1. 2-1 FINANCIAL STATEMENTS- THE BASIS OF ANALYSIS DF1 511: CORPORATE FINANCIAL REPORTING AND ANALYSIS PRESENTATION BY H ONDIGO SCHOOL OF BUSINESS UNIVERSITY OF NAIROBI 2012

2. 2-2 OBJECTIVES OF THE PRESENTATION Discuss the contents of financial Statements Discuss additional information included in financial reports Undertake analysis preview using – Comparative analysis – Common size analysis

3. 2-3 Financial Statements- the Basis of Analysis At the end of the accounting process/period, financial statements are prepared to report on the financing and investing activities at that point in time, and to summarize operating activities for the preceding period. Financial statements are the object (basis) of both accounting and financial analysis. Recall the relationships between business activities and financial statements presented in the last class

4. 2-4 Financial Statements and Business Activities

5. 2-5 Financial Statements Statement of Financial Position (Balance Sheet) Statement of Income Statement of changes in Shareholders’ Equity Statement of Cash Flows

6. 2-6 Statement of Financial Position This portrays the financial position of the business by showing what the company owns (controls) and what it owes to outsiders and owners at the report date. It is a snapshot, since it reports the company’s financial position at a specific point in time.

7. 2-7 Statement of Financial Position cont.. The Statement divided into two halves: Assets, always presented first Liabilities and Shareholders’ Equity In the standard accounting model, the formula of Assets=Liabilities + Shareholders’ Equity applies. Both halves are always in balance.

8. 2-8 Statement of Financial Position cont.. The two sides balance because, from an economic viewpoint, each dollar of assets must be “funded” by a dollar of liabilities or equity. Reported assets, liabilities, and shareholders’ equity are subdivided into line items or groups of similar “accounts” having a dollar amount or “balance.”

9. 2-9 Statement of Financial Position cont.. The Assets section includes all the goods and property controlled by the company, and uncollected amounts due (receivables) to the company from others. The Liabilities section includes all debts and amounts owed (payables) to outside parties.

10. 2-10 Statement of Financial Position cont.. The Shareholders’ Equity section represents the shareholders’ ownership interest in the company--what the company’s assets would be worth after all claims upon those assets were paid.

11. 2-11 Statement of Financial Position cont.. The Extract below shows the statement of financial position of Colgate as at December 31, 2006 and 2005

12. 2-12

13. 2-13 Statement of Financial Position Total Investing = Total Financing = Creditor Financing + Owner Financing Total Investing = Total Financing = Creditor Financing + Owner Financing

14. 2-14 STATEMENT OF COMPREHENSIVE INCOME The statement of comprehensive income should provide information about the performance of the entity. The statement of comprehensive income should include all items of income and expenses recognized in a period.

15. 2-15 STATEMENT OF COMPREHENSIVE INCOME CONT… This can be thought of more like a motion picture, since it reports on how a company performed during the period(s) presented and shows whether that company’s operations have resulted in a profit or loss.

16. 2-16 STATEMENT OF COMPREHENSIVE INCOME CONT… IAS 1 requires enterprises to present all items of income and expenses recognized in a period either (a)in a single statement of comprehensive income; or (b)in two statements; ( a separate income statement and a statement of other comprehensive income), separately from owner changes in equity

17. 2-17 The Statement of Income cont Other comprehensive incomes are items of income and expenses not recognised in profit or loss items that ordinarily would be excluded in the profit or loss for the period but affect shareholders equity. They are items that bypass the income statement but affect shareholders equity.

18. 2-18 The Statement of Income cont Examples include: changes in revaluation surplus actuarial gains and loses on defined benefit plans exchange gains (losses) arising from translating financial statements of foreign operations gains and losses on re-measuring available for sale financial assets

19. 2-19 STATEMENT OF COMPREHENSIVE INCOME CONT… A statement of income is a statement that shows the results of operations of a business entity during an accounting period. This is reflected by the revenues earned matched with the expenses incurred to generate the revenue.

20. 2-20 STATEMENT OF COMPREHENSIVE INCOME CONT… Revenue refers to increases in assets resulting from sale of goods or performance of services in the ordinary course of business. It consists of cash, claims to cash or a promise to receive cash in the future (accounts receivable).

21. 2-21 STATEMENT OF COMPREHENSIVE INCOME CONT… Revenue represents compensation for the sale of goods or performance of services. Other types of revenue may include: Sales revenue/Turnover Interest earned Dividend earned Rent earned Royalty earned

22. 2-22 STATEMENT OF COMPREHENSIVE INCOME CONT… Expenses refer to decreases in assets resulting from the costs incurred in order to earn revenue. They are measured by the amount of asset consumed or the amount of liability incurred. They may involve immediate cash payment or promises to pay in the future.

23. 2-23 STATEMENT OF COMPREHENSIVE INCOME CONT… An entity has the alternative of presenting an analysis of expenses in the profit or loss using a classification based on either the nature or their function within the entity. The guiding criteria in selecting the basis of the classification should be relevancy and reliability.

24. 2-24 STATEMENT OF COMPREHENSIVE INCOME CONT… Classification of expenses by function involves grouping expenses based on the purpose for which the cost was incurred. For example, advertising costs, depreciation of motor vehicles used for the purpose of distributing products and uncollectible debts would be classified as selling and distribution costs.

25. 2-25 STATEMENT OF COMPREHENSIVE INCOME CONT… The Extract below shows the statement of income of Colgate for the year ended December 31, 2006, 2005 and 2004

26. 2-261-26

27. 2-27 Income Statement Revenues – Cost of goods sold = Gross Profit Gross profit – Operating expenses = Operating Profit Revenues – Cost of goods sold = Gross Profit Gross profit – Operating expenses = Operating Profit Colgate’s Profitability (in $billions) $12.238 - $5.536 = $6.701 Gross Profit $6.701 - $4.5411 = $2.160 Operating profit

28. 2-28 The Statement of Changes in Owners’ Equity This statement serves as a connection between the statement of financial position (balance sheet) and the income statement by explaining the changes that have taken place in owners’ equity during the period covered. The statement of changes in equity provides information about the increase or decrease in the net assets or owners’ equity of an entity between the end of two reporting dates.

29. 2-29 The Statement of Changes in Owners’ Equity illustrative format

30. 2-30 The Statement of Changes in Owners’ Equity cont… Some companies combine the statement of income, statement of comprehensive income (statement of retained earnings), together with the statement of changes in owners’ equity as shown below for Colgate

31. 2-311-31

32. 2-32 Statement of Cash Flows The statement of cash flows reports on the company’s cash movements during the period(s) classifying them according to three activities: Operating, Investing and Financing

33. 2-33 Statement of Cash Flows cont.. The basic purpose of a statement of cash flows is to provide information about the sources and application of cash and cash equivalents of an entity. It communicates information about the financial adaptability of an enterprise for a given period of time.

34. 2-34 Statement of Cash Flows cont.. Cash comprises of cash on hand, and demand deposits (including those in foreign currencies) net of bank overdrafts. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are not subject to any significant risk of changes in value.

35. 2-35 Statement of Cash Flows cont.. They include short-term securities; investments that have a short maturity of three months or less from the specified redemption date Cash flows are inflows and outflows of cash and cash equivalents

36. 2-36 Statement of Cash Flows cont.. Unlike the statement of financial position and the statement of comprehensive income, which are required by the Companies Act, the statement of cash flows is a requirement of the International Financial Reporting Standards, International Accounting Standard No.7 in particular..

37. 2-37 Statement of Cash Flows cont.. Operating activities involve the company’s primary business activities, for example the production and delivery of goods and services. They reflect the cash effects of transactions, which are included in the determination of net income.

38. 2-38 Statement of Cash Flows cont.. Since many items enter into the determination of net income, the indirect method is often used to determine the cash provided by or used for operating activities. This method requires adjusting net income to reconcile it to cash flows from operating activities. The direct method can also be used to compute the cash flows from operating activities

39. 2-39 Statement of Cash Flows cont.. Common examples of cash flows from operating activities are: Cash Collected from customers Payments to suppliers of goods Payment for insurance Payment for Salaries and Wages Tax payments

40. 2-40 Statement of Cash Flows cont.. Investing activities include those activities relating to acquisition or disposal of non current assets, long term investments or short term investments not classified as cash equivalent Financing activities include those activities relating to the receipt and repayment of funds provided by creditors and investors. These activities include the issuance of debt or equity securities, the repayment of debt, and distribution of dividends

41. 2-41 Statement of Cash Flows cont.. The last part of the cash flow statement reflect the effect of exchange rate changes on cash as well as a reconciliation between the opening and ending cash and cash equivalents

42. 2-42 Statement of Cash Flows cont… Net Cash Flows from Operating Activities Net Cash Flows from Investing Activities Net Cash Flows from Financing Activities

43. 2-43 Statement of Cash Flows cont… The following is the general format of the statement of cash flow

44. 2-44 Statement of cash flows – Format of Presentation

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46. 2-46 Additional Information (Beyond Financial Statements) Management’s Discussion & Analysis (MD&A) Management Report Auditor Report Explanatory Notes to Financial Statements Supplementary Information

47. 2-47 Additional Information (Beyond Financial Statements) cont.. Management discussions and Analysis (MD&A)- public companies are required to highlight favorable and unfavorable trends and identify significant events and uncertainties that affect a company's liquidity, capital resources and results of operations. They must also disclose prospective information involving material events and uncertainties known to cause reported information to be less indicative of future operating activities or financial condition

48. 2-48 Additional Information (Beyond Financial Statements) cont.. Management Report: the purpose of this report is to reinforce the managements responsibilities for the companies financial and internal control systems and the shared role of management and directors in the preparation of the financial statements

49. 2-49 Additional Information (Beyond Financial Statements) cont.. Auditors Report- An external auditor is an independent certified Public Accountant hired by shareholders to provide an opinion on whether or not the company’s financial statements are prepared in conformity with the generally accepted accounting principles. Analyst should review the audit report to ascertain whether the company received unqualified (clean) opinion. Anything less than unqualified opinion increases the risk of analysis

50. 2-50 Board of Directors MSC Corporation We have audited the accompanying statement of financial Position of MSC Corporation as of 31 December 2011 and 2010, and the related statements of income, shareholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with International Auditing Sttandards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MSC Corporation at 31 December 2011 and 2010, and the results of its operations and its cash flows for the years then ended, in accordance with International Financial Reporting Standards as published by the International Accounting Standards Board. Signature of the Independent Auditor Date and Place of the Report

51. 2-51 Additional Information (Beyond Financial Statements) cont.. Explanatory notes- these play an integral part in financial statement analysis. They are a means of communicating additional information regarding items included or excluded from the financial statement. They may include information on accounting policies, commitments and contingencies, business combinations, transaction with related parties, stock options, legal proceedings, significant customers and detailed disclosures regarding individual financial statement items

52. 2-52 Additional Information (Beyond Financial Statements) cont.. Supplementary information – these are schedules on business data segments, export sales, marketable securities, short term borrowing and other quarterly financial data notes A proxy is a means whereby a shareholder authorizes another person to act for him or her at the AGM. A proxy statement contains information necessary for shareholder voting on a matter for which the proxy is solicited.

53. 2-53 Analysis Preview Purpose:Evaluation of consecutive financial statements Output: Direction, speed, & extent of any trend(s) Types:  Year-to-year Change Analysis  Index-Number Trend Analysis Purpose:Evaluation of consecutive financial statements Output: Direction, speed, & extent of any trend(s) Types:  Year-to-year Change Analysis  Index-Number Trend Analysis Comparative Analysis

54. 2-54 Analysis Preview 1-54

55. 2-55 Analysis Preview Purpose :  Evaluation of internal makeup of financial statements  Evaluation of financial statement accounts across companies Output: Proportionate size of assets, liabilities, equity, revenues, & expenses Purpose :  Evaluation of internal makeup of financial statements  Evaluation of financial statement accounts across companies Output: Proportionate size of assets, liabilities, equity, revenues, & expenses Common-Size Analysis

56. 2-56 Analysis Preview

57. 2-57 Analysis Preview

58. 2-58 THE END THANK YOU