Lecture Notes- Financial Statements

Financial Statements

Companies’ are required by law to publish their financial statements annually. This is because financial statements are used by a wide range of users and therefore they need to give accurate information to these users. Financial statements also need to be comparable and provide basic information to users.( FTC Kaplan 2007)

Financial statements on the whole are designed to provide overall picture of the financial position and performance of a business. To provide this overall picture most accounting systems provide 3 main financial statements, each of which deal with answering the following

·         What cash movement took place over a particular period?

·         How much wealth (profit) was generated by the business over a particular period?

·         What is the accumulated wealth of the business at the end of a particular period?

These questions are addressed by the three financial statements, each of which deals with one of them. The financial statements produced are

·         Balance Sheet

·         Profit and Loss account

·         Cash flow statement

Users of Financial Statements

Customer

To assess the ability of the business to continue in business and to supply the needs of customers

Competitors

To assess the threat to sales and profits posed by those business. To provide benchmark against which the competitors’ performance can be measured

Shareholders

The primary concerns of these is with receiving adequate return on their investments

Creditors

They are concerned with the security of the debt or loan

Management:

They are concerned with the trend and level of profit, since this is the main measure of their success

Lenders

To assess the ability of the business to meets its obligations and to pay interest and to repay the amount borrowed

Employees

To assess the ability of the business to continue to provide employment and reward employees for their labour

Suppliers

To assess the ability of the business to pay for the goods and services provided

Government

To assess how much tax

                                                                  

Other potential users include

·         Bank managers

·         Financial institutions

·         Professional advisors to investor

·         Financial journalist and commentator

The Balance Sheet

This set out the financial position of a business at particular point in time. It also reveals the forms in which the wealth of the business is held and how much wealth is held in each form.

The Balance Sheet also sets out the assets of the business on one hand and claims against the business on other hand ( Peter Atrill et al 2002)

In a nut shell the Balance Sheet reveals the financial position, the wealth as well as the assets held by a business.

Parts of Balance sheet

Fixed Assets

This deals with:

Tangible assets- Buildings, fittings and fixtures, machinery

Intangible assets- Patents, Trademarks, Brand names, Goodwill,

Current Assets

This deals with:

·         Cash at hand and at bank

·         Debtors/ receivables

·         Inventories/stocks- raw materials, work in progress, finished goods

Current Liabilities

Long term and short – loans, creditors, overdraft etc

Profit and Loss account (Income Statement)

This measures and reports on the profit (wealth) the business has generated over a period. The measurement of profit requires that the total revenues of the business generated during a particular period be calculated.

Revenue is the measure of inflow of assets that arises as a result of trading operations. Different forms of business enterprises will generate different forms of revenue. Some examples of different forms of revenues are

·         Sales of goods- manufacturer

·         Fees for services- a solicitor

·         Subscription – clubs

·         Interest received- investment funds

Expense- this represents the outflow of assets incurred as a result of generating revenue.

Examples of some common types of expense are:

·         Cost of goods sold/ cost of sale

·         Salaries and wages

·         Rents and rates

·         Insurances

·         Heat and light

The P and L account shows the total revenue generated during a particular period and deducts from this the total expense incurred in generating that revenue. The difference between the total revenue and the total expenses will represent either profit or loss. (Peter Atrill et al 2002)

Format for P & L

Sales

Less cost of sales

Opening stock

Closing stock

Gross profit

Less expense

Salaries & wages

Rents and rates

Insurance

Loan interest

Depreciation

Net profit

Cash flow statement

This is the summary of cash receipts and payment over the period concerned. It shows a business’ source of cash and how that cash is used.

Standard and layout

Net cash flow from operating activities

                                          Returns from investment and servicing finance

      Taxation

                                      

                    

Capital expenditure (asset)

                                                                       

                                                        

Equity dividend paid

                                                

Management of liquid resources

 

              

                                                Increase or decrease in cash over the period

Various parts of Cash flow statements

(1)Net cash flow operating activities

·         This deals with the operating activities

·         And cash sales or cash from debtors

(2) Returns from investment

·         This deals with fixed return finance e.g. interest bearing loans, preference, dividends, interest

(3)Taxation

·         Corporate tax - Companies pay tax in 2parts-50% in current year and 50% at the end of the year.

(4) Capital expenditure

·         Cash payment for additional assets

·         Cash receipts from disposable fixed assets

·         It could be loan made by the business

·         Shares in other companies

(5) Equity dividend paid

·         Payment made to ordinary shareholders

(6) Management of liquid resource

·         Short term cash

(7) Financing long term loan

Additional Financial Data

In addition to the above 3 financial statements businesses also publish the following statements

·         Auditor’s report

·         Director’s report

·         Chairman’s report.

References

1.       Atrill, Peter et al, 2002, 2^nd edition - Accounting: An Introduction, Prentice Hall, England