Lecture 2 - Understanding Financial Statements. Flashcards
(22 cards)
List some users of financial statements…
- Owners
- Shareholders
- Employees
- Suppliers.
- Government
- Competitors.
What are the 4 Primary financial statements?
- Statement of profit or loss
- Statement of financial position
- Statement of changes in equity
- Statement of cash flows.
What is the statement of profit or loss and meaning (income statement):
- A measure of financial performance.
- Shows profit/loss company has made during specific period.
- Summarises all revenue and expenses over a period and evaluates a businesses ability to be profitable.
- Prepared on an “accruals” basis
Revenue - Expenses = Profit/Loss
Within the statement of profit or loss what are the 3 key sections:
- Gross profit
- Operating profit
- Profit for the year.
Gross profit: Equation and meaning.
Revenue - Cost of sales
Represents the profits made after deducting the the direct costs which have helped raise the revenue.
Operating profit: Equation, meaning and examples of operating costs.
Gross profit - Operating expenses.
Takes account of business expenses which are not directly incurred with generating the revenue.
Examples:
- Electricity, insurance, wages and depreciation.
What can operating profit also be known as?
PBIT (Profit before interest and tax)
EBIT (Earnings before interest and tax)
OP doesn’t take into account taxes, finance income and expenses.
Profit for the year: Equation and meaning.
Operating profit + profit from other activities - net finances - Tax. (all expenses)
Can be compared to previous years to analyse performance.
The total is transferred to the statement of financial position on a rolling basis each year.
Also, the balance on this account accumulated under the heading “retained earnings”
What is the statement of financial position?
Firstly, is a snapshot. Showing a businesses assets and liabilities and the difference is the equity which belongs to the owners.
Assets - Liabilities = Equity (capital)
Assets = Equity + Liabilities.
(Accounting equation).
What is the statement of Changes in equity?
Shows the change in the balance of equity for the beginning to the end of a reporting period.
3 main categories are:
- Share capital
- Share premium
- Retained earnings.
What is an annual report?
An annual report also contains a series of notes to the financial statements which carry some of the detail to explain the headline numbers.
What is the statement of cashflows?
- Summarises the cash paid and received throughout the reporting period.
- Prepared on a “cash basis”.
What does the statement of cashflows help to assess?
- Liquidity and solvency of the business
- Financial adaptability of the business.
- Future cashflows of the business
- Self-sufficiency of the business.
What 3 sections is the statement of cashflows summarised into:
- Operating activities
- Investing activities
- Financing activities
What is cash in a business?
Cash is “king” because a business can be profitable but still fail due to a lack of cash.
Potential causes for cash flow problems:
- Lack of planning.
- Overtrading (occurs when a business is expanding rapidly without having the necessary funds for the expansion)
- Poor credit control (must ensure to agreed borrowing limits and that they pay on time).
Financial statement elements:
Financial statements portray the financial effects of transactions and other events know as “items”.
- This is done by grouping them into broad classes (called “elements”) according to economic characteristics.
The elements in the statement of profit or loss are:
- Income
- Expenses
The elements in the statement of financial position:
- Assets
- Liabilities
- Equity
Recognition of financial statement elements:
- Recognition is the point at which an element is included in the financial statements.
Per the IASB Conceptual framework, an item is recognised in financial statements if :
- The item meets the definition of an element (income, expense, asset, liability or equity).
- Recognition of that element provides users of the financial statements with information that is useful i.e (relevant/faithful representation).
Statement of P or L: Elements
Income - Increase assets or decreases in liabilities that result in increase in equity, other than those relating to contributions from holders of equity claims.
Expenses - Decreases in assets or increases in liabilities which results in a decrease in equity other than those relating to distributions to holders of equity claims.
Statement of financial position: Elements
Asset - Present economic resource controlled by the entity.
Liability - Debts
Equity - The residual interest in the assets of the entity after deducuting all its liabilities.
Assets: NCA and CA
NCA:
- Long term (more than 12 months).
Examples include:
- land/buildings (tangible)
- Motor vehicles/ machinery (tangible)
- Goodwill (intangible)
- Trademarks (intangible)
- Development costs (intangible).
CA:
- less than 12 months short term, held primarily for trading.
Examples include:
- Inventory
- Cash
- trade receivables.
Liabilities: NCL and CL
NCL:
- Long term, does not expect to be repayed within 12 months.
examples;
- bank loan
- mortgage
- Long term borrowings.
CL:
- expect to repay within 12 months.
Examples:
- Trade payables
- Short term borrowings.
- Bank over draft
- Accruals
