Published Financial

Statements 1

Dr. Zubair Ahmad

 Lecture Outline
Statement of Changes in Equity
Statement of Cash Flows
Narrative Reports
 Chairman statement
 Director remuneration report
 Directors report
 The business review / strategic report
Introduction to Financial Statement Analysis
Statement of Changes in Equity
• A statement of changes in equity (SCE) shows how each
components of equity has changed during an accounting
period.

• IAS 1 requires a company to present a SCE as a separate

component of the financial statements.

• The statement reconciles the capital and reserves at the

beginning of the period with those at the end.
 Statement of Changes in Equity for the Year Ended 31 Dec 2013

Note: The statement of changes in equity is a primary statement and is required to be presented with the same
prominence as other primary statements.
 The need for cash flow
statement
 Income Statement and Balance sheet paid little attention to
the entity’s cash or liquidity position.
 Cash is the lifeblood of every business entity. Cash is king.
 Solvency is a money or cash phenomenon. A solvent company
is one with adequate cash to pay its debts.
 Profitable companies can still have cash flow problems and
even become bankrupt.
 Profit is a matter of opinion, cash is a fact.
 Users of financial statements regard both the profit and
cash flow as important items of information.

Think If Profit = Cash ?

The Accrual Concept
A buys a pen for £30 and sells it for £35 to B
A’s profit = £35 - £30 = £5
Cash ↓ £30 then Cash ↑ £35 (cash profit = £5)
Cost of Sales ↑ £30 Sales ↑ £35 (SoCI profit of £5)

but what if B promises to pay later

Cash ↓ £30 then Receivables ↑ £35 (cash profit = - £30)
Cost of Sales ↑ £30 Sales ↑ £35 (SoCI profit of £5)

Statement of Comp Income Profit ≠ Cash Profit

The effects of transactions and other events are recognised when

they occur (and not as cash or its equivalent is received or paid)
and they are recorded and reported in the financial statements of
the periods to which they relate.
The relationship between profit and
cash
Consider a very simple business with no inventory
and no credit.
 Street Trader starts the day with £100 cash;
 It spends £100 buying inventory;
 It sells all inventory for £150.
The relationship between profit and
cash
 Instead of selling all of the goods, the company sells goods
which cost £80 for £120 cash(recall total goods was £100);
then...

• The difference is the inventory he has bought but not yet sold;
• Inventory has increased by £20 (£100 - £80);
• This £20 affects cash flow because some of the inventory has been
bought but does not yet appear in the P&L since it has not been
sold yet.
The relationship between profit and
cash
We can extend this simple example to show the
effects of:
 giving and receiving credit;
 buying new equipment;
 depreciation, etc.
They all help to explain the difference between
profit and cash.
 Cash flow statement
• The cash flow statement provides information
about cash inflows and outflows during an
accounting period.
• Liquidity is measured by the cash and cash
equivalent assets and the changes in those assets,
so a financial statement which explains cash
flows should be of general interest to users, but of
particular interest to creditors.
• The cash flow statement shows how cash is
generated and it helps users to understand how
much flexibility is available to adapt to changing
circumstances and opportunities.
 Cash flow statement
Cash flows from operating activities:
Cash inflows and outflows from normal day-to-day trading
activities;
Inflows: receipts from receivables, cash sales, etc.;
Outflows: payment for inventory, operating expenses (e.g.
wages, rent, tax, interest and dividend payments).
Cash flows from investing activities:
Acquisition and sale (or disposal) of non-current assets;
Includes financial investments in loans or shares.
Cash flows from financing activities:
Raising and repaying the long-term finance of the business
(shares and borrowing).
 Narrative Reports
Narrative reporting is the collection of forward looking
statements and analysis of operating and financial
aspects of the business.
The Cadbury Committee report (1992) highlighted the
importance of narrative reporting.
Narrative reports include
Chairman’s statement.
Directors’ remuneration report.
Directors’ report.
Business review / the strategic report.
Other reports such as corporate governance, and
corporate social responsibility and environmental
reports.
 Chairman’s statement
A letter from the chairman of the board to
shareholders reporting on the company’s
condition.
The statement, typically no longer than two
pages, includes a summary of initiatives, activities
of the board, and personal perspective of the
company’s future.
 Directors’ remuneration report
This includes, among other items of
information:
payments to the directors whether in the
form of basic salary or other rewards,
details of shares in the company owned by
directors.
 Directors’ report
The directors’ report includes, among other items
of information:
names of directors who served during the
reporting year,
principal activities of the company,
recommended dividend for the reporting year,
a business review (now replaced by strategic
report which is separate from the directors’ report).
 The business review
Companies were required to include a ’Business
Review’ as a part of the directors’ report. This
applied to reporting periods beginning on or after
1st October 2007
The Companies Act 2006 specified that the
purpose of the business review is to inform
members of the company and help them assess
how the directors have performed their duty
 The strategic report
On 1st October 2013, the requirement to include
a business review as part of the directors’ report
was replaced with a requirement to include a
separate ’Strategic Report’ in a company’s annual
report. This applies to financial years ending on
or after 30th September 2013.
The purpose of the strategic report is to inform
members of the company and help them assess
how the directors have performed their duty.
 The strategic report
The strategic report must contain:
A fair review of the company’s business.
Principal risks and uncertainties.
Analysis of performance of the company during the year
and the position at the end of the year.
Key performance indicators.
Factors that are likely to affect the future development,
performance, and position of the company’s.
Information about environmental matters, employees,
social, community, and human rights issues.
 Narrative reporting in practice
Highlights of Deloitte’s 2013 survey (p.20):
Annual reports keep on getting longer, with a 4%
increase in overall length from 103 pages in 2012 to 107 in
2013.
The balance between narrative financial reporting and
financial statements continues to lean towards more
narrative, with the average report containing 51% narrative
in 2013.

Tesco’s 2013 annual report: total 136 pages.

The narrative section: 68 pages (50%).
Annual report length (a sample of
100 UK listed companies)
Narrative Information
Introduction to Financial Statement Analysis

What is financial statement analysis?

”Tearing apart” the financial statements

and looking
at the relationships
Who analyses financial statements?
 Internal users (i.e., management)
 External users
 Examples?
 Investors, creditors, regulatory agencies &
…
 stock market analysts and
 auditors
 Financial Statement Analysis
What do internal users use it for?
Planning, evaluating and controlling company
operations
What do external users use it for?
Assessing past performance and current financial
position and making predictions about the future
profitability and solvency of the company as well as
evaluating the effectiveness of management
 Methods of
Financial Statement Analysis

Horizontal Analysis
Vertical Analysis
Common-Size Statements
Trend Percentages
Ratio Analysis
 Horizontal Analysis

Using
Using comparative
comparative financial
financial
statements
statements toto calculate
calculate pounds
pounds
or
or percentage
percentage changes
changes inin aa
financial
financial statement
statement item
item from
from
one
one period
period to
to the
the next
next
Horizontal Analysis Example
 CLOVER CORPORATION
Comparative Balance Sheets
December 31, 2009 and 2008
Increase (Decrease)
2009 2008 Amount %
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable £ 67,000 £ 44,000 £ 23,000 52.3
Notes payable 3,000 6,000 (3,000) (50.0)
Total current liabilities 70,000 50,000 20,000 40.0
Long-term liabilities:
Bonds payable, 8% 75,000 80,000 (5,000) (6.3)
Total liabilities 145,000 130,000 15,000 11.5
Stockholders' equity:
Preferred stock 20,000 20,000 - 0.0
Common stock 60,000 60,000 - 0.0
Additional paid-in capital 10,000 10,000 - 0.0
Total paid-in capital 90,000 90,000 - 0.0
Retained earnings 80,000 69,700 10,300 14.8
Total stockholders' equity 170,000 159,700 10,300 6.4
Total liabilities and stockholders' equity £ 315,000 £ 289,700 £ 25,300 8.7
 CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2009 and 2008
Increase (Decrease)
2009 2008 Amount %
Net sales £ 520,000 £ 480,000 £ 40,000 8.3
Cost of goods sold 360,000 315,000 45,000 14.3
Gross margin 160,000 165,000 (5,000) (3.0)
Operating expenses 128,600 126,000 2,600 2.1
Net operating income 31,400 39,000 (7,600) (19.5)
Interest expense 6,400 7,000 (600) (8.6)
Net income before taxes 25,000 32,000 (7,000) (21.9)
Less income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income £ 17,500 £ 22,400 £ (4,900) (21.9)
Vertical Analysis

For
For aa single
single financial
financial
statement,
statement, eacheach item
item
isis expressed
expressed as as aa
percentage
percentage of of aa significant
significant
total,
total,
e.g.,
e.g., all
all income
income statement
statement
items
items are
are expressed
expressed as as aa
percentage
percentage of of sales
sales
Vertical Analysis Example
Common-Size Statements

Financial
Financial statements
statements that
that show
show only
only
percentages
percentages and
and no
no absolute
absolute pound
pound
amounts
amounts
Common-Size Statements
Example
 Trend Percentages
Show
Show changes
changes over
over time
time in
in
given
given financial
financial statement
statement items
items
(can
(can help
help evaluate
evaluate financial
financial
information
information of
of several
several years)
years)
Trend Percentages Example
Wheeler, Inc. provides you with the following
operating data and asks that you prepare a trend
analysis.
Trend Percentages Example

Using 2005 as the base year, we develop the

following percentage relationships.

£1,991 - £1,820 = £171

£171 ÷ £1,820 = 9% rounded
 Ratio Analysis
Expression
Expression of of logical
logical relationships
relationships
between
between items
items inin aa financial
financial statement
statement of
of
aa single
single period
period
(e.g.,
(e.g., percentage
percentage relationship
relationship between
between
revenue
revenue and
and net
net income)
income)

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