CSTC COLLEGE OF SCIENCES TECHNOLOGY AND COMMUNICATION, INC.

CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
Registrar’s Office: 042 3290850 / 042 7192818
CSTC IT Center: 042 7192805
Atimonan Contact Number: 042 7171420

SCHOOL OF BUSINESS AND ACCOUNTANCY

Instructional Module in

FM112/MAS102A

Financial Management

STUDENT
Name:
Student Number:
Course/Year/Major:
Address:
Email Address:
Contact Number:

PROFESSOR
Name: Glazy Kae N. Navajas
Email Address: glazy.kae@gmail.com
Contact Number: 09484436339
 CSTC COLLEGE OF SCIENCES TECHNOLOGY AND COMMUNICATION, INC.
CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
Registrar’s Office: 042 3290850 / 042 7192818
CSTC IT Center: 042 7192805
Atimonan Contact Number: 042 7171420

SCHOOL OF BUSINESS AND ACCOUNTANCY

Preliminaries
I. Module Number 1
Module Title Financial Management for Prelim
II. Brief Introduction This module is designed to cover the introduction to
financial management such as its nature, purpose and scope. This module includes
the discussion of effects of the economic environment on business strategy.

III. Module Outcomes

Upon completion of this module, you must be able to:
1. Describe the nature, goal and basic scope of financial management
2. Explain briefly the three major types of decisions that the Finance Manager makes.
3. Discuss the importance or significance of financial management.
4. Describe the relationship between Financial Management and Accounting.
5. Describe the relationship between Financial Management and Economics.
 CSTC COLLEGE OF SCIENCES TECHNOLOGY AND COMMUNICATION, INC.
CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
Registrar’s Office: 042 3290850 / 042 7192818
CSTC IT Center: 042 7192805
Atimonan Contact Number: 042 7171420

Lesson Number 4
Lesson Title Understanding Financial Statements

This lesson covers the discussion of the nature and significance of the financial
statements

Lesson Objectives
At the end of this lesson, you will be able to:
1. Describe how business activities are reported through the financial statements
2. Enumerate and identify the needs of various users that demand financial accounting
information.
3. Identify the required financial statements and know how they are interconnected.
4. Appreciate the nature and significance of the financial statements.

Introduction/Discussion of Content

Understanding Financial Statements

These are reports by which the information accumulated and processed in financial
accounting is periodically communicated to the users. It comprises the following:
1. Income Statement. It is formally known as Statement of Financial Performance..
It shows the revenues and expenses of the company.
2. Statement of Changes in Equity. This statement shows how the owner’s equity
account has changed through additional investment, drawings and net
income/loss.
3. Statement of Cash Flows. It summarizes the cash transactions of the company
categorized into operating, financing and investing activities.
4. Balance Sheet. It is formally known as Statement of Financial Position. It shows
the assets, liabilities and owner’s equity of the business at a given time.
5. Notes to the Financial Statements. It provides a detailed explanation on how the
financial data in the statements are prepared.

HOW BUSINESS ACTIVITIES ARE REPORTED

To be able to analyze a company effectively or infer its value, it is important that
one must understand the company's business activities. This can be accomplished
through the financial statements. Financial statements report on a company’s
performance and financial condition and reveal executive management's privileged
information and insights.

GENERAL OBJECTIVES OF FINANCIAL STATEMENTS

The important objectives of financial statements are:
1. Providing Information for Economic Decisions - The economic decisions that are
taken by the users of financial statements require an evaluation of the ability of an
enterprise to generate cash and cash equivalents, and the timing and certainty of their
generation.
2. Providing Information About Financial Position - The financial position of an
enterprise is affected by the economic resources such as:
a. Information about the economic resources controlled by the enterprise and its
capacity in the past to modify these resources is useful in predicting the ability of the
enterprise to generate cash and cash equivalents in the future.
b. Information about financial structure is useful in predicting future borrowing needs
and how future profits and cash flows will be distributed among those with an
interest in the enterprise.
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CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
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c. Information is useful in predicting how successful the enterprise is likely to be in

raising further finance.
d. Information about liquidity and solvency is useful in predicting the ability of the
enterprise to meet the financial commitments as fall due.

3. Providing Information About Performance of an Enterprise - Another important

objective of the financial statements is that, it provides information about the
performance and in particular its profitability, which is required in order to assess
potential changes in the economic resources that are likely to control in future.

4. Providing Information about Changes in Financial position - The financial

statements provide information concerning changes in the financial position of an
enterprise, which is useful in order to assess its investing. financing and operating
activities during the reporting period.

DEMAND FOR FINANCIAL ACCOUNTING INFORMATION

The broad classes of users that demand financial accounting information include
the following:
1. Managers and Employees - For their own well-being and prospective earnings,
potential managers and employees need accounting information on the financial
condition, profitability and prospects of their companies as well as comparative financial
information on competing companies and business opportunities.

2. Investors and Analysts - Financial statements are used by these parties to decide
whether to buy or sell equity shares. Expectations about future profitability and the
ability to generate cash influence the price of securities and a company's ability to
borrow money at favorable terms.

3. Creditors and Suppliers - Banks and other lenders need financial accounting
information to help determine loan terms, loan amounts, interest rates and required
collateral. Suppliers demand financial data to establish credit terms and to determine
their long-term commitment to supply-chain relations.

4. Shareholders and Directors - Financial accounting information are needed by

owners and directors of the company to assess its profitability and risks, to evaluate
managerial performance and to help make leadership decisions.

5. Regulatory and Tax Agencies - The SEC, BIR, BSP and other legal institutions
demand financial accounting information to monitor the business firms’ compliance with
laws, for public protection, price setting and for setting tax and other regulatory policies.

6. Customers and Potential Strategic Partners - Customers both current and

potential, need accounting information to evaluate a company's ability to provide
products and services as agreed and to assess the company's reliability and staying
power. Potential strategic partners would wish to estimate the firm's profitability to
assess the fairness of returns on mutual transactions and strategic alliances.

7. Other decision makers - Financial accounting information are required for varied
purposes by other parties from assessing damages for environmental abuses to making
policy decisions involving economic, social, taxation and other initiatives.
 CSTC COLLEGE OF SCIENCES TECHNOLOGY AND COMMUNICATION, INC.
CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
Registrar’s Office: 042 3290850 / 042 7192818
CSTC IT Center: 042 7192805
Atimonan Contact Number: 042 7171420

SOURCES OF INFORMATION ABOUT BUSINESS ENTERPRISE

In the Philippines, publicly listed companies must file financial accounting
information with the Securities and Exchange Commission (SEC). These are;

1. The audited annual report that includes the four financial statements
(Statement of Financial Position [traditionally known as the Balance Sheet Statement),
Statement of Comprehensive Income, Statement of Stockholders' Equity, and
Statement of Cash Flow) with explanatory notes and the management's discussion and
analysis of financial results.

2. The unaudited quarterly or interim reports that include summary version of the
four financial statements and limited additional disclosure.

All other registered corporations and partnerships are likewise required to file
annually audited financial statements with accompanying explanatory notes with the
SEC.

BENEFITS OF DISCLOSURE
The advantages of supplying accounting information extend to a company's
capital, labor, input and output markets. Companies compete in these markets. For
instance, debt and equity financing are sourced from capital markets and the better a
company's prospects, the lower will be its cost of capital as reflected in higher stock
prices or lower interest rate. The same is true for a company's recruitment efforts in
labor markets and its ability to established and maintain superior supplier-customer
relations in the input and output markets.

COSTS OF DISCLOSURE
The preparation and dissemination costs of supplying accounting information can
be substantial, and the possibility for information to produce competitive disadvantages
is high.
Companies are apprehensive that disclosures of their activities such as product
or segment successes or failures, strategic initiatives, technological or systems
innovations could harm their competitive advantages.
Companies also face possible lawsuits when disclosures create expectations that
eventually are not met.

CONSTRAINTS ON RELEVANT AND RELIABLE INFORMATION

1. Timeliness - Management may need to balance the relative merits of timely reporting
and the provision of reliable information. To provide information on a timely basis, it may
often be necessary to report before all aspects of a transaction or other event are
known, thus impairing reliability.

2. Balance Between Benefit and Cost - The balance between benefit and cost is a
pervasive constraint rather than a qualitative characteristic. The benefits derived from
information should exceed the cost of providing it. The evaluation of benefits and costs
is, however, substantially a judgmental process.

3. Balance Between Qualitative Characteristics - Generally, the aim is to achieve an

appropriate balance among the characteristics in order to meet the objective of financial
statements.

4. True Fair View or Fair Presentation - Financial statements are frequently described
as showing a true and fair view of the financial position, performance and changes in
financial position of an enterprise.
 CSTC COLLEGE OF SCIENCES TECHNOLOGY AND COMMUNICATION, INC.
CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
Registrar’s Office: 042 3290850 / 042 7192818
CSTC IT Center: 042 7192805
Atimonan Contact Number: 042 7171420

FINANCIAL STATEMENTS
Business activities are periodically reported by companies using four financial
statements:
1. Statement of Financial Position
2. Statement of Comprehensive Income
3. Statement of Stockholders Equity
4. Statement of Cash Flows

Figure 1 – Financial Statement Links across time

LINKAGE OF FINANCIAL STATEMENTS

The four financial statements are linked with each other and linked across time.

The statement of financial position and statement of comprehensive income are

linked via retained earnings. Retained earnings are updated each period and reflect
cumulative income that has not yet been distributed to shareholders.

ORANGE INC.
Retained Earnings Reconciliation
For the Year Ended September 30, 2011
(pesos in millions)
Retained earnings, September P5.607
30, 2010
Add: Net income 3.496
Less: Dividends (0)
Other adjustments (.002)
Retained earnings, September P9.101
30, 2011
Figure 2 – Retained Earnings Reconciliation

In the absence of transactions with stockholders (e.g., stock issuances,

repurchases and dividend payments), the change in stockholders' equity equals income
or loss for the period.

The income statement, thus, measures the change in company value as

measured in accordance with financial reporting standards. This is not necessarily
company value as measured by the market. Of course, all value-relevant items
eventually find their way into the income statement. So, from a long-term perspective,
 CSTC COLLEGE OF SCIENCES TECHNOLOGY AND COMMUNICATION, INC.
CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
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Atimonan Contact Number: 042 7171420

the income statement does measure change in company value. This is why stock prices
react to reported income and to analysts’ expectations about future income.

Orange Inc. begins the fiscal year 2010-2011 with assets of P17.205 million,
consisting of cash for P6.392 million and noncash assets for P10.813 million. These
investments are financed with P7.221 million from nonowners and P9.984 million from
shareholders. The owner financing consists of contributed capital of P4.355 million,
retained earnings of P5.607 million and other stockholders’ equity of P22 million.

Figure 3 shows statement of financial position at the beginning and end of

Orange Inc. The statement of cash flows explains how operating, investing and
financing activities increase the cash balance by P2.960 million from P6.392 million at
the beginning of the year to P9.352 million at year-end.

Orange Inc.'s P3.496 million net income reported on the income statement is also
carried over to the statement of shareholders’ equity. The net income explains nearly all
of the change in retained earnings reported in the statement of shareholders’ equity
because Orange Inc. paid no dividends in that year (other adjustments reduced retained
earnings by P.002 million).

There is an order to financial statement preparation. First, a company prepares

its income statement using the statement of comprehensive income accounts. It then
uses the net income number and dividend information to update the retained earnings
account. Second, it prepares the statement of financial position using the updated
retained earnings account along with the remaining statement of financial position
accounts from the trial balance. Third, it prepares the statement of stockholders' equity.
Fourth, it prepares the statement of cash flows using information from the cash
accounts and other sources.
 CSTC COLLEGE OF SCIENCES TECHNOLOGY AND COMMUNICATION, INC.
CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
Registrar’s Office: 042 3290850 / 042 7192818
CSTC IT Center: 042 7192805
Atimonan Contact Number: 042 7171420

Figure 3 – Articulation of Orange Inc. Financial Statements

STATEMENT OF FINANCIAL POSITION

A Statement of Financial Position reports a company's financial position at a
point in time, the company's resources (assets) namely, what the company owns and
also the sources of asset financing. There are two ways a company can finance its
assets:
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CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
Quezon R4A
Registrar’s Office: 042 3290850 / 042 7192818
CSTC IT Center: 042 7192805
Atimonan Contact Number: 042 7171420

1. Owner financing. It can raise money from shareholders.

2. Nonowner financing. It can also raise money from banks or other creditors
and suppliers.

This means that both owners and nonowners hold claims on company assets.
Owner claims on assets are referred to as Equity, and nonowner claims are referred to
as Liabilities (or debt). Since all financing must be invested in something. we obtain the
following basic relation: (investing = financing). This equality is called the accounting
equation which follows: (assets = liabilities + owner’s equity).

Blue Company
Statement of Financial Position
December 31. 2011
(pesos in millions)
Assets
Cash P 88.658
Noncash assets 457.662
Total assets 546.320

Liabilities and Owner’s Equity

Total Liabilities P299.518
Owner’s Equity
Contributed capital 53.920
Retained earnings 144.306
Other equity _48.576

Total Owner’s equity _246.802

Total liabilities and owner’s equity P546.320

Figure 4 – Statement of Financial Position

Investing Activities
Statement of financial position is organized like the accounting equation.
Investing activities are represented by the company's assets. These assets are financed
by a combination of nonowner financing (liabilities) and owner financing (equity).

Financing Activities
Assets must be paid for, and funding is provided by a combination of owner and
nonowner financing. Owner (or equity) financing includes resources contributed to the
company by its owners along with any profit retained by the company. Nonowner
(creditor or debt) financing is borrowed money. We distinguish between these two
financing sources for a reason: borrowed money entails a legal obligation to repay
amounts owed, and failure to do so can result in severe consequences for the borrower.
Equity financing entails no such obligation for repayment.
Some questions that a reader of the Statement of Financial Position of Blue
Company might have at this early stage are:
• Blue Company reports P88.658 million of cash on its 2011 statement of financial
position, which is 16% of total assets. Many investment-type companies such as
Blue Company and high-tech companies such as Cisco Systems carry high levels
of cash. Why is that? Is there a cost to holding too much cash? Is it costly to carry
too little cash?
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CSTC College Bldg. Gen. Luna St. Maharlika Hi-way, Pob. 3, Arellano Sub. Sariaya Province of
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Registrar’s Office: 042 3290850 / 042 7192818
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• The relative proportion of short-term and long-term assets is largely dictated by

companies’ business models. Why is this the case? Why is the composition of
assets on statement of financial position for companies in the same industry
similar? By what degree can a company's asset composition safely deviate from
industry norms?
• What are the trade-offs in financing a company by owner versus nonowner
financing? If nonowner financing is less costly, why don't we see companies
financed entirely with borrowed money?
• How do shareholders influence the strategic direction of a company? How can
long-term creditors influence strategic direction?
• Most assets and liabilities are reported on the statement of financial position at
their acquisition price, called historical cost. Would reporting assets and liabilities
at fair values be more informative? What problems might fair-value reporting
cause?

Review the Blue Company Statement of Financial Position summarized in Figure

4 and think about these questions.
Working Capital
Current assets are often called working capital because these assets "turn over",
that is, they are used and then replaced throughout the year.

Net working capital - is the difference between current assets minus current liabilities
net operating working capital - is the difference between current assets and non-interest
bearing current liabilities.

STATEMENT OF COMPREHENSIVE INCOME

The statement of comprehensive income reports on a company s performance
over a period of time and lists amounts for revenues (also called sales), expenses and
other comprehensive income. Revenues less expenses yield the bottom-line net income
amount.
Figure 5 shows the Blue Company Statement of Comprehensive Income. Refer
to its income statement to verify the following: revenues = P236.490 million; expenses =
P210.064 million; and net income P26.426 million. Net income reflects the profit (also
called earnings) to owners for that specific period.

Blue Company
Statement of Comprehensive Income
For Year Ended December 31, 2011
(pesos in millions)
Revenues P236.490
Expenses __210.064
Net Income (loss) 26.426
Other comprehensive _______0
income
Total P26.426
Figure 5 – Statement of Comprehensive Income

Manufacturing and merchandising companies typically include an additional

expense account, called cost of goods sold (or cost of sales), in the statement of
comprehensive income following revenues. It is also common to report a subtotal called
gross profit (or gross margin), which is revenues less cost of goods sold.
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The company's remaining expenses are then reported below gross profit. This
income statement layout follows:

Revenues
• Cost of goods
sold*
= Gross profit**
• Expenses***
= Net income (loss)

*Cost of materials, labor and overhead

**Revenues less cost of goods sold
***Expenses other than product cost of sales

Operating Activities
Operating activities use company resources to produce, promote and sell its
products and services. These activities extend from input markets involving suppliers of
materials and labor to a company's output markets involving customers of products and
services. Input markets generate most expenses (or costs) such as inventory, salaries,
materials and logistics. Output markets generate revenues (or sales) to customers.
Output markets also generate some expenses such as marketing and distributing
products and services to customers. Net income arises when revenues exceed
expenses. A loss occurs when expenses exceed revenues.
The following questions might be considered regarding the Statement of
Comprehensive Income.

• Assume that a company sells a product to a customer who promises to pay in 30

days. Should the seller recognize the sale when it is made or when cash is collected?
• When a company purchases a long-term asset such as a building, its cost is reported
on the statement of financial position as an asset. Should a company, instead record
the cost of that building as an expense when it is acquired? If not, how should a
company report the cost of that asset over the course of its useful life?
• Manufacturers and merchandisers report the cost of a product as an expense when
the product sale is recorded. How might we measure the costs of a product that is old
by a merchandiser? By a manufacturer?
• If an asset, such as building, increases in value that increase is not reported as
income until the building is sold, if ever. What concerns arise if we record increases in
asset values as part of income, when measurement of that increase is based on
appraised values?
• Employees commonly earn wages that are yet to be paid at the end of a particular
period. Should their wages be recognized as an expense in the period that the work
is performed, or when the wages are paid?
• Companies are not allowed to report profit on transactions relating to their own stock.
That is, they don't report income when stock is sold, nor do they report an expense
when dividends are paid to shareholders. Why is this the case?

Review the Blue Company Statement of Comprehensive Income summarized in

Figure 5 and think about these questions.

STATEMENT OF STOCKHOLDERS' EQUITY

The statement of stockholders’ equity reports on changes in key types of equity
over a period of time. For each type of equity, the statement reports the beginning
balance, a summary of the activity in the account during the year and the ending
balance.
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Quezon R4A
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Blue Company
Statement of Stockholders' Equity
For Year Ended December 31, 2011
(pesos in millions)
Contributed Retained Other Total
Capital Earnings Equity
December 31, 2010 P53.060 P117.824 P50.478 P221.362
Stock issuance .860 .860
(repurchase)
Net income (loss) 26.426 26.426
Dividends (0) (0)
Other _______ ____.056 ___(1.902) ____(1.846)
December 31, 2011 P53.920 P144.306 P48.576 P246.802

Figure 6. Statement of Stockholders' Equity

Contributed capital represents the cash that the company received from the sale of
stock to stockholders (also called shareholders), less any funds expended for the
repurchase of stock. Retained earnings (also called earned capital or reinvested capital)
represent the cumulative total amount of income that the company has earned and that
has been retained in the business and not distributed to shareholders in the form of
dividends. The change in retained earnings links consecutive statement of financial
position via the income statement:
Ending retained earnings = Beginning retained earnings + Net income -
Dividends.
For Blue Company, its recent year's retained earnings increases from P117.824
million to P144.306 million. This increase of P26.482 million is explained by net income
of P26.426 million, no payment of dividends and P0.056 million related to a mandated
accounting change.

STATEMENT OF CASH FLOWS

The statement of cash flows reports the change (either an increase or decrease)
in a company's cash balance over a period of time. The statement reports on cash
inflows and outflows from operating, investing and financing activities over a period of
time.

Blue Company
Statement of Cash Flows
For Year Ended December 31, 2011
(pesos in millions)
Operating cash flows P12,550
Investing cash flows (13,428)
Financing cash flows ___1,464
Net increase in cash 586
Cash, December 31, 2010 __43,743
Cash, December 31, 2011 P44,329

Figure 7. Statement of Cash Flows

Consider the following questions regarding the Statement of Cash flows:

• What is the usefulness of the statement of cash flows? Do the statement of financial
position and income statement provide sufficient cash flow information?
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• What types of information are disclosed in the statement of cash flows and why are
they important?
• What kinds of activities are reported in each of the operating, investing and financing
sections of the statement of cash flows? How is this information useful?
• Is it important for a company to report net cash inflows (positive amounts) relating to
operating activities over the longer term? What are the implications if operating cash
flows are negative for an extended period of time?
• Why is it important to know the composition of a company's investment activities?
What kind of information might we look for? Are positive investing cash flows
favorable?
• ls it important to know the source of a company's financing activities? What
questions might that information help us answer?
• How might the composition of operating, investing and financing cash flows change
over a company's life cycle?
• Is the bottom line increase in cash flow the key number? Why or why not?

References
• Cabrera, Ma. Elenita (2012-2013). Financial Management Principles and
Applications Comprehensive Volume. GIC Enterprises
• Bautista, Precila R. Bautista (2018). Simplified Approach To Financial
Management. Unlimited Books Library Services &
• Valencia, Edwin (2015). Basic Accounting. Valencia Educational Supplies Baguio
City Philippines

Prepared by: Reviewed by:

GLAZY KAE N. NAVAJAS, LPT MARK ANTHONY C. DELGADO, CPA, LPT, MBA
Instructor Academic Coordinator, SBA