ABSENTEEISM LOG FOR SESSION 2 :

FINANCIAL STATEMENTS: FINDING MEANING BEHIND THE NUMBERS AND

LINKING ACCOUNTS TO CORPORATE FINANCE

Financial Statements represent a formal record of the financial activities of an entity. These are
written reports that quantify the financial strength, performance and liquidity of a company.
Financial Statements reflect the financial effects of business transactions and events on the entity.
Financial Statements are mainly divided into four components
1.
2.
3.
4.

Balance Sheet
Income Statement
Cashflow Statement
Statement of Retained Earnings

Balance Sheet is defined as a statement of the assets, liabilities, and capital of a business or other
organization at a particular point in time, detailing the balance of income and expenditure over
the preceding period.
The balance sheet uses the accounting equation (assets = liabilities + owner's equity) to show a
financial picture of the business on a specific day. In other words, a balance sheet lists all of the
assets that a company owns as well as the debts owed by the company and the owner's interest or
ownership share in the company. Assets are listed separately first and liabilities and owner's
equity are listed together second. Think about the accounting equation. Assets = Liabilities +
Owner's equity. Assets have to total the sum or liabilities and owner's equity. This is where the
"balance" in balance sheet comes from. Assets have to balance with liabilities and owner's equity.

Balance sheets can be presented in two different formats: account format and report format.
Account format goes from right to left with assets on the right and liabilities and owner's equity

on the right. Report form is vertical with assets on the top and liabilities and owner's equity on
the bottom.
Major Components under Assets side are :
Current assets:

Cash & securities

Receivables

Inventories

Fixed assets:

Tangible assets

Intangible assets

Major Components under Liabilities side are :

Current liabilities

Payables
Short-term debt

Long-term liabilities
Shareholders' equity

Income Statement

The income statement is sometimes referred to as the profit and loss statement (P&L), statement
of operations, or statement of income. We will use income statement and profit and loss
statement throughout this explanation.

The income statement is important because it shows the profitability of a company during the
time interval specified in its heading. The period of time that the statement covers is chosen by
the business and will vary.
Income
The term "income" is the excess of revenues over expenses. Sometimes, it is also known as the
"net income". Income = Revenues Expenses Increase in cash has nothing to do with revenue or
income. One borrows $10,000 from the bank. Then, the person has an increase of $10,000 cash
(i.e. of asset), and liability of $10,000 to the Bank. He then uses the $10,000 to buy a piece of
equipment, i.e. a reduction of $10,000 in cash, and an increase in fixed asset of $10,000.

Expenditure
An "expenditure" is not necessarily an "expense". For example, we buy $400 fuel for our car. It
is an expenditure. If we do not use the fuel, it remains to be our asset, and we have not incurred
an expense. If we use 3/4 of the fuel, the expense will then be $300 and we still have an asset of
fuel which is valued at $100.
Similarly for equipment items, at the time of acquisition we have an "expenditure" item and no
"expense". When we depreciate the equipment item, we then have an "expense" equal to the
amount of depreciation.
The balance sheet provides information on what the company owns (its assets), what it owes (its
liabilities) and the value of the business to its stockholders (the shareholders' equity) as of a
specific date.

Assets are economic resources that are expected to produce economic benefits for their

owner.

Liabilities are obligations the company has to outside parties. Liabilities represent others'

rights to the company's money or services. Examples include bank loans, debts to suppliers and
debts to employees.

Shareholders' equity is the value of a business to its owners after all of its obligations

have been met. This net worth belongs to the owners. Shareholders' equity generally reflects the
amount of capital the owners have invested, plus any profits generated that were subsequently
reinvested in the company.
For example, if you purchase a $30,000 vehicle with a $25,000 loan and $5,000 in cash, you
have acquired an asset of $30,000, but have only $5,000 of equity.
The Balance Sheet equation is given by - Assets = Liabilities + Owner's Equity

Thus, in the previous example: $30,000 Asset = $25,000 Liability + $5,000 Owner Equity.
Full Disclosure :
The full disclosure principle states that you should include in an entity's financial
statements all information that would affect a reader's understanding of those statements. The
interpretation of this principle is highly judgmental, since the amount of information that can be
provided is potentially massive. To reduce the amount of disclosure, it is customary to only
disclose information about events that are likely to have a material impact on the entity's
financial position or financial results.

Schedules:
Schedules and parenthetical disclosures are also used to present information not provided
elsewhere in the financial statements. They often detail disclosures required by audited
statements, as well as the accounting methods and assumptions used by management.
Supplemental schedules can include information such as natural resources reserves, an overview
of specific business lines, or the segmentation of income or other line items by geographical area
or customer distribution. All financial statements have to have schedules attached to it.
Information Signalling :
Actions taken by a company to telegraph its financial outlook. For example, the declaration of an
unscheduled dividend may be a company's attempt to convey a positive outlook on its earnings
prospects.
In other words, market is expecting your profit on the basis of the information that you provide
in your financial statements.
Contingent liability:
A potential obligation that may be incurred depending on the outcome of a future event. A
contingent liability is one where the outcome of an existing situation is uncertain, and this
uncertainty will be resolved by a future event. A contingent liability is recorded in the books of
accounts only if the contingency is probable and the amount of the liability can be estimated.
For example, a company may be facing a lawsuit from a rival firm for patent infringement. If the
company's legal department thinks that the rival firm has a strong case, and the company
estimates that the damages payable if the rival firm wins the case are $2 million, it would book a
contingent liability of this amount on its balance sheet.