Reading Financial Statements

Course Instructor – Scott

About Scott...

Scott is a CFI founder and the company’s Chief

Content Officer. Now based in Vancouver, Scott
spent a significant portion of his career in London,
New York, and Hong Kong. Scott has a passion for
teaching with over 25 years of experience designing
and delivering learning solutions for firms in the
financial services sector – particularly in the areas of
commercial banking, investment banking, capital
markets, and asset management. Some of the
companies he has worked with over his career include
Bank of America Merrill Lynch, BCI, Credit Suisse,
Deutsche Bank, HSBC, ING, JP Morgan, Royal Bank of
Scott Powell Scotland, and TD Bank, to name but a few.
Chief Content Officer

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Learning Objectives

Outline the contents of an annual Explain a company’s operations and Identify the many risk factors a
report. business strategy. company must navigate.

Analyze company financial Read and comprehend the Review the notes to the financial
statements, as well as its different Management Discussion & Analysis statements for additional detail.
business segments. (MD&A) section.

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Understanding the Annual Report
The Benefits of an Annual Report
Publicly traded companies and many other organizations publish an annual report after the end of their fiscal year.

Financial Operational Strategic

• Messages from the Chair,

• Management discussion & • Growth and investment
CEO
analysis (MD&A) plans
• Corporate profile
• Financial statements • Cost-cutting initiatives
• MD&A
• Notes to financial • Human capital strategy
• Risk and control processes
statements • Acquisitions outlook
and analysis

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Contents of an Annual Report

01. 02. 03. 04. 05.

Management’s
Letter to the Business Reporting on
Discussion and Audit report
shareholders description internal controls
Analysis (MD&A)

06. 07. 08. 09.

Balance sheet,
Income Notes to the Listing of
Statement, and financial Earnings per share directors of the
Statement of statements company
Cash Flows

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Understanding Financial Statements
The Three Main Financial Statements

Income Statement Balance Sheet Cashflow Statement

Statement of operation / Statement of financial Statement of cash
profit and loss position flows

Revenues Liabilities Operating

Assets
Expenses Investing
Equity

Profit or loss Financing

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Balance Sheet

Cashflow
Income
Balance
Statement
Statement
Sheet Represents a snapshot of the
Statement
Statement
Statementof
ofoperation
cash /
of financial financial position of the
profit
flowsand loss
position company at a point in time.

Operating
RevenuesLiabilities

Assets
Investing
Expenses
Equity Important component of
determining the financial
Financing
Profit or loss
strength of a company.

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Balance Sheet

Contains the transactions of a

Cashflow
Balance
IncomeSheet
Statement
Statement
company over a period of
Statement
Statement
Statement of
ofoperation
cash
of financial / time (quarterly or annual).
profit
flows
positionand loss

Operating
Revenues
Liabilities

Assets
Investing
Expenses
Equity Uses accrual accounting
rules to show all revenues and
Financing
Profit or loss expenses.

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Balance Sheet

Categorizes cash flows by

Income
Cashflow
Balance
Statement
Sheet
Statement
operating, investing, or
Statement
Statement
of operation
Statement of cash
/
of financial financing activities.
profitposition
andflows
loss

Revenues
Operating
Liabilities

Assets
Expenses
Investing
Equity Closing cash balance will
match the balance on the
Profit or
Financing
loss balance sheet.

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Simplified Balance Sheet

Assets Liabilities
Current assets Current Liabilities
Expected to Expected to be
Cash 20,000 Accounts payable 2,000
convert into paid in<1 year
cash <1 year Accounts receivable 3,000 Accrued expenses 1,000
Inventory 60,000 Total current liabilities 3,000
Prepaid expenses 11,000 Non-current liabilities
Expected to be
Total current assets 94,000 Bank loan 111,000
paid in > 1 year
Non-current assets Shareholders’ Equity
Expected to be
Property Plant & Equipment 110,000 Common shares 89,000
held > 1 year
Intangible assets 10,000 Retained earnings 11,000
Total non-current assets 120,000 Total common equity 100,000
Total assets 214,000 Total liabilities & Equity 214,000

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Investments

A company will hold external investments for two

reasons:
v
 Excess cash
 Accumulating cash to make a large purchase Short Term
(less than year)

or

Long Term
Companies may also make internal investments.
(more than year)
v
Joint venture Subsidiary

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Investments

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Investments

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Deferred Taxes

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Deferred Taxes

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Deferred Taxes

Example:
Tax Rules Accounting Rules

Accounting income
+ Accounting depreciation (straight-line method)
- Tax depreciation (declining method)
Taxable income
Taxable Accountable
Income Income

If the deduction will be allowed in the The difference is the basis for deferred
future, there will be a timing difference, income taxes (future income taxes) and
and a deferred tax will be recorded. is recorded on the balance sheet.

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Goodwill

If a company is purchased for more than the Goodwill:

fair value of net assets (assets less liabilities):
i.e., brand, customers, intellectual capital

Purchase price x
Fair value of net assets acquired (x)
 Intangible value
Goodwill x  Non-current assets
 Measured annually

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Intangible Assets
Intangible assets are assets that are used to generate revenue but have no physical substance.

Trademarks
(i.e., Coca Cola trademark,
Nike swoosh).
Intangible Assets:

Patents
 Appear on the balance sheet
 Amortized, like PP&E

Copyrights

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Deferred Revenue
Deferred revenue, also known as unearned revenue, arises when a company sells something it has not yet delivered.

Deferred
Revenue

Revenue

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Common vs. Preferred Shares

Common Shares: Preferred Shares:

Allows for participation in the profits of the Offers investors a fixed dividend.
company.
- It may or may not only be paid annually
- Comes in the form of dividends

Allows for voting rights in a company. Will accumulate/pay before common share
dividends.
- One vote for every share held

If dissolved, any residual amount after Usually carries no voting rights in a

everyone else has been paid goes to company.
common shareholders.

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Authorized Shares vs. Outstanding Shares

Authorized Outstanding
Shares Shares

The total number The total number

of shares a of shares a
company can sell. company has sold.

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Contributed Surplus
Another item that may appear in the equity section of a company's balance sheet is contributed surplus or paid-in capital.

Example:

180,000 Shares
Contributed 40¢/each
Surplus 25¢/par

Par Receives How would this be shown on

their balance sheet?

Paid-up share capital (180,000 x 25¢) $45,000

Contributed surplus (180,000 x 15¢) $27,000

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Par Value & Contributed Surplus
Starbucks has shares with a par value of 1/10th of a cent.

Authorized vs Outstanding

2.4000 billion shares authorized

1.1426 billion shares outstanding

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Accumulated Other Comprehensive Income
AOCI represents certain gains and losses a company may have that are not recorded through the income statement.

AOCI Example:

Unrealized gains and losses on

hedging instruments.

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Noncontrolling Interests
Some companies will recognize noncontrolling interest on the balance sheet, with a corresponding expense on the income
statement.

Check our Accounting for Business

Combinations & Other Equity
Investments course for more on
noncontrolling interest.

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The Full Disclosure Principle
A critical part of reading a set of financial statements relates to the notes that accompany them.

Explains how inventory is

recorded.

Describes what is included

in deferred taxes.

Notes allow the reader to make more informed

judgments on the financial activities of the company.

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Significant Accounting Policies
One of the most important financial statement notes is the significant accounting policies note.

Company How inventory &

Financial
accounting investments are
instruments
standards valued

How revenue is How PP&E is Any other

recognized amortized policies

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Income Statement & Cashflow Statement
Introduction to the Income Statement

The Income Statement

Contains transactions of a company

Income Statement over a period of time.
Statement of operation /
profit and loss
Starts with a zero balance and contains
transactions affecting revenues and expenses.
Revenues

Summarizes revenue, expenses, and net profit

Expenses
after amortization, interest, and taxes.

Profit or loss
The importance of the income statement is in
showing the profitability of the company.

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Cost of Sales
Cost of goods sold may also be referred to as cost of sales, which is the description normally given in a service-based
industry.

Direct Materials
(I.e., materials used in manufacturing)

Direct Labor
(I.e., professional services delivered)

Other Allocations
(I.e., overhead, costs related to production)

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Selling, General and Administrative Expenses
SG&A contains a large number of expense items that are all grouped into one line item on the income statement.

Advertising and Legal, insurance,

Office Other related
promotion and accounting Rent
supplies expenses
costs expenses

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Gains and Loses
Gains and losses may be shown separately or may be grouped under other income and expenses.

They are related to activities that are incidental to

the operations of the business, such as:

Sale of investments

Check our Accounting for Business

Combinations & Other Equity
Financial instrument transactions Investments course for more on
equity investees and income from
associates.

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Introduction to the Cashflow Statement

The Cashflow Statement:

Organizes all transactions that affect cash to

Cashflow Statement arrive at the net cash movement for the year.
Statement of cash
flows
The closing cash balance will match the cash
reflected on the balance sheet.
Operating

Shows where cash is being generated and

Investing
where it's being used in the business.

Financing
Transactions are sorted by operating activities,
investing activities, and financing activities.

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Operating Activities

Cashflow Statement
Statement of cash
flows
Day-to-day Business Operations
Operating Includes revenues and expenses that have
been collected and paid during the year.
Investing

Financing

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Investing Activities

Cashflow Statement
Statement of cash
flows

Operating

Non-current assets that support the business

Investing Includes property, plant & equipment, as
well as business acquisitions.
Financing

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Financing Activities

Cashflow Statement
Statement of cash
flows

Operating

Investing

Transactions regarding shares or debt

Financing A company raises funds by either borrowing
or issuing shares.

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Direct vs Indirect Method

Direct Method Indirect Method

Operating Activities Operating Activities
Cash collected from customers Net income
Cash paid to suppliers Add back depreciation & amortization
Cash paid to employees Adjust change in working capital balances
Cash flow from operating activities Cash flow from operating activities
Investing Activities Investing Activities
Purchase of equipment Purchase of equipment
Disposal of property Disposal of property
Cash flow from investing activities Cash flow from investing activities
Financing Activities Financing Activities
Issuance of shares Issuance of shares
Repayment of debt Repayment of debt
Cash flow from financing activities Cash flow from financing activities
Net movement in cash Net movement in cash
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Course Summary