Financial Statements

Class ACYFAR5

Created @June 18, 2021 1:09 PM

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Financial Statements

Structured representations of the entity's Financial Condition and Performance

Structured because it is being presented in a logical and understandable

manner

Representation of the entity's Management as to the Financial Health or

Condition and Financial Performance of the entity

Financial Statements 1
 Representation: Assertions being made by the management of the
company regarding the condition and the performance of the entity for a
particular Reporting Period

Show the results of the Management's stewardship over the Resources that were
entrusted to them by the providers of Capital

Management's Stewardship: How well the Management cared for the

Resources entrusted to them by the Creditors and Shareholders

How effectively they used the Assets of the company in order to generate
profits for the entity, therefore, will eventually returns to the Creditors and
Shareholders

Basically: Financial Statements act as a Report Card by the Management

How effective, efficient, well they performed in a particular Reporting Period

In making Economic Decisions about the Financial Condition and Performance of an

entity, what are the relevant information that you must find in the Financial Statements?

Financial Condition

Financial Statements 2
 Decisions based on the information on the Liquidity and Solvency of the
company

Liquidity and Solvency: Ability of the company to meet its obligations as

they fall due

Liquidity: Ability of the entity to meet its current maturing obligations

Solvency: Ability of the company to meet is long-term obligations

Financial Flexibility

Ability of the entity to convert its Other Assets into Cash in a short span of
time

For Example: If most of your Assets are invested on the Working Capital
(Receivables or Inventory), therefore, whenever you need Cash to settle
your obligation (whether current or non-current), you can easily convert
those Receivables or Inventories into Cash

This shows how flexible you are as a company

However, if majority of your Assets are being invested in Long-term or

Fixed Assets, then the Financial Flexibility of the company decreases
because in case you need money in the soonest possible time to settle
your obligation, you may have have a hard time selling your Fixed
Assets and converting them into Cash right away

Decisions about Capital Structure of the company

Capital Structure: We remember the basic Accounting Equation

How much of the Total Asset of the company are being financed by the
Creditors

How much of the Total Asset of the company are being financed by the
Shareholders

In Finance, whenever a company is too leveraged (their Assets are

being financed by too much Liabilities), it is very risky on the part of
the entity because the Cash Flows or the Cash Payments of your
Liabilities are Fixed, while the Cash Flows generated by the Assets
in the Ordinary Course of business may vary from time to time

Financial Statements 3
 There is a possibility that the Cash Flow generated by your
Assets from your Operations may not be enough to settle the
Fix Payments of your Liabilities, thus there is a risk that you
may Default on your obligation

If Asset is being financed by too much Equity: Costly on the

other hand because you need to provide Returns on the
Investments by the Shareholders in the form of Dividends and
Capital Gains

In Finance, we remember that the Cost of Equity is more

expensive than the Cost of Debt, thus relying too much on
Equity may not be risky but expensive; therefore, there should
be an optimal balance between the amount of Liabilities and
Equity being maintained by the company to support its Total
Assets

Financial Performance

We want to know about the entity's Profitability

We want to assess the quality of earnings by the entity

Quality of Earnings: Majority of the Revenues of the company should

come from its Ordinary Course of Business (Sales of Goods and Services)
because can be converted into Operating Cash Flows

You can have a Profit but if the Revenues is composed of a significant

amount of a gain from a one time transaction, then the reason why you had
the profit is not because of your Ordinary Course of Business, but because
of a Non-Cash Revenue item, thus may have an impact about the ability of
the company to generate its Operating Cash Flows; therefore, if the quality
of earnings of an entity is high (majority of Revenues is from bread and
butter, sale of goods and services), you can expect that the entity's ability to
generate Operating Cash Flows from its Normal Operations is higher as
well

Financial Statements 4
 Inter-relationship between Financial Statements

Financial Statements are meant to be read, analyzed, and understood in connection

with each other

For Example: If you want to know about the entity's ability to meet its
obligations as they fall due, read the Statement of Financial Position, you have
to know their sources of Cash

Aside from Cash and Cash Equivalents, you have your Short-term
Investments, Receivables, Inventory, and Other Assets of the company

You can also find information about the ability of the company to generate
its Operating Cash Flows from their Normal Course of Business because as
stated in the discussion of Statement of Cash Flows, there is a relationship
between the company's Profitability and the Ability of the company to
generate Operating Cash Flows; therefore, you also read the Statement of
Comprehensive Income and Statement of Cash Flows because of that

Thus, in order for you to make a meaningful Economic Decision, you

should not just read 1 Financial Statement without reading the other
components of the Financial Statements

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