Finance for non-Finance Executives The Concept of Responsibility Centres Functional Classification 1. Inve Invest stm ment ent cent center ers s 2. Cost cente enters rs 3. Reve Revenu nue e cen cente ters rs 4. Pro Profit fit cent cente ers The Principles for Responsible Investment will contribute to improved corporate performance on environmental, social and governance issues. Financial Responsibility 1. Become Become knowledgea knowledgeable ble requirements.
of,
and
follow, follow,
applicable applicable
financia financiall
standards standards
and
2. Apply sound sound financial financial practices practices and ensure ensure transparen transparency cy in financial financial dealings. dealings. 3. Active ively prom romote and practice ice resp esponsible ible fin financial ial behavior throu roughout supply chain.
the
Financial Statements Finan Financia ciall statem statement ents s provid provide e inform informatio ation n of value value to compan company y officia officials ls as well well as to various outsiders, such as investors and lenders of funds. Publicly owned companies are requir required ed to period periodica ically lly publish publish genera general-pu l-purpo rpose se financi financial al statem statement ents s that that includ include e a balance sheet, an income statement, and a statement of cash flows. Some companies also issue a statement of stockholders' equity and a statement of comprehensive income, which provide additional detail on changes in the equity section of the balance sheet. Financial statements provide an overview of a business' financial condition in both short and long term. There are four basic financial statements : 1. Balanc Balance e sheet sheet: also also referre referred d to as statem statement ent of finan financial cial position position or conditi condition, on, reports on a company's assets, liabilities and net equity as of a given point in time. 2. Incom Income e statem statement ent: also also referre referred d to as Profit Profit and Los Loss s statem statement ent (or a "P&L") "P&L"),, reports on a company's results of operations over a period of time. 3. Statemen Statementt of retained retained earnings: explains the changes changes in a company's company's retained earnings over the reporting period. 4. Statemen Statementt of cash flows: reports on a company's company's cash flow activities, activities, particularly particularly its operating, investing and financing activities. For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and management discussion and analysis. The
notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.
Purpose of financial statements "The "The object objective ive of financia financiall statem statement ents s is to provid provide e inform informati ation on about about the financi financial al strength, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." [2] Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities and equity are directly related to an organization's financial position. Reported income and expenses are directly related to an organization's financial performance.
Finan Financia ciall statem statement ents s are intend intended ed to be unders understan tandab dable le by reader readers s who have have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."
1. Owners and Managers require require financial financial statemen statements ts to make make important important business business decisions that affect its continued operations. Financial analysis are then performed on these statements statements to provide provide managem management ent with a more detailed understandin understanding g of the figur figures es.. Thes These e statem statemen ents ts are are also also used used as part part of mana managem gemen ent' t's s repo report rt to its stockholders, as it form part of its Annual Report. 2. Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings. 3. External Users are potential investors, banks, government agencies and other parties who are outside the business but need financial information about the business for a diverse number of reasons. Prospective Investors make use of financial statements to assess assess the viabili viability ty of invest investing ing in a busin business ess.. Finan Financia ciall analy analyses ses are often often used used by investors and is prepared by professionals (financial analysts), thus providing them with the basis in making investment decisions. 4. Financial Institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.
5. Government Entities (tax authorities) need financial statements to ascertain the
notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.
Purpose of financial statements "The "The object objective ive of financia financiall statem statement ents s is to provid provide e inform informati ation on about about the financi financial al strength, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." [2] Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities and equity are directly related to an organization's financial position. Reported income and expenses are directly related to an organization's financial performance.
Finan Financia ciall statem statement ents s are intend intended ed to be unders understan tandab dable le by reader readers s who have have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."
1. Owners and Managers require require financial financial statemen statements ts to make make important important business business decisions that affect its continued operations. Financial analysis are then performed on these statements statements to provide provide managem management ent with a more detailed understandin understanding g of the figur figures es.. Thes These e statem statemen ents ts are are also also used used as part part of mana managem gemen ent' t's s repo report rt to its stockholders, as it form part of its Annual Report. 2. Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings. 3. External Users are potential investors, banks, government agencies and other parties who are outside the business but need financial information about the business for a diverse number of reasons. Prospective Investors make use of financial statements to assess assess the viabili viability ty of invest investing ing in a busin business ess.. Finan Financia ciall analy analyses ses are often often used used by investors and is prepared by professionals (financial analysts), thus providing them with the basis in making investment decisions. 4. Financial Institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.
5. Government Entities (tax authorities) need financial statements to ascertain the
propriety and accuracy of taxes and other duties declared and paid by a company.
6. Media and the General Public are also interested in financial statements for a variety of reasons. Finan Financia ciall statem statement ents s includ include e notes, notes, which which are conside considered red an integr integral al part part of the statements. The notes contain required disclosures of additional data, assumptions and methodologies employed, and other information deemed useful to users.
The financial statements statements of publicly publicly owned owned companies companies also include include an auditor's report, indicating that the statements have been audited by independent auditors. The auditor's opinion is related to fair presentation in conformity with GAAP.
The external financial statements required for not-for-profit organizations are similar to those for business enterprises, except that there is no ownership component (equity) and no incom income. e. Not-fo Not-for-p r-prof rofit it organi organizat zation ions s presen presentt a statem statement ent of financi financial al positio position, n, a statement of activities, and a statement of cash flows. The financial statements must classify the organization's net assets and its revenues, expenses, gains, and losses based on the existence or absence of donor-imposed restrictions. Each of three classes of net assets—perma assets—permanently nently restricted, restricted, temporarily temporarily restricted, restricted, and unrestricted—must be displayed in the statement of financial position, and the amounts of change in each of those classes of net assets must be displayed in the statement of activit activities. ies. Govern Governme menta ntall bodies bodies,, which which are guided guided by the Govern Governme menta ntall Acc Accoun ounting ting Standards Board (GASB), present general-purpose external financial statements that are similar similar to those of other other not-for-pro not-for-profit fit organization organizations, s, but they classify classify their financial statements according to fund entities.
Government financial statements The rules for the recording, recording, measurement measurement and presentatio presentation n of governmen governmentt financial financial statement statements s may be different different from those those required required for business business and even for non-profit non-profit organization organizations. s. They may use either of two accounting accounting methods: methods: accrual accounting, accounting, or cash accounting, or a combination of the two. A complete set of chart of accounts is also used that is substantially different from the chart of a profit-oriented business.
1. Audit and legal implications
Although the legal statutes may differ from country to country, an audit of financial statements are usually, but not exclusively required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report.
There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them. But this may not be the case as determined by common law precedent. In Canada, auditors are liable only to investors using a prospectus to buy shares in the primary market. In the United Kingdom, they have been held liable to potential investors when the auditor was aware of the potential investor and how they would use the information in the financial statements. Nowadays auditors tend to include in their report liability restricting language, discouraging anyone other than the addressees of their report from relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability. In the United States, especially in the post-Enron era there has been substantial concern about the accuracy of financial statements. Corporate officers (the chief executive officer (CEO) and chief financial officer (CFO)) are personally liable for attesting that financial statements "do not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by th[e] report". Making or certifying misleading financial statements exposes the people involved to substantial civil and criminal liability. For example Bernie Ebbers (former CEO of WorldCom) was sentenced to 25 years in federal prison for allowing WorldCom's revenues to be overstated by 11 billion over five years. `
2. Standards and regulations Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the preparation of financial statements. Recently there has been a push towards standardizing accounting rules made by the
International Accounting Standards Board ("IASB"). IASB develops International Financial Reporting Standards that have been adopted by Australia, Canada and the European Union (for publicly quoted companies only), are under consideration in South Africa and other countries. The United States Federal Accounting Standards Board has made a commitment to converge the U.S. GAAP and IFRS over time.
3. Inclusion in annual reports To entice new investors, most public companies assemble their financial statements on fine paper with pleasing graphics and photos in an annual report to shareholders, attempting to capture the excitement and culture of the organization in a "marketing brochure" of sorts. Usually the company's chief executive will write a letter to shareholders, describing management's performance and the company's financial highlights. In the United States, prior to the advent of the internet, the annual report is considered the most effective way for corporations to communicate with individual shareholders. Blue chip companies went to great expense to produce and mail out attractive annual reports to every shareholder. The annual report was often prepared in the style of a coffee table book.
The Balance Sheet The balance sheet, also known as the statement of financial position or condition, presents the assets, liabilities, and owners' equity of the company at a specific point in time. The assets are the firm's resources, financial or nonfinancial, such as cash, receivables, inventories, properties, and equipment. The total assets equal (balance) the sources of funding for those resources: liabilities (external borrowings) and equity (owners' contributions and earnings from firm operations).
The balance sheet is used by investors, creditors, and other decision makers to assess the overall composition of resources, the constriction of external obligations, and the firm's flexibility and ability to change to meet new requirements.
Firms frequently issue a separate statement of stockholders' equity to present certain
changes in equity, rather than showing them on the face of the balance sheet. The statement of stockholders' equity itemizes the changes in equity over the period covered, including investments by owners and other capital contributions, earnings for the period, and distributions to owners of earnings (dividends) or other capital. Sometimes companies present a statement of changes in retained earnings rather than a statement of stockholders' equity. The statement of changes in retained earnings, also known as the statement of earned surplus, details only the changes in earned capital: the net income and the dividends for the period. Then the changes in contributed capital (stock issued, stock options, etc.) must be detailed on the balance sheet or in the notes to the financial statements. In financial accounting, a balance sheet or statement of financial position is a summary of a persons or organization's assets, liabilities and Ownership equity on a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a company's financial condition. Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time.
A company balance sheet has three parts: assets, liabilities and shareholders' equity. The main categories of assets are usually listed first and are followed by the liabilities. The difference between the assets and the liabilities is known as the net assets or the net worth of the company. According to the accounting equation, net worth must equal assets minus liabilities.
Records of the values of each account or line in the balance sheet are usually maintained using a system of accounting known as the double-entry bookkeeping system. A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period, plus any cash in hand. However, real businesses are not paid immediately; they build up inventories of goods and they acquire buildings and equipment. In other words: businesses have assets and so they can not, even if they want to, immediately turn these into cash at the end of each period. Real businesses owe money to suppliers and to tax authorities, and the proprietors do not withdraw all their original capital and profits at the end of each period. In other words businesses also have liabilities.
Types of balance sheets
A balance sheet summarizes an organization or individual's asset, equity and liabilities at a specific point in time. Individuals and small businesses tend to have simple balance sheets. Larger businesses tend to have more complex balance sheets, and these are presented in the organization's annual report. Large businesses also may prepare balance sheets for segments of their businesses. A balance sheet is often presented alongside one for a different point in time (typically the previous year) for comparison. 1. Personal balance sheet A personal balance sheet lists current assets such as cash in checking accounts and savings accounts, long-term assets such as common stock and real estate, current liabilities such as loan debt and mortgage debt due or overdue, and long-term liabilities such as mortgage and other loan debt. Securities and real estate values are listed at market value rather than at historical cost or cost basis. Personal net worth is the difference between an individual's total assets and total liabilities. 2. Small business balance sheet Sample Small Business Balance Sheet Assets
Liabilities and Owners' Equity
Cash
16,600
Liabilities
Accounts Receivable
1,200
Notes Payable
Land
52,000
Accounts Payable
Building
36,000
Total liabilities
Tools and equipment
12,000
Owners' equity
7,000
37,000
Capital Stock
80,000
Retained Earnings
800
Total owners' equity Total
30,000
117,800 Total
80,800 117,800
A small business balance sheet lists current assets such as cash, accounts receivable, and inventory, fixed assets such as land, buildings, and equipment, intangible assets such as patents, and liabilities such as accounts payable, accrued expenses, and longterm debt. Contingent liabilities such as warranties are noted in the footnotes to the balance sheet. The small business's equity is the difference between total assets and total liabilities.
3. Corporate balance sheet structure Guidelines for corporate balance sheets are given by the International Accounting Standards Committee and numerous country-specific organizations. Balance sheet
account names and usage depend on the organization's country and the type of organization. Government organizations do not generally follow standards established for individuals or businesses. If applicable to the business, summary values for the following items should be included on the balance sheet.
Assets Current Assets 1. inventories 2. accounts receivable 3. cash and cash equivalents Long-term Assets 1. property, plant and equipment 2. investment property, such as real estate held for investment purposes 3. intangible assets 4. financial assets (excluding investments accounted for using the equity method, accounts receivables, and cash and cash equivalents) 5. investments accounted for using the equity method 6. biological assets, which are living plants or animals. Bearer biological assets are plants or animals which bear agricultural produce for harvest, such as apple trees grown to produce apples and sheep raised to produce wool.
Liabilities 1. accounts payable 2. provisions for warranties or court decisions 3. financial liabilities (excluding provisions and accounts payable), such as promissory notes and corporate bonds 4. liabilities and assets for current tax 5. deferred tax liabilities and deferred tax assets 6. minority interest in equity 7. issued capital and reserves attributable to equity holders of the parent company 8. Equity The net assets shown by the balance sheet equals the third part of the balance sheet, which is known as the shareholders' equity. Formally, shareholders' equity is part of the company's liabilities: they are funds "owing" to shareholders (after payment of all other liabilities); usually, however, "liabilities" is used in the more restrictive sense of liabilities excluding
shareholders'
equity.
The
balance
of assets and
liabilities (including
shareholders' equity) is not a coincidence. Records of the values of each account in the
balance sheet are maintained using a system of accounting known as double-entry bookkeeping. In this sense, shareholders' equity by construction must equal assets minus liabilities, and are a residual. 1. numbers of shares authorised, issued and fully paid, issued but not fully paid 2. par value of shares 3. reconciliation of shares outstanding at the beginning and end of period 4. description of rights, preferences, and restrictions of shares 5. treasury shares, including shares held by subsidiaries and associates 6. shares reserved for issuance under options and contracts 7. a description of the nature and purpose of each reserve within owners' equity In accounting, a current asset is an asset on the balance sheet which is expected to be sold or otherwise used up in the near future, usually within one year, or one business cycle - whichever is longer. Typical current assets include cash, cash equivalents, accounts receivable, inventory, the portion of prepaid accounts which will be used within a year, and short-term investments. On the balance sheet, assets will typically be classified into current assets and long-term assets. The current ratio is calculated by dividing total current assets by total current liabilities. It is frequently used as an indicator of a company's liquidity, its ability to meet short-term obligations.
A Sample Balance Sheet Structure The following balance sheet structure is just an example. It does not show all possible kinds of assets, equity and liabilities, but it shows the most usual ones. Because it shows goodwill, it could be a consolidated balance sheet. Monetary values are not shown, summary (total) rows are missing as well. Balance Sheet of XYZ, Ltd. as of 31 December 2006 ASSETS Current Assets 1. Cash and cash equivalents 2. Accounts receivable (debtors) 3. Inventories
4. Prepaid Expenses 5. Investments held for trading 6. Other current assets Fixed Assets (Non-Current Assets) 1. Property, plant and equipment 2. Less : Accumulated Depreciation 3. Goodwill 4. Other intangible fixed assets 5. Investments in associates 6. Deferred tax assets LIABILITIES and EQUITY Creditors: amounts falling due within one year (Current Liabili ties) 1. Accounts payable 2. Current income tax liabilities 3. Current portion of bank loans payable 4. Short-term provisions 5. Other current liabilities Creditors: amounts falling due after one year (Long-Term Liabilities) 1. Bank loans 2. Issued debt securities 3. Deferred tax liability 4. Provisions 5. Minority interest Equity 1. Share capital 2. Capital reserves 3. Revaluation reserve 4. Translation reserve 5. Retained profit
Constructing a balance sheet Case Study 1.1 A new business starts up as a limited liability company called Sunrise Ltd by raising 10,000 from the owners i.e. share holders. The money is put into a new bank account.
`
What would the assets, liabilities and equity be? Assets : Bank Balance
10,000
Equity & Liabilities: Share Capital
10,000
1.2 They then use 6,000 of its bank account to buy a delivery van. Assets and liabilities after this transaction: Assets : Bank Balance Delivery Van
4,000 6,000
Equity & Liabilities : Share Capital 10,000 1.3 Sunrise Ltd then buys some inventory at 3,000 on credit. Assets and liabilities after this transaction: Assets : Bank Balance
4,000
Delivery Van Inventory
6,000 3,000
Liabilities: Accounts Payable
3,000 (to be paid to creditors)
Equity: Share Capital
10,000
Total assets must always equal total liabilities (and equity). This is inevitable, as liabilities (and equity) provide the funds that are spent on these assets.
1.4 Shortly afterwards, after selling 1,000 of inventory for 2,500, payment of 2,600 of the accounts payable and the purchase of 2,200 of machinery financed by a 2,200 bank loan, the assets and liabilities change to the following: Sunrise Ltd. Balance
Sheet
As of December 31, 2005 Assets Current assets Bank balance
Inventory
1,400
2,000
Accounts receivable
2,500
Total current assets
5,900
Fixed assets
Delivery van
6,000
Machinery
2,200
Total fixed assets
8,200
Total assets
14,100
Liabilities and stockholders' equity Current liabilities Accounts payable
400
Long-term liabilities
Loans payable
2,200
Total liabilities
2,600
Stockholders' equity Share capital
10,000
Retained earnings
1,500
Total stockholders' equity (Net worth)
11,500
Total liabilities and stockholders' equity
14,100
Points to note:
Must be headed with the name of the reporting entity (e.g., Sunrise Ltd.) and the date.
The van has not been depreciated and there are no other trading expenses.
The terms 'Current Liability' and 'Long-Term Liability' are the traditional names possibly used by sole traders or partnerships. Limited companies may use the phrases 'Liabilities: Amounts falling due within 1 year' and 'Liabilities: Amounts falling due after 1 year'.
The Total Equity may also be called the 'Net Worth'.
The Net Worth is in principle what the company is worth; it shows the monetary amount that would effectively be left if all assets were sold and all liabilities paid off.
Accounts receivable
Accounts receivable is one of a series of accounting transactions dealing with the billing of customers who owe money to a person, company or organization for goods and services that have been provided to the customer. In most business entities this is typically done by generating an invoice and mailing or electronically delivering it to the customer, who in turn must pay it within an established timeframe called credit or payment terms. An example of a common payment term is Net30, meaning payment is due in the amount of the invoice 30 days from the date of invoice. Other common payment terms include Net45 & Net60 but could in reality be for any time period agreed upon by the vendor and client. While booking a receivable is accomplished by a simple accounting transaction, the process of maintaining and collecting payments on the accounts receivable subsidiary account balances can be a full time proposition. Depending on the industry in practice, accounts receivable payments can be received up to 10 - 15 days after the due date has been reached. These types of payment practices are sometimes developed by industry standards, corporate policy, or because of the financial condition of the client.
On a company's balance sheet, accounts receivable is the amount that customers owe to that company. Sometimes called trade receivables, they are classified as current assets. To record a journal entry for a sale on account, one must debit a receivable and credit a revenue account. When the customer pays off their accounts, one debits cash and credits the receivable in the journal entry. The ending balance on the trial balance sheet for accounts receivable is always debit. Business organizations which have become too large to perform such tasks by hand (or small ones that could but prefer not to do them by hand) will generally use accounting software on a computer to perform this task. Associated accounting issues include recognizing accounts receivable, valuing accounts receivable, and disposing of accounts receivable. Accounts receivable departments use the sales ledger. Other types of accounting transactions include accounts payable, payroll, and trial balance.
Since not all customer debts will be collected, businesses typically record an allowance for bad debts which is subtracted from total accounts receivable. When accounts receivable are not paid, some companies turn them over to third party collection agencies or collection attorneys who will attempt to recover the debt via negotiating payment plans, settlement offers or legal action.
Outstanding advances are part of accounts receivables : If a company gets an order from its customers with advance agreed in payment terms. Since no billing is being done to claim the advances several times this area of collectible is not reflected in Accounts Receivables. Ideally, since advance payment is mutually agreed term, it is the responsibility of the accounts department to take out periodically the statement showing advance collectible and should be provided to sales & marketing for collection of advances. The payment of accounts receivable can be protected either by a letter of credit or by Trade Credit Insurance. Companies can use their accounts receivable as collateral when obtaining a loan (Assetbased lending) or sell them through Factoring (finance). Pools or portfolios of accounts receivable can be sold in the capital markets through a Securitization.
Cash and cash equivalents are the most liquid assets found within the asset portion of a company's balance sheet. Cash equivalents are assets that are readily convertible into cash, such as money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial paper. Cash equivalents are distinguished from other investments through their short-term existence; they mature within 3 months whereas short-term investments are 12 months or less, and long-term investments are any investments that mature in excess of 12 months.
"Cash and cash equivalents", when used in the context of payments and payments transactions refer to currency, coins, money orders, paper checks, and stored value poducts such as gift certificates and gift cards.
Income Statement or Profit and Loss Statement (P&L)
An Income Statement, also called a Profit and Loss Statement (P&L), is a financial statement for companies that indicates how Revenue (money received from the sale of products and services before expenses are taken out, also known as the "top line") is transformed into net income (the result after all revenues and expenses have been accounted for, also known as the "bottom line"). The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported. Charitable organizations that are required to publish financial statements do not produce an income statement. Instead, they produce a similar statement that reflects the fact that the charity is not operating to make a profit.
Revenue - Cash inflows or other enhancements of assets of an entity during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major operations. Usually presented as sales minus sales discounts, returns, and allowances.
Expenses - Cash outflows or other using-up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing
major operations. o
General and administrative expenses (G & A) - represent expenses to manage the business (officer salaries, legal and professional fees, utilities, insurance,
depreciation of office building and equipment, stationery, supplies) o
Selling expenses - represent expenses needed to sell products (e.g., sales salaries and commissions, advertising, freight, shipping, depreciation of sales
equipment) o
R & D expenses - represent expenses included in research and development
o Depreciation - is the charge for a specific period (i.e. year, accounting period) with
respect to fixed assets that have been capitalised on the balance sheet.
Non-operating section
•
Other revenues or gains - revenues and gains from other than primary business
activities (e.g. rent, patents). It also includes unusual gains and losses that are either unusual or infrequent, but not both (e.g. sale of securities or fixed assets).
•
Other expenses or losses - expenses or losses not related to primary business
operations. Irregular items They are reported separately because this way users can better predict future cash flows - irregular items most likely won't happen next year. These are reported net of taxes.
•
Discontinued operations is the most common type of irregular items. Shifting
business location, stopping production temporarily, or changes due to technological improvement do not qualify as discontinued operations. •
Extraordinary items are both unusual (abnormal) and infrequent, for example,
unexpected nature disaster, expropriation, prohibitions under new regulations. Note: natural disaster might not qualify depending on location (e.g. frost damage would not qualify in Canada but would in the tropics). •
Changes in accounting principle is, for example, deciding to depreciate an
investment property that has previously not been depreciated. However, changes in estimates (e.g. estimated useful life of a fixed asset) do not qualify. Earnings per share Because of its importance, earnings per share (EPS) are required to be disclosed on the face of the income statement. A company which reports any of the irregular items must also report EPS for these items either in the statement or in the notes. There are two forms of EPS reported:
Basic: in this case "weighted average of shares outstanding" includes only actual stocks outstanding.
Diluted: in this case "weighted average of shares outstanding" is calculated as if all stock options, warrants, convertible bonds, and other securities that could be transformed into shares are transformed. This increases the number of shares and so EPS decreases. Diluted EPS is considered to be a more reliable way to measure EPS.
-
INCOME
STATEMENT
BOND
LLC
-
For
the
year
ended
DECEMBER
Revenues:
31
2007
Rs.
GROSS
PROFIT
(including
rental
496,397 income) --------
Expenses: ADVERTISING
6,300
INSURANCE LEGAL
&
750 PROFESSIONAL
SERVICES
RENT UTILITIES PRINTING,
491 POSTAGE
&
STATIONERY
ENTERTAINMENT &
632 CREDIT
CARD
FEES
BOOKKEEPING MORTGAGES
144 3,350
EMPLOYEES RENTAL
320 5,550
LICENSES BANK
1,575 13,000
88,000 AND
FEES
74,400 --------
TOTAL
EXPENSES
(194,512) --------
NET
INCOME
301,885 ========
Factoring is a word often misused synonymously with accounts receivable financing. Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables, not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of an asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.
The three parties directly involved are: the seller, debtor, and the factor. The seller is owed money (usually for work performed or goods sold) by the second party, the debtor. The seller then sells one or more of its invoices at a discount to the third party, the specialized financial organization (aka the factor) to obtain cash. The debtor then directly pays the factor the full value of the invoice
Depreciation Depreciation - is the charge for a specific period (i.e. year, accounting period) with respect to fixed assets that have been capitalised on the balance sheet Depreciation is simply put to be the expense generated by the use of an asset. It is the wear and tear of an asset or diminution in the historical value owing to usage. Further to this; it is the cost of the asset less any salvage value over its estimated useful life. It is an expense because it is matched against the revenue generated through the use of the same asset. Depreciation is usually spread over the economic useful life of an asset because it is regarded as the cost of an asset absorbed over its useful life. Invariably the depreciation expense is charged against the revenue generated through the use of the asset. The method of depreciation to be adopted is best left for the management to decide in consideration to the peculiarity of the business, prevailing economic condition of the assets and existing accounting guideline
and principles as implied in the
organizational policies.
The primary objective of a business entity is to make profit and increase the wealth of its owners. In the attainment of this objective it is required that the management will exercise due care and diligence in applying the basic accounting concept of “Matching Concept”. Matching concept is simply matching the expenses of a period against the revenues of the same period. Generally, the use of assets in the generation of revenue is usually more than a year-
that is long term. It is therefore obligatory that in order to accurately determine the net income or profit for a period depreciation is charged on the total value of asset that contributed to the revenue for the period in consideration and charge against the same revenue of the same period. This is essential in the prudent reporting of the net revenue for the entity in the period. Net book value of an asset is basically the difference between the historical cost of that asset and it associated depreciation. From the foregoing, it is apparent that in order to report a true and fair position of the financial jurisprudence of an entity it is relatable to record and report the value of fixed assets at its net book value. Apart from the fact that it is enshrined in Standard Accounting Statement (SAS) 3 and IAS 16 that value of asset should be carry at the net book value, it is the best way of consciously presenting the value of assets to the owners of the business and potential investor.
Equity method Equity method in accounting is the process of treating equity investments, usually 20– 50%, in associate companies. The investor keeps such equities as an asset. Proportional part of associate company's net income increases the investment, and payment of dividends decreases it. The ownership of more than 50% of voting stock creates a subsidiary. Its financial statements consolidate into the parents' ones. Another type of account is the cost method, which keeps the value of the investment in subsidiary account at historic book value.
Cash flow statement
Statement of Cash Flow - Simple Example for the period 12/31/2005 to 12/31/2006
Cash flow from operations
4,000
Cash flow from investing
1,000
Cash flow from financing
2,000
Net increase (decrease) in cash
1,000
In financial accounting, a cash flow statement or statement of cash flows is a financial statement that shows a company's incoming and outgoing money (sources and uses of cash) during a time period (often monthly or quarterly). The statement shows how changes in balance sheet and income accounts affected cash and cash equivalents, and breaks the analysis down according to operating, investing, and financing activities. As an analytical tool the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals with cash flow statements.
People and groups interested in cash flow statements include
accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses
potential lenders or creditors, who want a clear picture of a company's ability to repay
potential investors, who need to judge whether the company is financially
sound
potential employees or contractors, who need to know whether the company will be able to afford compensation
Purpose
The cash flow statement was previously known as the statement of changes in financial position or flow of funds statement. The cash flow statement reflects a firm's liquidity or solvency.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues.
The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These noncash transactions include depreciation and write-offs on bad debts. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Noncash activities are usually reported in footnotes.
The cash flow statement is intended to 1. provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances 2. provide additional information for evaluating changes in assets, liabilities and equity
3. improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods 4. indicate the amount, timing and probability of future cash flows The cash flow statement has been adopted as a standard financial statement because it eliminates allocations which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.
History and variations Cash basis financial statements were common before accrual basis financial statements. The "flow of funds" statements of the past were cash flow statements.
The Financial Accounting Standards Board (FASB) defined rules that made it mandatory under Generally Accepted Accounting Principles (US GAAP) to report sources and uses of funds, but the definition of "funds" was not clear.
"Net working capital" might be cash or might be the difference between current liabilities and current assets. From the late 1970 to the mid-1980s, the FASB discussed the usefulness of predicting future cash flows. In 1987, FASB Statement No. 95 (FAS 95) mandated that firms provide cash flow statements.
In 1992, the International Accounting Standards Board issued International Accounting Standard 7 (IAS 7), Cash Flow Statements, which became effective in 1994, mandating that firms provide cash flow statements.
Cash flow activities The cash flow statement is partitioned into cash flow resulting from operating activities, cash flow resulting from investing activities, and cash flow resulting from financing activities. Operating activities Operating activities include the production, sales and delivery of the company's product as well as collecting payment from its customers. This could include purchasing raw materials, building inventory, advertising and shipping the product.
Under IAS 7, operating cash flows include
receipts from the sale of goods or services
receipts for the sale of loans, debt or equity instruments in a trading portfolio
interest received on loans
dividends received on equity securities
payments to suppliers for goods and services
payments to employees or on behalf of employees
tax payments
interest payments (alternatively, this can be reported under financing activities in IAS 7, but not in GAAP)
payments for the sale of loans, debt or equity instruments in a trading portfolio
Items which are added back to the net income figure (which is found on the Income Statement) to arrive at cash flows from operations generally include:
Depreciation (loss of tangible asset value over time)
Deferred tax
Amortization (loss of intangible asset value over time)
Any gains or losses associated with an asset sale (unrealized gains/losses are also added back from the income statement)
Investing activities Investing activities focus on the purchase of the long-term assets a company needs in order to make and sell its products, and the selling of any long-term assets.
Under IAS 7, investing cash flows include
collections on loan principal and sales of other firms' debt instruments
investment returns from other firms' equity instruments, including sale of those instruments
receipts from sale of plant and equipment
expenditure for purchase of plant and equipment
loans made and acquisition of other firms' debt instruments
expenditure for purchase of other firms' equity instruments (unless held for trading or considered cash equivalents)
Items under investing activities include:
Capital expenditures, which include purchases (and sales) of property, plant and equipment
Investments
Financing activities Financing activities include the inflow of cash from investors such as banks and shareholders, as well as the outflow of cash to shareholders as dividends as the company generates income. Other activities which impact the long-term liabilities and equity of the company are also listed in the financing activities section of the cash flow statement. Under IAS 7, financing cash flows include
•
proceeds from issuing shares
proceeds from issuing short-term or long-term debt
payments of dividends
payments for repurchase of company shares
repayment of debt principal, including capital leases
for non-profit organizations, receipts of donor-restricted cash that is limited to long-
term purposes
Items under the financing activities section include:
Dividends paid
Sale or repurchase of the company's stock
Net borrowings
Disclosure of noncash activities Under IAS 7, noncash investing and financing activities are disclosed in footnotes to the financial statements. Under GAAP, noncash activities may be disclosed in a footnote or within the cash flow statement itself. Noncash financing activities may include
leasing to purchase an asset
converting debt to equity
exchanging noncash assets or liabilities for other noncash assets or liabilities
issuing shares in exchange for assets
Preparation methods
The direct method of preparing a cash flow statement results in a more easily understood report. The indirect method is almost universally used, because FAS 95 requires a supplementary report similar to the indirect method if a company chooses to use the direct method. Direct method The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments. Under IAS 7, dividends received may be reported under operating activities or under investing activities. If taxes paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly linked to investing activities or financing activities, they are reported under investing or financing activities.
Sample cash flow statement using the direct method
Cash flows from operating activities
Cash receipts from customers
27,500 `
Cash paid to suppliers and employees
(20,000)
Cash generated from operations (sum)
7,500
Interest paid
(2,000)
Income taxes paid
(2,000)
Net cash flows from operating activities
3,500 `
Cash flows from investing activities
Proceeds from the sale of equipment
7,500
Dividends received
3,000
Net cash flows from investing activities
10,500
Cash flows from financing activities
Dividends paid
Net cash flows used in financing activities
.
(12,000)
(12,000)
Net increase in cash and cash equivalents 2,000
Cash and cash equivalents, beginning of year
1,000
Cash and cash equivalents, end of year
3,000 `
Indirect method The indirect method uses net-income as a starting point, makes adjustments for all transactions for non-cash items, then adjusts for all cash-based transactions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. This method converts accrual-basis net income (loss) into cash flow by using a series of additions and deductions.
Rules The following rules are used to make adjustments for changes in current assets and liabilities, operating items not providing or using cash and nonoperating items.
Decrease in noncash current assets are added to net income
Increase in noncash current asset are subtracted from net income
Increase in current liabilities are added to net income
Decrease in current liabilitiesare subtracted from net income
Expenses with no cash outflows are added back to net income
Revenues with no cash inflows are subtracted from net income (depreciation expense is the only operating item that has no effect on cash flows in the period)
Nonoperating losses are added back to net income
Nonoperating gains are subtracted from net income
Citigroup Incorporated cash flow example:
Citigroup Cash Flow Statement (all numbers in thousands)
Period ending
12/31/2006
12/31/2005
12/31/2004
Net income
21,538,000
24,589,000
17,046,000
Operating activities, cash flows provided by or used in:
Depreciation and amortization
2,790,000
2,592,000
2,747,000
Adjustments to net income
4,617,000
621,000
2,910,000
Decrease (increase) in accounts receivable
12,503,000
17,236,000
--
Increase (decrease) in liabilities (A/P, taxes payable)
131,622,000
19,822,000
37,856,000
--
--
--
Decrease (increase) in inventories
Increase (decrease) in other operating activities
(173,057,000) (33,061,000) (62,963,000)
13,000
31,799,000 (2,404,000)
(4,035,000)
(3,724,000) (3,011,000)
Net cash flow from operating activities
Investing activities, cash flows provided by or used in:
Capital expenditures
Investments
Other cash flows from investing activities
(201,777,000) (71,710,000) (75,649,000)
1,606,000
17,009,000
(571,000)
Net cash flows from investing activities
(204,206,000) (58,425,000) (79,231,000)
Financing activities, cash flows provided by or used in:
Dividends paid
(9,826,000) (9,188,000) (8,375,000)
Sale (repurchase) of stock
(5,327,000) (12,090,000)
133,000
Increase (decrease) in debt
101,122,000
26,651,000
21,204,000
Other cash flows from financing activities
120,461,000
27,910,000
70,349,000
206,430,000
33,283,000
83,311,000
645,000 (1,840,000)
731,000
Net cash flows from financing activities
Effect of exchange rate changes
Net increase (decrease) in cash and cash equivalents
2,882,000 `
4,817,000 `
2,407,000 `
Cost-Volume-Profit (CVP) Analysis
Analysis that deals with how profits and costs change with a change in volume. More specifically, it looks at the effects on profits of changes in such factors as variable costs, fixed costs, selling prices, volume, and mix of products sold. By studying the relationships of costs, sales, and net income, management is better able to cope with many planning decisions. For example, CVP analysis attempts to answer the following questions:
1) What sales volume is required to break even? 2) What sales volume is necessary in order to earn a desired (target) profit? 3) What profit can be expected on a given sales volume? 4) How would changes in selling price, variable costs, fixed costs, and output affect profits? 5) How would a change in the mix of products sold affect the break-even and target volume and profit potential? Cost-volume-profit analysis (CVP), or break-even analysis, is used to compute the volume level at which total revenues are equal to total costs. When total costs and total revenues are equal, the business organization is said to be "breaking even." The analysis is based on a set of linear equations for a straight line and the separation of variable and fixed costs. Total variable costs are considered to be those costs that vary as the production volume changes. In a factory, production volume is considered to be the number of units produced, but in a governmental organization with no assembly process, the units produced might refer, for example, to the number of welfare cases processed. There are a number of costs that vary or change, but if the variation is not due to volume changes, it is not considered to be a variable cost. Examples of variable costs are direct materials and direct labor. Total fixed costs do not vary as volume levels change within the relevant range. Examples of fixed costs are straight-line depreciation and annual insurance charges. Total variable costs can be viewed as a 45 line and total fixed costs as a straight line. In the break-even chart shown in Figure 1, the upward slope of line DFC represents the change in variable costs. Variable costs sit on top of fixed costs, line DE.
