1. CHAPTER 2
FINANCIAL STATEMENTS

2. Chapter outline Introduction The objectives of financial statements
Who are the users of financial statements?
Requirements for financial statements
The standardisation of financial statements
Statement of financial position
Statement of comprehensive income
Statement of cash flows
Conclusion

3. Learning outcomes By the end of this chapter, you should be able to:
Discuss the objectives and requirements of financial statements
Identify the users of financial statements
Identify the components included in the main types of financial statements
Distinguish between the three main types of financial statements
Describe the formats of a statement of financial position, statement of comprehensive income and statement of cash flows.

4. Introduction Companies provide annual report at end of financial year
Annual report provides analysts with information
Includes a set of financial statements:
Statement of financial position
Statement of comprehensive income
Statement of cash flows
Indicates financial performance and position of company for analysis and comparison

5. The objectives of financial statements
Main objective:
Provide summary of financial position
Financial performance
Change in financial position
Financial position
Influenced by economic resources and the capital structure used to finance these resources
Evaluated by focusing on assets, liabilities and shareholders’ equity included in the statement of financial position

6. The objectives of financial statements (cont.)
Financial performance
Company’s ability to generate income with its available assets
Evaluated by focusing on the revenue and expenses provided in the statement of comprehensive income
Change in financial position
Depends on the investment, financing and operating activities during the year
The statement of cash flows provides a summary of these activities

7. Users of financial statements
Stakeholders:
Shareholders – Evaluate existing and expected performance
Management – Planning and control
Providers of debt capital – Evaluate capital structure and ability to pay interest
Government – SARS, economic statistics
Other stakeholders – Employees, clients, customers, suppliers, competitors

8. Requirements for financial statements
Understandable
Relevant
Significance
Timeliness
Accurate and objective
Comparable

9. The standardisation of financial statements
Financial statements need to be comparable
Statements of companies may not be comparable as a result of different accounting guidelines
SA companies converted to IFRS; comparison to previous years where other accounting guidelines were used may be problematic
Solution
Standardise published financial statements
Facilitates comparison between companies & over time
Simplifies the calculation of financial ratios

10. Statement of financial position
Summary of a firm’s financial position at a specific point in time

11. Statement of financial position
Current
assets
Ordinary
shares
Reserves
Preference shares
Non-controlling interest
Non-current assets
Current liabilities
Non-current liabilities

12. Assets Capital investment - apply assets to generate revenue
Two types of assets:
Non-current
Current
Distinction based on how the assets are applied, as well as the period of time over which they will be applied

13. Non-current assets PPE at cost price Accumulated depreciation
Usually indicated at original purchase price of items
Accumulated depreciation
Accumulate depreciation provided on PPE in the statement of comprehensive income
PPE at carrying value
Cost minus accumulated depreciation
Assets under construction
Asset not yet completed; no depreciation provided

14. Non-current assets Intangible assets Investment in associate
Goodwill
Other intangible assets (software, licences)
Investment in associate
Owns 20% - 50% of shares in another company
Other long-term assets
Loans granted
Share investments < 20%
Deferred tax assets
Difference in accounting and tax treatment

15. Current assets Inventories Trade and other receivables
Required for operations of a company
Trade and other receivables
Credit sales still outstanding
Short-term outstanding amounts
Short-term financial assets
Financial assets with lifetime of less than a year
Cash and cash equivalents
Other short-term assets
Assets for sale

16. Total equity
Breakdown of different forms of equity capital to finance company’s assets
Includes all capital provided by different shareholders
Important to distinguish between contributions of different types of shareholders

17. Components of total equity
Share capital
Proceeds from sale of ordinary shares to shareholders
Reserves
Share-based payments
Share repurchases
Retained earnings
Accumulation of retained profits reinvested
Preference share capital
Proceeds from the sale of preference shares

18. Components of total equity
Shareholders’ equity
Total capital invested by all shareholders
Non-controlling interest
Financial statements of subsidiary companies included

19. Liabilities Breakdown of the different forms of debt capital
Two types of liabilities:
Non-current liabilities
Current liabilities
Distinction based on the period over which the debt capital is obtained

20. Non-current liabilities
Long-term debt capital
Interest-bearing borrowings
Long-term loans
Mortgages
Debentures
Post-retirement obligations
Deferred tax liabilities

21. Current liabilities Short-term debt capital Trade and other payables
Outstanding amount on credit purchases
Other short-term obligations
Short-term debt
Loans redeemed in the next financial year

22. Current liabilities Short-term financial liabilities
Tax payable to SARS
Bank overdraft
Other current liabilities
Liabilities in disposal groups, short-term provisions, short-term deferred income

23. Statement of comprehensive income
Summary of financial performance for the financial year matching income and expenses
Income:
Turnover
Operating income
Investment income
Non-recurring income
Other

24. Statement of comprehensive income (cont.)
Expenses:
Cost of sales
Operating expenses
Non-recurring expenses
Finance cost
Taxation
Non-controlling interest
Preference dividends
Ordinary dividends

25. Statement of comprehensive income (cont.)
EXPENSES
RETAINED
PROFIT

26. Cost of sales and services rendered (88 508) (74 634) Gross profit
2009
2008
(R million)
Turnover
Cost of sales and services rendered
(88 508)
(74 634)
Gross profit
49 328
55 309
Other operating income
1 021
635
Operating expenses
(25 681)
(22 128)
Operating profit
24 666
33 816
Investment income
2 060
989
Finance cost
(1 917)
(1 145)
Profit before tax
24 809
33 660
Tax
(10 480)
(10 129)
Profit after tax
14 329
23 531
Non-controlling interest
(67)
(1 111)
Preference share dividends
(614)
(3)
Attributable earnings
13 648
22 417
Ordinary dividends
(7 193)
(5 766)
Retained earnings (for the year)
6455
16651

27. Statement of comprehensive income components
Turnover
Income received for products or services rendered by the company during the financial year
Cost of sales and services rendered
All costs directly incurred to generate turnover
Purchases of inventory, transport costs, customs, etc. incurred to deliver products to customers
Gross profit
Turnover minus cost of sales
Profit generated by sales activities of company

28. Statement of comprehensive income components
Other operating income
Income items not part of the sales activities of the company, but which are generated as part of the operating activities
Operating expenses
Expenses incurred to support primary activities
Includes depreciation, employee costs, research and development, operating lease charges, etc
Operating profit
Profit resulting from primary activities of business
Excludes income items not part of the business’s normal activities

29. Statement of comprehensive income components
Investment income
Income generated by financial investments
Dividends & interest received
Finance cost
Interest paid on debt financing
Profit before tax
Tax
Tax calculated on the profit before tax
Profit after tax

30. Statement of comprehensive income components
Non-controlling interest
Portion of profit that belongs to non-controlling interest shareholders
Preference share dividends
Dividends paid to preference shareholders
Preference above ordinary dividends
Attributable earnings
Portion of profit left after all expenses have been allocated
Important to the ordinary shareholders: amount available for ordinary dividend payments

31. Statement of comprehensive income components
Ordinary share dividends
Total amount paid to ordinary shareholders in the form of dividends
Retained earnings
Portion of profit not paid out as dividends to shareholders but reinvested
Transferred to reserves of business and used to finance business’s activities
Earnings still belongs to shareholders – included as part of shareholders’ equity

32. Statement of cash flows
Summary of a firm’s cash flows for the financial year
Three major categories:
Cash from operating activities
Cash from investing activities
Cash from financing activities

33. Statement of cash flows
CASH FROM OPERATING ACTIVITIES
CASH FROM INVESTING ACTIVITIES
CASH FROM FINANCING ACTIVITIES
CASH AT BEGINNING OF YEAR
MOVEMENT IN CASH DURING THE YEAR
CASH AT END OF YEAR + =
+ / -

34. Statement of cash flows
2009
2008
(R million)
Cash received from customers
Cash paid to suppliers and employees
(96 776)
(88 712)
Cash generated by operating activities
48 187
34 740
Finance income received
2 264
957
Finance expenses paid
(2 168)
(2 405)
Tax paid
(10 252)
(9 572)
Cash available from operating activities
38 031
23 720
Dividends paid
(7 193)
(5 766)
Cash retained from operating activities
30 838
17 954

35. Statement of cash flows
2009
2008
(R million)
Additions to assets under construction
(13 047)
(8 671)
Additions to other intangible assets
(126)
(17)
Non-current assets sold
697
184
Acquisitions of businesses
(30)
(431)
Disposal of businesses
3 486
693
Purchases of investments
(89)
(42)
Proceeds from sale of investments 7
Other cash flows from investing activities
(917)
(393)
Cash flow from investing activities
(12 518) (10 844)

36. Statement of cash flows
2009
2008
(R million)
Share capital issued
1 189
475
Share capital repurchased
(1 114)
(7 300)
Proceeds from long-term debt
5 575
3 806
Repayments of long-term debt
(4 820)
(4 588)
Proceeds from short-term debt
280
1 942
Repayments of short-term debt
(2 091)
(2 292)
Other
(212)
(458)
Cash flow from financing activities
(1 193) (8 415)
Translation effect of foreign operations
(870)
(448)
Increase/(decrease) in cash and cash equivalents
16 257
(981)
Cash and cash equivalents at the beginning of the year
4 335
6 088
Cash and cash equivalents at the end of the year

37. Cash flow from operating activities
Cash generated from normal operating activities of the company
Cash received from customers
Cash amount that customers paid for products sold and services rendered
Cash generated by operating activities
Cash received from customers minus cash paid to suppliers and employees

38. Cash flow from operating activities (cont.)
Finance income received on investments
Finance expenses paid on interest-bearing debt capital
Tax paid in cash
Cash available from operating activities
Indicates if sufficient cash flow was generated to afford a dividend payment
Negative value: indicates that cash dividend can only be afforded if cash is obtained elsewhere

39. Cash flow from operating activities (cont.)
Dividends paid
Cash payment of preference and ordinary dividends
Cash retained from operating activities
Negative operating cash flow – no surplus cash flow available to invest in replacement and expansion of assets
Additional cash has to be generated from financing activities or company may have to sell assets to finance cash deficit
Consistent failure to generate positive cash flow can be seen as indicator of serious financial problems

40. Cash flow from investing activities
Additions to PPE, to assets under construction & to other intangible assets
Cash incurred to purchase additional assets
Non-current assets sold
Cash proceeds from sale of non-current assets
Acquisitions of businesses & disposal of businesses
Cash effect of acquiring & selling business units
Proceeds from sale of investments and purchases of investments
Cash result of increases & decreases in investment

41. Cash flow from financing activities
New share capital issued
Cash inflow
Share capital repurchased
Cash outflow
New long-term debt obtained
Repayments of long-term debt
Proceeds from short-term debt and repayments of short-term debt
Cash inflows and outflows respectively

42. Conclusion
The main objectives of financial statements are to provide information about the financial position, financial performance and changes in the financial performance of a company.
The users of financial statements include the existing and potential shareholders; providers of debt capital; the management of the company; government; and other stakeholders.
The requirements for financial statements are that they should be understandable, relevant, accurate, objective and comparable.

43. Conclusion (cont.)
It is sometimes necessary to standardise the published financial statements of a company to ensure that they are comparable with other companies, and over time.
The statement of financial position provides a summary of a company’s financial position on a specific date. The statement consists of two parts: the asset side, and the equity and liabilities side. The asset part provides an indication of the specific assets that the company owns. The equity and liability part contains the different sources of capital used to finance these assets.

44. Conclusion (cont.)
The statement of comprehensive income provides a summary of a company’s financial performance over a period of time. Within a statement of comprehensive income the turnover generated during the financial year is allocated to the different stakeholders up to a point where only retained earnings are left.
The statement of cash flows provides a summary of a business’s ability to generate cash and the application of cash (i.e. how the cash is used). A distinction is made between the cash results of operating, investing and financing activities.