Introduction to Financial Statements Accounting is the process of: identifying measuring, and communicating economic information To permit: informed judgements and decisions by the users of the information
Introduction to Financial Statements What are the Financial Statements? • Statement of financial position (balance sheet) • Statement of financial performance (profit and loss statement) • Statement of cash flows • Notes to the accounts And attached … • Auditor’s Report • Director’s Report • Director’s Declaration
Changes to Financial Statements Introduction to Financial Statements • Profit and loss statement Statement of financial performance • structural changes • some items are in Notes, e.g. individual significant items • More disclosure, e.g. cost of sales • Balance sheet • Statement of financial position • optional structural changes • concepts redefined
Introduction to Financial Statements The statement of financial position • we own – we owe = our wealth • assets – liabilities = net assets, or shareholders equity/funds Issues for Directors – • Solvency and liquidity • Capital structure • Is the risk profile appropriate? • Accuracy of the data • How can we increase net wealth?
Introduction to Financial Statements Statement of financial position – Assets Current assets Cash Receivables Inventories Other Total current assets Non-current assets Receivables Investments Property, plant and equipment Intangibles Total non-current liabilities Total assets • Some issues: • valuation of assets • composition – the right assets • earning capacity • movements in assets
Introduction to Financial Statements Statement of financial position – Liabilities Current liabilities Accounts payable Interest-bearing liabilities Provisions Other Total current liabilities Non-current liabilities Accounts payable Interest-bearing liabilities Provisions Other Total non-current liabilities Total liabilities • Some issues: • timing of repayments • cost of borrowing • contingent liabilities • any special feature of liabilities?
Introduction to Financial Statements Watch contingent liabilities ! • Contingent liabilities are potential expenses which may or may not arise, depending upon future events. • Typically these relate to the provision of guarantees, but can also arise from tax and legal claims. • Pacific Dunlop had a vast contingent liability as a result of law suits in the US following the failure of its pacemaker leads.
Introduction to Financial Statements Statement of financial position – equity Share capital Reserves Asset revaluations Asset realisation General Foreign exchange Retained earnings Total equity • Some issues: • movements • level of reserves • dividend payouts • Is equity increasing?
Introduction to Financial Statements Statement of financial performance revenue – expenses = OPBT OPBT – tax = OPAT OPAT – dividends = retained earnings for year Statement of financial position assets – liabilities = equity
Introduction to Financial Statements Issues for Directors – Statement of financial performance • Quality / strength of revenue / profits • Future maintainable earnings • Profit margins • Depreciation, amortisation • Taxation (yes!) • Significant items – • size and effect • positive (revenue) • negative (loss, write-down)
Introduction to Financial Statements operating activities opening bank balances add or subtract cash flows from investing activities financing activities
Introduction to Financial Statements Directors’ duties re financial statements These are mandatory under the Corporations Act: • Keep accounting records • Have financial reports made out • Have accounts audited • Directors’ report • Directors’ declaration • Apply accounting standards
Introduction to Financial Statements Insolvent Trading Insolvency … unable to pay debts as and when they fall due • Duties • Defences • What incurring a debt means • Joint and several liability
ProfitProfit = Revenue – ExpensesProfit MarginProfit Margin = Profit Revenue(Indicates financial performance relative to total revenue)
Typical Expense Categories • Cost of Goods Sold • Plant • Labour • Materials • Subcontractor • Administration • Overheads • Interest Expense • Taxation Expense
Gross ContributionGross Contrbibution = Revenue – COGS(Indicates the return of Business Operations)
Earning Before Interest & TaxationEBIT = Revenue – COGS – Overheads(Indicates the performance of the business before capital structure and tax effect)
Earning Before TaxEBT = Revenue – COGS – Overheads – Interest Expense(Indicates the financial performance reported to Tax Office)
Net ContributionNet Contribution = EBT – Income TaxIndicates the overall financial performance of the business after all expenses)
How do Business Owners measure financial return…..? • Return on Revenue • Return on Assets • Return on Equity Business Owners want to know what return are they getting for their investment….?
Return on Revenue (ROR)ROR = Net Contribution Revenue Return on Assets (ROA)ROA = Net Contribution Total Assets
Return on Equity (ROE)ROR = Net Contribution Total Equity Debt to Equity RatioDebt to Equity = Total Debt Total Equity