1. CHAPTER 3 Financial Statements
Key Financial Statements
Balance sheet
Income statements
Statement of cash flows

2. Financial Statements
The Financial Statements give a snapshot of a company’s worth at the end of a particular period, as well as a view of the company’s operations and whether it has made a profit.

3. Financial Statements
Key group of people who rely on financial statements
Investors: need information to judge whether or not the company is a good investment.
Analysts: need information to develop analytical reviews for clients considering the company for investments.
Creditors: need information to determine whether to risk lending more money to the company
Competitors: need information to formulate a competitive business strategy.

4. Financial Statements
Key group of people who rely on financial statements.
Executive and Managers.
They need to know how well they are meeting or exceeding the organization’s target.
Also they need to get information about problems areas of the operations and how to improve.
They need to know how well the company is doing financially

5. Financial Statements
As well as an annual report, listed companies need to produce the following:
Interim report ( currently at the 6 month stage)
Notification of materials: events such as major business acquisitions, contracts awarded, major restructuring of business operations, etc.
Notification of major changes in the shareholdings.

6. Financial Statements
Example of Notification of materials reports

7. The annual report The Basic Parts of an Annual Reports
Chairman statement: A report from the chairman about the progress during the preceding years and prospects for the future.
Operating review: This report is by the key directors of the main divisions of the company, giving management’s view on progress. ie. The finance director and the CFO, write the finance part of the report.
Auditor’s report: a statement by the auditor regarding the findings of their audit of the company’s book 7

8. The annual report The Basic Parts of an Annual Reports
Financial statements: These include the balance sheet, income statement and the statement of the cash flows.
Notes to the financial statements: The notes give additional information about the contents of the financial statements
Corporate governance report: This report is about how the company applies the principles of good corporate behavior as outlined in the companies act.
List of major shareholders: 8

9. The annual report Balance sheet
provides a snapshot of a firm’s financial position at one point in time.
Items on firm’s Balance sheet
Assets Accounts
L-Term assets: are assets that will be held more than 12 months
Land, Buildings, Motor vehicle, Plant & Machinery, Furniture & fixtures, and etc.

10. Balance sheet: Assets Cash A/R Inventories Total CA Gross FA
Less: Dep.
Net FA
Total Assets
2009
7,282
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
2008
57,600
351,200
715,200
1,124,000
491,000
146,200
344,800
1,468,800

11. The annual report Items on firm’s Balance sheet
S-Term assets: are assets that will be used up in the next 12 months.
Inventory ( or stock) of products a company has available for sale, or to be used in manufacturing a product.
Account receivable
Cash in banks or on hand( or petty cash)
Marketable securities, shares of other companies purchase using firm’s excess funds.
Intangible assets, assets which have value to the company but difficult to measures.

12. The annual report
Items on firm’s Balance sheet
Intangible assets, assets which have value to the company but difficult to measures.
Goodwill: Arise when a company that purchase another company pays more than the actual value of its assets minus liabilities. The premium paid, which may account for things such as customers loyalty, exceptional workforce, and great location, is listed on the books as goodwill.
Intellectual property: it is a form of copyright and patents, on product or services which the company has been granted exclusive rights.

13. Balance sheet: Liabilities and Equity
Accts payable
Notes payable
Accruals
Total CL
Long-term debt
Common stock
Retained earnings
Total Equity
Total L & E
2009
524,160
636,808
489,600
1,650,568
723,432
460,000
32,592
492,592
2,866,592
2008
145,600
200,000
136,000
481,600
323,432
203,768
663,768
1,468,800

14. The annual report Items on firm’s Balance sheet Liability accounts
S-Term liabilities : include money owed in the next 12 months.
Account payable
Notes payable, it includes all the payments to banks that are due less than a year
Accruals

15. The annual report Items on firm’s Balance sheet Liability accounts
L-Term liabilities : include money due beyond the next twelve months
Loan payable: This account keep tracks of mortgages, long term financial loan, commercial papers loan.
Bond payable: This account keep tracks of corporate bonds that have been issued for a term longer than a year. Bonds are a type of debt sold on the market that must be repaid in full with interest.

16. Firm’s Long Term Financing
Long Term debt(Bond)
Bond (IOU)
“Coupon interest”
Funds (capital)
Firms
Creditors

17. The annual report
Long Term debt(Bond certificate sample)

18. The annual report Items on firm’s Balance sheet Equity accounts
Share capital. This account reflects the nominal value of the ordinary share in issue. Each share represents a portion of ownership.
Share premium. If when purchasing shares, the shareholders pay more than the nominal value, then the excess ( or premium ) is recorded in this account.
Preference shares. These shares fall between bonds and ordinary shares in terms of characteristics.

19. The annual report Items on firm’s Balance sheet Equity accounts
Retained earnings. These numbers reflect earnings retained rather than paid out as dividends to shareholders.

20. Equity Shares (ownership) “Dividend” Funds (capital) Shareholders
Firms
Shareholders

21. The annual report Income statement
summarizes a firm’s revenues and expenses over a given period of time.
Items on firm’s Income statement
Sales of goods and services ( Revenue)
Cost of goods sold: costs directly related to the sale of goods or services
Purchase discount
Purchase returns and allowances

22. Income statement Sales COGS Other expenses EBITDA Depr. & Amort. EBIT
Interest Exp.
EBT
Taxes
Net income
2009
6,034,000
5,528,000
519,988
(13,988)
116,960
(130,948)
136,012
(266,960)
(106,784)
(160,176)
2008
3,432,000
2,864,000
358,672
209,328
18,900
190,428
43,828
146,600
58,640
87,960

23. The annual report Items on firm’s Income statement
Expense accounts: Any costs not directly related to the generating revenue
Operating expanse, ie. advertising, insurance, legal and accounting fees, office expense, utilities, etc
Interest expense, interest paid on company’s debt.
Depreciation expense on tangible goods and Amortization on intangible goods.
Taxes

24. The annual report Statement of retained earnings
shows how much of the firm’s earnings were retained, rather than paid out as dividends.

25. Statement of Retained Earnings (2009)
$203,768
(160,176)
(11,000)
$32,592
Balance of retained
earnings, 12/31/08
Add: Net income, 2009
Less: Dividends paid
earnings, 12/31/09

26. Other data No. of shares EPS DPS Stock price 2009 100,000 -$1.602
$0.11
$2.25
2008
$0.88
$0.22
$8.50

27. The annual report Statement of cash flows
It gives the financial report reader a map of cash receipt, cash payments, and changes in cash that arise from the operations of the company.
In addition, the statement looks at money that flows into or out of the company through investing and financing activities.
Why we need Statement of cash flows ?
Cash is company’s lifeblood
Accrual accounting makes it hard to pinpoint exactly how much cash a company actually hold.

28. Statement of Cash Flows (2009)
OPERATING ACTIVITIES
Net income
Add (Sources of cash):
Depreciation
Increase in A/P
Increase in accruals
Subtract (Uses of cash):
Increase in A/R
Increase in inventories
Net cash provided by ops.
(160,176)
116,960
378,560
353,600
(280,960)
(572,160)
(164,176)

29. Statement of Cash Flows (2009)
(711,950)
436,808
400,000
(11,000)
825,808
(50,318)
57,600
7,282
L-T INVESTING ACTIVITIES
Investment in fixed assets
FINANCING ACTIVITIES
Increase in notes payable
Increase in long-term debt
Payment of cash dividend
Net cash from financing
NET CHANGE IN CASH
Plus: Cash at beginning of year
Cash at end of year

30. A/c data for investors and management decision
NOPAT
NOWAC
FCF
EVA
MVA

31. Net operating after taxes (NOPAT)
NOPAT = EBIT (1 – Tax rate)
NOPAT09 = -$130,948(1 – 0.4)
= -$130,948(0.6)
= -$78,569
NOPAT08 = $114,257 31

32. What effect did the expansion have on net operating working capital?
NOWC = Operating Non-interest
current assets bearing CL
NOWC09 = ($7,282 + $632,160 + $1,287,360) – ($524,160 + $489,600)
= $913,042
NOWC08 = $842,400 32

33. What effect did the expansion have on operating capital?
Operating capital = NOWC + Net Fixed Assets
Operating Capital09 = $913,042 + $939,790
= $1,852,832
Operating Capital08 = $1,187,200 33

34. Economic value added (EVA)
EVA = NOPAT – Annual dollar cost of capital
In order to generate positive EVA, a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital.
EVA takes into account the total cost of capital, which includes the cost of equity. 34

35. Sales xxx COGS (xxx) Depreciation (xxx) EBIT xxx Interest Expense (xx) xxx Tax (xx) Net Income xxx

36. What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2008 and 13% in 2009.
EVA05 = NOPAT – (A-T cost of capital) (Capital)
= -$78,569 – (0.13)($1,852,832)
= -$78,569 – $240,868
= -$319,437
EVA04 = $114,257 – (0.10)($1,187,200)
= $114,257 – $118,720
= -$4,463 36

37. Did the expansion increase or decrease MVA?
MVA = Market value __ Equity capital
of equity supplied
During the last year, the stock price has decreased 51%. As a consequence, the market value of equity has declined, and therefore MVA has declined, as well. 37

38. Equity Capital Shares Market Value Book Value x x
Current price
Shares outstanding
Initial issue price
Shares outstanding

39. Equity Capital Supplied
Initial capital supplied-IPO (RM)= 4.6/ share Equity supplied= 100,000 shares Equity supplied (RM)= 460,000

40. Market Value Equity
Market price of share= RM2.25/ share Equity outstanding= 100,000 shares Market value equity= RM225,000

41. MVA
MVA= Market value – Equity capital equity supplied = RM225,000 - RM460,000 = - RM235, ,000 – 460,000 = ≈ - 51% 460,000