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COMM 103 (179)
Chapter 14

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Queen's University
COMM 103
Gregory Libitz

Chapter 14: Understanding Financial Statements The Role of Financial Statements  Analysing and interpreting financial statements is what enables a management team to keep its “fingers on the pulse” of the organization  Need to know if the company is effectively using its resources  F.S. keep managers up to date on the success of an org’s sales and marketing initiatives  Let’s managers know the organizations ability of controlling its costs to maintain its gross and profitability margins  Managers generally rely on I.S., B.S., and the Cash Flow statement o Provide info regarding liquidity, profitability, and solvency  Provides info relating to the overall growth of the company Fundamental Types of Business Transactions  Operational Transactions: Represent the flow of money within the organization o Directly related to day-to-day operations o ie. Revenue, expenses  Capital Asset Transactions: Decisions made with respect to investment/disinvestment of capital assets  Buildings, equipment o Not directly related to current year’s profit, but they do have an impact on cash flow Liquidity, Solvency, Efficiency, and Financial Capacity Liquidity  The ability of a company to meet ongoing financial obligations based on how much cash they have and the cash generated within its operations  Businesses must generate enough revenue/have sufficient cash to pay for expenses o If need be, can we pay off all current liabilities? Solvency  Refers to the long-term assessment of a company’s financial stability  Focuses on forward anticipated profitability of firm&whether it can continue in the future  Takes into account future revenue, products in development, market position  In essence, it refers to the org’s ability to pay off long term liabilities and to profitably grow the company Efficiency  Refers to how effective the org is in deploying its resources and managing operations o ie. Efficiency in collections? How long to turnover inventory? Return on assets? Financial Capacity  Relates to orgs cash reserves & borrowing power capacity to live through revenue drop  Used to determine the amount of resources an org has to work with (for R&D) Three Primary Financial Statements Income Statement  Reflects a specific period of time, identifies the revenue which we have received, and then subtracts the expenses which the business has incurred in generating such revenue.  Revenue: Dollar amount which the org received from selling goods/services  COGS: Expense which are directly incurred in manufacturing a good/service  Gross Profit: The difference between total revenue and total expenses. Left over $  Operating Expenses: Indirect expenses which an org incurs  must be paid from GP  Earnings before Interest and Taxes: EBIT  subtract Operating Expenses from GP  Interest Expense: Interest payments which the org is obligated to pay during a period  Earnings Before Income Tax: Earning produced prior to recognizing fed & prov tax  Net Income/Loss: Firm’s profit/loss from the sale of goods/services  GP – Expenses Balance Sheet  Provides managers with an understanding of a business’ resources at any point of time, as well as any obligations which a business has incurred to obtain the resources  Assets: Represent a company’s resources which can be utilized to generate profit o Current ( = 1 year) Long-Term (> 1 year)  Liabilities: Represent an org’s debt and financial obligations which it has incurred as a part of conducting business o Current and Long-Term Liabilities  Owners’ Equity: Represents the value of capital received from the owners of the business o Used to fund the start-up or ongoing operations of the firm o Generally companies retain a portion of their earnings to buy equipment, fund R&D Cash Flow Statement  Summarizes the sources and uses of an organizations cash  Revenue is not always cash  Provides managers with a full understanding of the total movement of cash into & out of the business  Provides insight into the current and projected liquidity position of a firm Net Results Net Result from the Net Results Net Results Changes to Income Cash from Cash from from Cash Cash Operating Investing Financing Position Statement Activities Activities Activities Analysing and Interpreting Financial Information  In conducting an analysis of an organization, the focus is on four specific areas o Ratio Analysis - Assessing & interpreting relationships between financial results o Leverage Analysis - Assessing the impact of the amount of debt which and org has incurred o Trend/Comparative Analysis - Look at trends over time by analysing periods of financial statements o Absolute Analysis - Look at specific dollar amount of existing financial resources Ratio Analysis  Seek to define the relationship between critical components of information found on the financial statements  However, ratios by themselves are not always indicative of an org’s financial health Profitability Ratios  Focus on assessing the amount of income which the org has earned in comparison to the operating activity which has taken place and the assets that have been used to support it o Return on Sales: Percentage of sales that actually represents profit  Net Income/Net Sales o Return on Assets: Reflects how productive the use of assets were in producing income for the organization  for every $1 of asset, it made $X of net profit  Net Income/Total Assets o Return on Equity: The amount of income which was earned on each dollar of capital invested  for every $1 invested, it made $X of net income  Net Income/Total Equity o Earnings per Share: Reflects the return on what investors would recognize for every share that they owned  Net Income/Number of Outstanding Shares Solvency and Liquidity Ratios  Help managers understand if they have enough cash to meet financial obligations  Done by comparing financial obligations w. financial resources to meet upcoming needs o Current Ratio: Shows relationship between an orgs current assets and liabilities  Current Assets/Current Liabilities o Quick Ratio: Used when an org is concerned with its current liquidity
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