Introduction to Financial Statements

Accounting is the process of:identifyingmeasuring, andcommunicating 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 flowsNotes to the accounts

And attached …

Auditor’s ReportDirector’s ReportDirector’s Declaration

Changes to Financial Statements

Profit and loss statementStatement of financial performance

• structural changes• some items are in Notes, e.g. individual significant items• More disclosure, e.g. cost of sales

Introduction to Financial Statements

Balance sheetStatement of financial position• optional structural changes• concepts redefined

Introduction to Financial Statements

The statement of financial position

we own – we owe = our wealthassets – liabilities = net assets, or

shareholders equity/funds

Issues for Directors – Solvency and liquidityCapital structure Is the risk profile appropriate?Accuracy of the dataHow can we increase net wealth?

Introduction to Financial Statements

Current assetsCashReceivables

InventoriesOther

Total current assets

Non-current assetsReceivablesInvestmentsProperty, plant and equipmentIntangibles

Total non-current liabilities

Total assets

Statement of financial position – Assets

Some issues:•valuation of assets•composition – the right assets•earning capacity•movements in assets

Introduction to Financial Statements

Current liabilitiesAccounts payableInterest-bearing liabilitiesProvisionsOther

Total current liabilities

Non-current liabilitiesAccounts payableInterest-bearing liabilitiesProvisionsOther

Total non-current liabilities

Total liabilities

Some issues:•timing of repayments•cost of borrowing•contingent liabilities•any special feature of liabilities?

Statement of financial position – 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

Share capital

ReservesAsset revaluationsAsset realisationGeneralForeign exchange

Retained earnings

Total equity

Statement of financial position – 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

opening bank balances

operatingactivities

investingactivities

financingactivities

add or subtractcash flows from

Introduction to Financial Statements

Directors’ duties re financial statements

These are mandatory under the Corporations Act:

Keep accounting recordsHave financial reports made outHave accounts auditedDirectors’ reportDirectors’ declarationApply 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 – Expenses

Profit 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 Contribution

Gross Contrbibution = Revenue – COGS

(Indicates the return of Business Operations)

Earning Before Interest & Taxation

EBIT = Revenue – COGS – Overheads

(Indicates the performance of the business before capital structure and tax effect)

Earning Before Tax

EBT = Revenue – COGS – Overheads – Interest Expense

(Indicates the financial performance reported to Tax Office)

Net Contribution

Net Contribution = EBT – Income Tax

Indicates 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 ContributionRevenue

Return on Assets (ROA)

ROA = Net ContributionTotal Assets

Return on Equity (ROE)

ROR = Net ContributionTotal Equity

Debt to Equity Ratio

Debt to Equity = Total Debt Total

Equity