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Financial Statements, Cash Flow, and Taxes

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The  “ Quality ”  of Financial Statements

Simplicity Relevance Comparability Understandability Completeness

Accuracy Promptness Reliability Analytical Qualities

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First, there is a verbal section, often presented as a letter  from the chairperson, which describes the firm ’ s operating results during the past year and discusses new developments that will affect future operations. Second, the report provides these four basic financial statements:

The  balance sheet The  income statement The  statement of cash flows The  statement of stockholders’ equity

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The balance sheet is a  “ snapshot ”  of a firm ’ s position at a specific point in time.

A balance sheet is  a financial statement that reports a company's assets, liabilities, and shareholder equity .

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Table

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Figure 3-1 indicates, assets are divided into two major categories: Current assets and fixed, or long-term, assets.  Current assets consist of assets that should be converted to cash within one year; and they include cash and cash equivalents, accounts receivable, and inventory.   Long-term assets are assets expected to be used for more than one year; they include plant and equipment in addition to intellectual property such as patents and copyrights.  Plant and equipment is generally reported net of accumulated depreciation.  Allied ’ s  long-term assets consist entirely of net plant and equipment, and we often refer to them as  “ net  fixed assets. ”

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Stockholders' equity = Paid -in capital + Retained earnings

Stockholders' equity = Total assets - Total liabilities

Stockholders’ equity can be thought of in two ways. First, it is the amount that stockholders paid to the company when they bought shares the company sold to raise capital, in addition to all of the earnings the company has retained over the years:

The retained earnings are not just the earnings retained in the latest year—they are the cumulative total of all of the earnings the company has earned during its life. Stockholders’ equity can also be thought of as a residual:

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Table 3-1 shows  Allied’s  year-end balance sheets for 2008 and 2007. From the 2008 statement, we see that Allied had $2 billion of assets—half current and half long term. These assets were financed with $310 million of current liabilities, $750million of long-term debt, and $940 million of common equity. Comparing the balance sheets for 2008 and 2007, we see that  Allied’s  assets grew by $320 million and its liabilities and equity necessarily grew by that same amount. Assets must, of course, equal liabilities and equity; otherwise, the balance sheet does not balance.

Table

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An income statement helps business owners decide whether they can generate profit by increasing revenues, by decreasing costs, or both. It also shows the effectiveness of the strategies that the business set at the beginning of a financial period. The business owners can refer to this document to see if the strategies have paid off. Based on their analysis, they can come up with the best solutions to yield more profit.

Understanding Income Statements | Cleverism

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Several additional points about the balance sheet should be noted:

Cash versus other assets Working capital Net working capital Net working capital = Current assets – (Payables + Accruals) = $1,000 - ($60 + $140) = $800 Other sources of funds Depreciation Market values versus book values The time dimension

Financial Statements, Cash Flow, and Taxes

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