Course Notes: Reading Financial Statements

Course Notes
Reading Financial Statements
2017, all rights reserved. https://www.corporatefinanceinstitute.com

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Course Objectives:
Reading and understanding company annual reports, and sets of financial
statements

Understanding the Balance Sheet

Three Key Financial Statements
1. Balance sheet
2. Income statement
3. Statement of cash flows

Balance Sheet
Represents the company at a point in time
Assets, liabilities and equity
Helps in determining the financial stature and strength of the company

Income Statement
Represents the company over a period of time
Revenue, expenses and profit
Demonstrates profitability

Statement Of Cash Flows
Acts like a bank statement
Reconciles the opening cash balance with the closing cash balance
Connects the income statement to the balance sheet

Statement Of Cash Flows
Divided into three specific cash flow types
A useful financial statement to understand where cash is being generated

and used in the business

Simplified Balance Sheet
May be presented in a horizontal or vertical format
Displays current and non-current accounts

Current Vs Non-current
Assets
Current: will be redeemed in a year or less
Non-current: to be held for longer than a year

Current VS NON-CURRENT
Liabilities
Current: amounts due to a creditor in a year or less
Non-current: obligations due for terms longer than a year

Microsoft Balance Sheet Demonstration
Includes Assets, Liabilities and Equity
Microsoft statement is in millions of dollars
Always has a notation if the numbers are not reported as whole dollars

2010 and 2009 accounts are reported to provide comparative results
See accompanying notes at the bottom

Accounts making up the balance sheet
Cash Accounts payable

Accounts receivable Debts
Inventories Common stock
Property and Equipment Retained deficit

Investments
Investments are held to take advantage of idle cash
Alternatively, investments help accumulate cash

Investments
Investments can be:
Internal or external
Short term or long term
Debt or equity

Deferred Income Tax
Often seen on financial statements
Due to difference between tax and accounting rules

What Is Goodwill?
The difference between purchase price and fair value
Recorded as non-current asset
Remeasured every year

Intangible Assets
Assets that generate revenue, but without physical substance
Examples are trademarks, patents and copyrights
Recorded as non-current assets

Unearned Revenue
Arises when a company is paid for an undelivered good or service
Examples are licenses and subscriptions
The balance is shown as liability

Commitments
Future obligations that a company agrees to
Examples are new buildings, building improvements and

leasehold improvements

Contingencies
Possibilities that are not 100% certain
Example: Lawsuit
Accounting rules are conservative; contingent losses are recorded,

while contingent gains are harder to allow

Contingencies
The liability must be recorded if:
1. A future event will confirm impairment of an asset or a liability

existed as at balance sheet date
2. The loss amount can be reasonably estimated

Common Vs Preferred Shares
Common shares
Residual claim to assets
Voting rights
Partake in profits

Common Vs Preferred Shares
Preferred shares
Fixed dividend
Paid before common shares
Has a par value

Authorized Vs Outstanding Share Capital
Authorized shares are the maximum saleable shares
Outstanding shares are the total shares held by investors currently

Contributed Surplus
Excess value received above par value of a share

Other Comprehensive Income
Gains and losses outside of main operations

Balance Sheet Component Matching Exercise
Open the balance sheet component matching exercise and

balance sheet component matching solution for results

Statement Of Shareholders Equity
Itemizes equity transactions for the period
This consists of stock and retained earnings

The Full Disclosure Principle
Notes are provided below financial statements for additional

information
Notes allow for stronger judgment by readers

Three Key Financial Statement Notes
1. Significant accounting policies
2. Direct information
3. Indirect information

Significant Accounting Policies
Company accounting principles
Valuation techniques
Financial instruments

Significant Accounting Policies
Revenue recognition
Depreciation methods

Direct Information
Breakdown of investment types

Debt
Financial assets

Indirect Information
Commitments
Contingencies
Stock based compensation plans

Noteworthy exercise
Open the Noteworthy exercise and Noteworthy solution for

results.

Understanding The Income Statement And Cash
Flow

Three key financial statements
1. Balance sheet
2. Income statement
3. Statement of cash flows

Single Step Vs Multi-step Income Statements
Single step
Groups revenues vs expenses in separate sections
Profitability/net income is shown at the very end
Multi step
More commonly seen
Displays revenues then expenses in a logical order

Cost Of Sales
The direct costs of the items sold or services provided

Selling, General And Administrative
Varied expense items
Expenses outside of cost of goods sold

Gains And Losses
Related to sale, gains and losses of investments
Alternatively, related to exchange rate translations

Microsoft Income Statement Exercise
Open the Microsoft income statement exercise and Microsoft

income statement solution for results

The Cash Flow Statement
Inflows and outflows of cash

Cash Flow Activities
Sorted by:
Operating activities
Investing activities
Financing activities

Operating Activities
Main operations
Revenues collected and expenses paid
If indirect method, add back non-cash expenses

Investing Activities
Long-term assets needed for the business
Companies must reinvest cash back into the business

Financing Activities
Equity or debt transactions
The method by which a company raises funds

Direct Method Vs Indirect Method
Statement of cash flows can be prepared using direct or indirect

method
CFO is derived differently; CFF and CFI are the same

Direct Method
Begins with cash transactions
Classifies into receipts from customers, and payments to suppliers

Indirect Method
Begins with net income
Non-cash and non-CFO transactions are added back to arrive at CFO

Key Elements In A Cash Flow Statement
Net cash
Changes in working capital
Capital expenditure

Microsoft Cash Flow Statement Exercise
Open the Microsoft cash flow statement exercise and Microsoft

cash flow statement solution for results.

The Benefits Of An Annual Report
Mixture of financial and non-financial information
Hear from the company itself
Management may provide explanations for their strategy

Contents Of Annual Report
Letter to shareholders
Description of business
MD&A

Contents Of Annual Report
Reporting on internal controls
Audit report
Three Financial Statements

Management Discussion And Analysis
Explanation for:
Past performance
Financial highlights
Future strategic direction

Management discussion and analysis
Lists future actions to be taken
Identifies the key risks facing the organization

Microsoft reporting challenge exercise
Open the Microsoft reporting challenge exercise and Microsoft

reporting challenge solution for results

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Course Notes: Reading Financial Statements

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Course Notes

Reading Financial Statements

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2017, all rights reserved. https://www.corporatefinanceinstitute.com

3. Statement of cash flows

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Represents the company at a point in time

Assets, liabilities and equity

Helps in determining the financial stature and strength of the company

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Represents the company over a period of time

Revenue, expenses and profit

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Acts like a bank statement

Connects the income statement to the balance sheet

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Divided into three specific cash flow types

A useful financial statement to understand where cash is being generated

2017, all rights reserved. https://www.corporatefinanceinstitute.com

May be presented in a horizontal or vertical format

Displays current and non-current accounts

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Current: will be redeemed in a year or less

Non-current: to be held for longer than a year

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Current: amounts due to a creditor in a year or less

Non-current: obligations due for terms longer than a year

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Includes Assets, Liabilities and Equity

Microsoft statement is in millions of dollars

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2010 and 2009 accounts are reported to provide comparative results

See accompanying notes at the bottom

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Accounts making up the balance sheet

Cash Accounts payable

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Investments are held to take advantage of idle cash

Alternatively, investments help accumulate cash

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Investments can be:

Short term or long term

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Often seen on financial statements

Due to difference between tax and accounting rules

2017, all rights reserved. https://www.corporatefinanceinstitute.com

The difference between purchase price and fair value

Recorded as non-current asset

Remeasured every year

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Assets that generate revenue, but without physical substance

Examples are trademarks, patents and copyrights

Recorded as non-current assets

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Arises when a company is paid for an undelivered good or service

Examples are licenses and subscriptions

The balance is shown as liability

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Future obligations that a company agrees to

Examples are new buildings, building improvements and