Financial Statement Analysis

Degree in Tourism
Summary
• CHAPTER 1
•
• INTRODUCTION
•
• PART A
•
• 1.- The four financial Statements
• 2.- The Balance Sheet
• 3.- The Income Statement
• 4.- The Statement of Stockholders’ Equity
• 5.- The Statement of Cash Flow
• 6.- Generally Accepted Accounting Principles
The four financial statements
• Companies present four basic financial
statements:
•
• 1. Balance Sheet
• 2. lncome Statement
• 3. Statement of Stockholders' Equity
• 4. Statement of Cash Flows
•
• Each statement provides information about a
different perspective of the company's finances
The four financial statements
• What does the company own and who has
claims against the company? The BALANCE
SHEET provides a snapshot of a company's
financial position as of a certain date. lt
reports assets, items of value such as
inventory and equipment, and whether the
assets are financed with liabilities (debts) or
stockholders' equity (owners' shares).
The four financial statements
The four financial statements
• How profitable is the company? The INCOME
STATEMENT reports the company's
profitability during an accounting period. lt
reports revenues, amounts received from
customers for products sold or services
provided, and expenses, the costs incurred to
produce revenues. The difference is net
income.
The four financial statements
The four financial statements
• Who owns the company? The STATEMENT OF
STOCKHOLDERS' EQUITY reports if the
earnings (net income) of this accounting
period are distributed as dividends or retained
in the business as retained earnings. lt also
reports amounts paid (contributed) by
stockholders to purchase common stock and
preferred stock.
The four financial statements
The four financial statements
• Does the company generate cash flow? The
STATEMENT OF CASH FLOWS reports cash
inflows and cash outflows during an
accounting period.
The four financial statements
The four financial statements
• Together, these four financial statements help
investors understand a company's finances
The Balance Sheet
• The accounting equation (also called the
balance sheet identity) is the basis of the
accounting system:

• Assets = Liabilities + Owners’ Equity.

The Balance Sheet
• The left-hand side of this equation relates to
the resources controlled by a company, or
assets. These resources are investments that
are expected to generate future earnings
through operating activities.

• To engage in operating activities, a company

needs financing to fund them.
The Balance Sheet
• The right-hand side of this equation identifies
funding sources. These are two: Liabilities and
Owners’ Equity.
• Liabilities are funding from creditors and
represent obligations of a company or,
alternatively, claim of creditors on assets.
The Balance Sheet
• Owners’ Equity (or shareholders’ equity) is
the total of (1) funding invested or
contributed by owners (contributed capital)
and (2) accumulated earnings in excess of
distributions to owners (retained earnings)
since inception of the company. From the
owners’, or shareholders’, point of view, equity
represents their claim on company assets
The Balance Sheet
• Assets and liabilities are separated into
current and noncurrent amounts. Current
assets are expected to be converted to cash or
used in operations within one year or the
operating cycle, whichever is longer. Current
liabilities are obligations the company is
expected to settle within one year or the
operating cycle, whichever is longer.
The Balance Sheet
• The difference between current assets and
current liabilities is called working capital
The Balance Sheet
The Balance Sheet
• Based on the accounting equation, assets can be
financed either with liabilities or with
stockholders' equity. For example, Nike's 512,443
million in assets were financed with 54,617
million worth of liabilities (debt) and 57,826
million in stockholders' equity. To use the
accounting equation:
•
•
•
The Income Statement
• An income statement measures a company’s
financial performance between balance sheet
dates. It is a representation of the operating
activities of a company. The income statement
provides details of revenues, expenses, gains,
and losses of a company for a time period. The
bottom line, earnings (also called net income),
indicates the profitability of the company.
The Income Statement
• Earnings reflect the return to equity holders for
the period under consideration, while the line
items of the statement detail how earnings are
determined. Earnings approximate the increase
(or decrease) in equity before considering
distributions to and contributions from equity
holders. For income to exactly measure change in
equity, we need a slightly different definition of
income, called comprehensive income, which we
discuss in the section on links between financial
statements later in this chapter
The Income Statement
• The income statement includes several other
indicators of profitability. Gross profit (also
called gross margin) is the difference between
sales and cost of sales (also called cost of
goods sold). It indicates the extent to which a
company is able to cover costs of its products.
This indicator is not especially relevant for
service and technology companies where
production costs are a small part of total costs
The Income Statement
• Earnings from operations refers to the
difference between sales and all operating
costs and expenses. It usually excludes
financing costs (interest) and taxes. Earnings
before taxes, as the name implies, represents
earnings from continuing operations before
the provision for income tax.
The Income Statement
• Earnings from continuing operations is the
income from a company’s continuing business
after interest and taxes. It is also called
earnings before extraordinary items and
discontinued operations.
The Income Statement
• Earnings are determined using the accrual
basis of accounting. Under accrual accounting,
revenues are recognized when a company
sells goods or renders services, regardless of
when it receives cash. Similarly, expenses are
matched to these recognized revenues,
regardless of when it pays cash
The Income Statement
The Income Statement
• NET lNCOME is the difference between
revenues and expenses. Net income is also
referred to as profit (loss), earnings, or the
bottom line.
The Statement of Stockholders’ Equity
• The statements of shareholders’ equity report
changes in the accounts that make up equity.
This statement is useful in identifying reasons
for changes in equity holders’ claims on the
assets of a company. During this period,
shareholders’ equity changes due to the
issuing and repurchasing of (treasury) stock,
and reinvesting earnings
The Statement of Stockholders’ Equity
• Although many companies show Other
Comprehensive Income (Loss) separate from
retained earnings, in reality it is an integral
component of retained earnings. The
Statement of Stockholders' Equity reports
changes in the contributed capital and
retained earnings accounts during an
accounting period
The Statement of Stockholders’ Equity
The Statement of Cash Flows
• Earnings do not typically equal net cash flows,
except over the life of a company. Since
accrual accounting yields numbers different
from cash flow accounting, and we know that
cash flows are important in business
decisions, there is a need for reporting on
cash inflows and outflows.
The Statement of Cash Flows
• For example, analyses involving reconstruction
and interpretation of business transactions
often require the statement of cash flows.
Also, certain valuation models use cash flows.
The statement of cash flows reports cash
inflows and outflows separately for a
company’s operating, investing, and financing
activities over a period of time.
The Statement of Cash Flows
• The Statement of Cash Flows reports cash
Inflows and outflows during an accounting
period.
The Statement of Cash Flows
The Statement of Cash Flows
• Business activity can be divided into three distinct
areas: operating, investing, and financing.
• OPERATING ACTIVITIES relate to a company's main
business: selling products or services to earn net
income. INVESTING ACTIVITIES relate to the need for
investing in property, plant, and equipment or
expanding by making investments in other companies.
FINANCING ACTIVITIES relate to how a company
finances its assets -- with debt or stockholders' equity.
The Statement of Cash Flows describes a company's
cash inflows and outflows for each of these three
areas.
 Regulation
The role of capital markets
as fund providers

Economic consequences Managerial incentives to

of financial information suppress unfavorable
information

Need for regulation

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 ACCOUNTING PRINCIPLES
AND CONCEPTS
 Generally accepted accounting
principles (GAAP) are:
 Guidelines that govern how accountants
 Measure

 Process

 Communicate

Financial information
 Based upon a conceptual framework
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Accounting Principles and Concepts

 Financial Accounting Standards Board (FASB)

establishes US GAAP
 GAAP – Generally Accepted Accounting Principles
 GAAP is derived from the conceptual framework
 Other parties involved in defining how accounting
should be practised:
 SEC: Securities and Exchange Commission
 AICPA

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 KEY US ACCOUNTING ORGANIZATIONS

Public Sector
Law creates the SEC to
regulate the stock and
bond market in the U.S.

Private Sector Private Sector

Accountants apply The FASB determines
GAAP through generally accepted
GAAP governs accounting principles
the AICPA accounting
information

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 KEY SPANISH ORGANIZATIONS
(relevant for the Accounting practice)

• Ministry of Treasury
• ICAC
– Instituto de Contabilidad y Auditoría de Cuentas
• Bank of Spain
• UE Comission
• CNMV
– Similar to SEC
• AECA
– Asociación Española de Contabilidad y Auditoría

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Conceptual Framework

 Accounting provides information useful for

decision making
 To be useful, information must be
 Relevant – able to influence a decision
 Reliable – verifiable and free from error
 Comparable – can be compared with different
companies
 Consistent – can be compared from one period to the
next

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ACCOUNTING PRINCIPLES AND CONCEPTS

• They are present in the elaboration of all

accounting information
• They are mainly, five:
– Entity concept
– Reliability principle
– Cost principle
– Going-concern concept
– Stable-monetary-unit concept

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ACCOUNTING PRINCIPLES AND CONCEPTS

 The entity concept

 States that an organization is an economic unit
that keeps its affairs separate from
those of the owner(s) or other entities
 Example: the company sells the products, not
the owner.

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ACCOUNTING PRINCIPLES AND CONCEPTS
• The reliability (or objectivity) principle
– States that accounting records and statements
should be based on accurate data.
– Use the most reliable data available and
documented by objective evidence
– Actual cost is usually more reliable than market
value
– Data is reliable if:
• It is verifiable
• It can be confirmed by an independent observer

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ACCOUNTING PRINCIPLES AND CONCEPTS
 The cost principle
 States that acquired assets and services should be
recorded at their actual (historical) cost and should
maintain that historical cost for as long as they are owned

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ACCOUNTING PRINCIPLES AND CONCEPTS
• The going-concern concept

– States that the entity will remain in operation for

the foreseeable future

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ACCOUNTING PRINCIPLES AND CONCEPTS

 The stable-monetary-unit concept

 States that each dollar has the same purchasing power as

any other dollar at any other time
 It allows accounts to ignore the effect of inflation in the
accounting records

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