Corporations and their Financial Statements Flashcards
(16 cards)
1
Q
Why are financial statements important for investment decisions?
A
- Before investing in any company’s stocks or bonds, you should be able to interpret its financial statements correctly, analyze them effectively, and compare them with those of other companies.
- Financial statements act as an assessment of the company’s financial health and as an overview of its operations: they show what the company owns and how it was financed, as well as how much money it earned or lost over a given period (typically, one year).
2
Q
What three items does the financial position show and what are two ways of viewing totals of adding them up?
A
- The statement of financial position shows three items:
o Assets consist of what the company owns and what is owed to it.
o Equity represents the shareholders’ interest in the company.
o Liabilities are what the company owes. - The company’s financial position can be expressed as an equation in two ways, as shown below:
o Total Assets = Total Equity + Total Liabilities
o Total Assets – Total Liabilities = Total Equity
3
Q
What are items 1-3 PPE, goodwill and other intangible assets?
A
- The category of PP&E consists of land, buildings, machinery, tools and equipment of all kinds, trucks, furnishings, and other items used in the day-to-day operations of a business. A company’s PP&E is valuable because it is used directly in producing the goods and services the company eventually sells. Unlike current assets, which are consumed or converted by successive steps into cash, the items that make up a company’s PP&E are not intended to be sold.
o Property (except land), plant, and equipment wear out over time or otherwise lose their usefulness. Between the time that a given asset is acquired and the time when it is no longer economically useful, it decreases in value. This loss over a period of years is known as depreciation. - Goodwill is often defined as the probability that a regular customer of a company will continue to do business with that company because of its location or its reputation for fair dealing and good products. People in the habit of doing business with a firm are likely to continue that habit even when the firm changes hands. For that reason, a buyer of a business is often willing to pay for the good name of that business, or for its continued good management, in addition to the value of its assets.
- Intangible assets are non-monetary assets that do not have physical substance. They can be sold, licensed, or transferred, but they usually decline greatly in value when a company is liquidated. Some common examples are patents, copyrights, franchises, and trademarks.
4
Q
What are current assets, and what is an example of one type?
A
- Current assets are assets that will be realized, consumed, or sold in the normal course of business, typically within one year. They include inventory, prepaid expenses, and trade receivables, as well as cash and cash equivalents. Current assets are the most important group of assets because they largely determine a firm’s ability to pay its dayto-day operating expenses.
o Inventory consists of the goods and supplies that a company keeps in stock. For example, a furniture manufacturer that sells chairs to Trans-Canada Retail would have inventories of raw materials (the fabric and wood used to build the chairs), work-in-progress (the assembled chair frames), and finished goods (the completed chairs ready for shipping).
o Prepaid expenses are payments made by the company for services to be received in the near future. Prepaid expenses are the equivalent of cash because they eliminate the need to pay cash for goods or services in the immediate future.
o The trade receivables category represents money owing to a company for goods or services it has sold.
o The cash and cash equivalents category represents cash on hand, funds in the company’s bank accounts, or funds held in short-term investments. These items hold minimal risk of a change in value and are readily convertible into cash.
5
Q
Explain items 11-13, share capital, retained earnings, and non-controlling interest:
A
- Share capital is the money paid in by shareholders. This is the amount received by the company for its shares at the time that they were issued.
- Retained earnings represent the profits earned over time that have not been paid out as dividends—in other words, the portion of annual earnings retained by the company after payment of all expenses and the distribution of all dividends.
- Non-controlling interest appears as a category when a company owns more than 50% of a subsidiary company and consolidates its financial statements. In other words, the company combines all the assets, liabilities, and operating accounts of the parent company with those of its subsidiary or subsidiaries into a single joint statement. However, the part of the subsidiary that is not owned by the parent company is shown in the statement of financial position as non-controlling interest. This item is the interest or ownership that outsiders have in the subsidiary company.
6
Q
What are non-current liabilities?
A
- The long-term debt of a company is debt that is due in annual instalments over a period of years, or else in a lump sum in a future year. The most common of these debts are mortgages, bonds, and debentures.
- The deferred tax liabilities category represents income tax payable in future periods. These liabilities commonly result from temporary differences between the book value of assets and liabilities as reported on the statement of financial position and the amount attributed to that asset or liability for income tax purposes.
7
Q
What are current liabilities?
A
- For the most part, current liabilities are debts incurred by a company in the ordinary course of its business that must be paid within the company’s normal operating cycle (typically, one year).
o Current portion of long-term debt due in one year
o Taxes payable to the government in the near term
o Trade payables (unpaid bills for items such as raw materials and supplies)
o Short-term borrowings from financial institutions
8
Q
What is the statement of comprehensive income and what three factors does it reveal?
A
- The statement of comprehensive income shows how much money a company earned during the year compared to how much money it spent. The difference between the two amounts is the company’s profit or loss for the year, out of which dividends may be paid to the shareholders.
- The statement of comprehensive income reveals the following information about a company:
o Where earnings come from
o Where earnings go
o The adequacy of earnings, both to assure the successful operation of the company and to provide income for the holders of its securities
9
Q
The statement of comprehensive income has three sections, what are these, and explain them each?
A
- Revenue is a key figure in the statement of comprehensive income. It consists of income made from the sale of products or services.
- Expenses that arise in producing the income received from the sale of the company’s products or services are deducted from revenue. The first such deduction, in the case of a manufacturing or merchandising business, is termed cost of sales. This item includes costs of labour, raw materials, fuel and power, supplies and services, and other kinds of expenses that go directly into the cost of manufacturing, or in the case of a merchandising company, expenses that go directly into the cost of goods purchased for resale.
- After deducting the cost of sales from the amount of revenue we have the company’s gross profit figure for the period. This figure is significant because it measures the margin of profit or spread between the cost of goods produced for sale and revenue. When the percentage of gross profit to revenue is calculated and compared with those of other companies engaged in the same line of business, it provides an indication of whether the company’s merchandising operations are more or less successful in producing profits than its competitors. Between different companies in the same business, differences in the margin of gross profit generally reflect differences in managerial ability.
10
Q
What is other income and other expenses in the statement of comprehensive income?
A
- Generally, a company has two main sources of income, revenue and other income. Revenue is derived from the sale of products or services, whereas other income is not directly related to a company’s normal operating activities. This category includes dividends and interest from investments, rents, and sometimes profits from the sale of PP&E.
- After other income is added to gross profit, the following general expenses are deducted:
o Distribution costs, including such expenses as advertising costs and salaries and commissions to sales personnel
o Administrative expenses, including office salaries, accounting staff salaries, and office supplies
o Other expenses not directly related to the company’s normal operating activities, including expenses associated with the sale of PP&E
o Finance costs in the form of interest payments on debtholders’ securities or loans to the company
11
Q
What are retained earnings?
A
- Retained earnings are the profits a company keeps instead of paying them out as dividends. Retained earnings are money the company reinvests into itself — for growth, new projects, paying off debt, etc. The more the company reinvests successfully, the more valuable your shares can become over time. A growing retained earnings line over the years can be a sign of a healthy, growing business — especially if those earnings are being used wisely.
12
Q
What is total comprehensive income?
A
- Total comprehensive income = Net income (profit) + other gains/losses not shown on the income statement (like foreign exchange or asset revaluations). It gives a full picture of the company’s performance, beyond just net profit. It helps you understand if a company is quietly gaining or losing value in ways that don’t appear in the usual income statement. When evaluating a company’s long-term potential, this is useful to see the real economic impact of all changes, not just from operations.
13
Q
What is the statement of cash flows and what sorts of questions can it help to answer?
A
- The statement of cash flows shows how a company generates and uses cash over a given period. It helps evaluate a company’s liquidity (ability to pay short-term obligations) and solvency (ability to survive long term), providing insight into the company’s financial health beyond just profits on the income statement. The assessment should address the following questions:
o Can the company pay its creditors, especially in business downturns?
o Can it fund its needs internally, if necessary?
o Can it reinvest while continuing to pay dividends to shareholders? - A review of the statement of cash flows over a number of years may illustrate trends that might otherwise go unnoticed.
14
Q
What are operating, financing, and investment activities?
A
- Operating Activities These reflect the cash generated or used by the company’s core business operations—such as sales, supplier payments, and employee wages. Positive cash flow in this section is a key indicator of a company’s ability to sustain itself through its normal business functions.
- This section covers how the company raises or returns capital. Examples include: Cash inflows from issuing new shares (Item 38) or taking on new debt (Item 40). Cash outflows from repaying debt (Item 39) or paying dividends to shareholders (Item 41). This section is important to investors because it highlights changes in the company’s capital structure. Significant increases in debt or issuing new shares can signal potential risk or dilute shareholder value.
- This section shows how the company is using surplus cash to invest in itself or others. It includes: Capital expenditures like purchasing or selling property, equipment, or other long-term assets (Items 42 and 43). Dividends received from investments in associates (Item 44).
- The final part of the statement of cash flows adds together cash flows from operating, investing, and financing activities to calculate the net increase or decrease in cash for the year (Item 45). This net figure explains the actual change in the company’s cash position. The ending balance in cash and cash equivalents (Item 46) reflects this result and corresponds to the cash reported in the company’s year-end statement of financial position.
15
Q
Briefly list all the types of financial statements, what they show, and why they are important for investors:
A
check the table
16
Q
What is an annual report and what are the two most important sections?
A
- An annual report is a key document that gives shareholders and potential investors an overview of a company’s financial health, operations, and risks over the past year. It includes both narrative and financial sections that help you understand where the business stands and where it may be heading.
Check the table
