partnerships are
likewise required to file annually audited financial
statements with notes to SEC.
 Benefits of Disclosure

• It extend to a company’s capital, labor, input and output

markets as companies compete in these markets.
• Example, debt and equity financing are sourced from
capital markets and the better a company’s prospects,
the lower will be its costs of capital.
• Same is true for the company’s recruitment efforts in
labor markets and its ability to establish and maintain
superior supplier-customer relations.
• It also enables the company better compete in capital,
labor, input and output markets.
 Costs of Disclosure
• Preparation and dissemination of supplying accounting
information can be substantial
• Possibility for information to produce competitive
disadvantages is high
• Disclosure of activities like product or segment success
or failures, strategic initiatives, technology or systems
innovations could harm their competitive advantages.
• Disclosures that creates expectations that are not
eventually met may face possible lawsuits.
 Constraints on Relevant
and Reliable Information
1. Timeliness – undue delay in reporting information may
lose its relevance.
2. Balance Between Benefit and Cost - benefits derived
from information should exceed the costs of providing it.
3. Balance Between Qualitative Characteristics – aim is
to achieve an appropriate balance among the
characteristics to meet the objective of the financial
statements.
4. True Fair View of Fair Presentation – frequently
describes financial statements but this framework does
not deal directly with such concepts.
Financial Statements
 Linkage of Financial Statements

The 4 financial statements linkage with each other and

linkage across time, is known as ARTICULATION.

Statement of Statement of
Financial Comprehensive
Position Income

linked via
Retained Earnings
 Linkage of Financial Statements
There is an order of financial statement preparation.
• First statement prepared is the Statement of
Comprehensive Income – net income figure and dividend
information is used to update the retained earnings account.
• Second, it prepares the Statement of Financial Position
using the updated retained earnings account along with the
remaining statement of financial position accounts from the
Trial Balance.
• Third, it prepares the Statement of Stockholders Equity
• Fourth, it prepares the Statement of Cash Flows using
information from the cash accounts and other sources.
ARTICULATION OF FINANCIAL STATEMENTS
 Statement of Financial Position
Reports a company’s financial position at a point in time, the
company’s resources (assets), what the company owns and also the
sources of asset financing.
Two (2) Ways to Finance Company Assets
1. Owner Financing – it can raise money from shareholders
2. Non-owner Financing – it can also raise money from banks or
other creditors or suppliers.
This means that both owners and non-owners hold claims on
company assets. Owners claim on assets are referred to as Equity,
while Non-owners claims are referred to a Liabilities (Debt).
Since all financing must be invested in something, hence:
Investing = Financing
This equality is called the accounting equation:
Assets = Liabilities + Owner’s Equity
Statement of Financial Position
 Statement of Financial Position
Investing Activities – are represented by the company’s
assets which can be financed by a combination of equity and
liabilities.
Financing Activities – assets must be paid or and funding is
provided by a combination of owner and non-owner financing.
Working Capital – current assets are often called working
capital because these assets “turn over” - they are used and
replaced throughout the year.
Net Working Capital – is the difference between current
assets and current liabilities.
Net Operating Working Capital – is the difference between
current assets and non-interest bearing current liabilities.
Statement of Comprehensive Income
This reports on a company’s performance over a period of time and
Lists amounts for revenues (also called sales), expenses and other
comprehensive income.
Revenues less expenses yield the bottom line net income amount.
Statement of Comprehensive Income
• Manufacturing and merchandising companies typically include an
additional expense account, called Cost of Goods Sold (or Cost of
Sales), in the statement of comprehensive income following
revenues.
• It is also common to report a subtotal called Gross Profit (or Gross
Margin), which is revenues less cost of goods sold. The company’s
remaining expenses are then reported below gross profit. This
income statemen layout follows:
Statement of Comprehensive Income
Operating Activities – use company resources to produce,
promote and sell its products and services.
– These activities extend from input markets involving
suppliers of materials and labor to a company’s output
markets involving customers of products and services.
– Input markets generate most expenses (or costs) such as
inventory, salaries, materials and logistics.
– Output markets generate revenues (or sales) to
customers.
– Output markets also generate some expenses such as
marketing and distributing products and services to
customers.
– Net income arises when revenues exceed expenses.

– Loss occurs when expenses exceed revenues.

 Statement of Stockholder’s Equity
The statement of stockholder equity reports on changes in key types of
Equity over a period of time. For each type of equity, the statement reports
the beginning balance, a summary of the activity in the account during the
year and the ending balance.
 Statement of Stockholder’s Equity
Contributed capital represents the cash that the company received
form the sale of stock to stockholders, less any fund expended for the
repurchase of stock.
Retained earnings (also called earned capital or reinvested capital)
represent the cumulative total amount of income that the company
has earned and that has been retained in the business and not
distributed to shareholders in the form of dividends.
The change in retained earnings links consecutive statement of
financial position via the income statement:
End. Retained Earnings = Beg. Retained Earnings + Net Income - Dividends
 Statement of Cash Flows
The statement of cash flows report the change (either an increase or decrease)
in a company’s cash balance over a period of time. The statement reports on
cash inflows and outflows from operating, investing and financing activities over
a period of time.
OPEN FORUM

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END OF PRESENTATION