CityPress - - Business -

If you have trou­ble the first few times you try to un­der­stand fi­nan­cial state­ments, don’t worry – that’s nor­mal. The more you read fi­nan­cial state­ments, the more com­fort­able you will be­come with the pre­sen­ta­tion, and the bet­ter able you will be to in­ter­pret what the state­ments are telling you. Most of the num­bers in the fi­nan­cial state­ments don’t stand alone.

Each in­te­grated re­port will have nu­mer­ous foot­notes that am­plify on the num­bers – make sure you read these care­fully. It’s also im­por­tant to re­mem­ber that to get a good feel for the com­pany, you should look at it within a much larger frame­work.

Some of the things you need to con­sider be­fore you even ap­proach the fi­nan­cial state­ments or in­te­grated re­port in­clude:

CON­TEXT Put the com­pany into a con­text that in­cludes its in­dus­try, the econ­omy, in­ter­est rates, the busi­ness cy­cle, etc. For ex­am­ple, the fi­nan­cial state­ments and ra­tios of util­i­ties such as Eskom are vastly dif­fer­ent from those of re­tail­ers such as Ed­con.

TRENDS Look at the com­pany’s own trends or how it has per­formed over the past three, five or 10 years. You might find that this year’s per­for­mance is much bet­ter, or worse, than the per­for­mance over the past few years. If so, look for rea­sons – it may be that a com­pany that sup­plies an­i­mal feed suf­fered a down­turn dur­ing the drought.

When you are read­ing a com­pany’s fi­nan­cial state­ments, re­mem­ber that pub­lic com­pa­nies pro­duce two types of num­bers: unau­dited and au­dited.

UNAU­DITED Unau­dited num­bers are some­times called man­age­ment fig­ures. They are pro­duced for ex­ec­u­tives and man­agers for spe­cific pur­poses, such as in­ven­tory con­trol and cash flow pro­jec­tions.

AU­DITED This is where an in­de­pen­dent au­dit­ing firm has re­viewed the num­bers to pro­vide as­sur­ance that cer­tain pro­ce­dures have been fol­lowed so that the num­bers con­form to ac­count­ing principles. Note that not all num­bers that com­pa­nies re­lease to the pub­lic have been re­viewed by out­side au­di­tors.

T 1he three fi­nan­cial state­ments you are go­ing to en­counter are the in­come state­ment, the bal­ance sheet and the cash flow state­ment. Here’s what you need to look for in each: THE IN­COME STATE­MENT shows what the com­pany gen­er­ates in prof­its or losses dur­ing the re­port­ing pe­riod, such as a quar­ter or year. Key in­for­ma­tion in the in­come state­ment in­cludes:

Rev­enues, gross rev­enues, net op­er­at­ing rev­enues or sales: The com­pany’s to­tal sales or rev­enues dur­ing the pe­riod. This is of­ten re­ferred to as the “top line”.

Head­line earn­ings: These are a mea­sure­ment of a com­pany’s earn­ings based solely on op­er­a­tional and cap­i­tal in­vest­ment ac­tiv­i­ties. It specif­i­cally ex­cludes any in­come that may re­late to staff re­duc­tions, sales of as­sets, or ac­count­ing write-downs.

Cost of goods sold: For a man­u­fac­turer, this typ­i­cally in­cludes the cost of in­ven­tory (raw ma­te­ri­als and sup­plies to make the com­pany’s prod­ucts), as well as the ex­penses of turn­ing raw ma­te­ri­als into fin­ished prod­ucts, such as labour and di­rect over­heads. For a re­tailer, this cat­e­gory is what the com­pany pays for the prod­ucts it sells on its shelves. It is only the cost of the mer­chan­dise pur­chased for re­sale, not the cost of pro­vid­ing the ser­vice to cus­tomers. For a ser­vice com­pany, this cat­e­gory is typ­i­cally small.

Gross profit: Rev­enues mi­nus cost of goods sold re­sults in gross profit. Most com­pa­nies pay spe­cial at­ten­tion to manag­ing the gross profit mar­gin or the gross mar­gin.

Op­er­at­ing ex­penses: Most com­pa­nies present op­er­at­ing ex­penses in a gen­eral cat­e­gory called “sell­ing, gen­eral and ad­min­is­tra­tive ex­penses”. Op­er­at­ing ex­penses typ­i­cally in­clude rent, salaries and wages paid, pay­roll taxes, prop­erty taxes, tele­phone, in­surance, re­search and devel­op­ment, de­pre­ci­a­tion and amor­ti­sa­tion, and bad debts.

Other rev­enues or ex­penses: This in­cludes items such as dis­con­tin­ued op­er­a­tions, the sale of an in­vest­ment, un­usual or ex­tra­or­di­nary items, changes in ac­count­ing principles and mi­nor­ity in­ter­est.

In­come taxes: The amount of in­come tax the com­pany paid that year.

Net in­come: Net in­come is what’s left af­ter all ex­penses have been de­ducted. This is of­ten re­ferred to as the bot­tom line.

Earn­ings per share: This tells you how much of a com­pany’s profit is al­lo­cated to each share of com­mon stock. It is de­ter­mined by di­vid­ing net in­come mi­nus pre­ferred div­i­dends by the av­er­age num­ber of com­mon shares out­stand­ing for the pe­riod.

2THE BAL­ANCE SHEET is a snap­shot of the com­pany’s as­sets, li­a­bil­i­ties and share­hold­ers’ equity on the last day of the re­port­ing pe­riod. The left side of the bal­ance sheet lists the as­sets, or what the com­pany owns. The right side lists the li­a­bil­i­ties, or what the com­pany owes, and the share­hold­ers’ equity, or the funds in­vested in the com­pany and re­tained earn­ings. The two sides must bal­ance, so the bal­ance sheet for­mat is as­sets equal li­a­bil­i­ties plus share­hold­ers’ equity (A = L + E).

The bal­ance sheet shows data from the two most re­cent years, which al­lows you to cal­cu­late changes from one year to an­other. Sig­nif­i­cant changes in any ac­count must be ex­am­ined and could be worth fol­low­ing up. Items on the bal­ance sheet in­clude:

Cur­rent as­sets: As­sets that could be ex­pected to be turned into cash or sold or con­sumed within a year or within the nor­mal op­er­at­ing cy­cle of the com­pany, if it is longer than a year.

Cash and cash equiv­a­lents: Cash and short-term, highly liq­uid in­vest­ments. Ex­am­ples in­clude money mar­ket funds.

Ac­counts re­ceiv­able: Amounts due from cus­tomers to the com­pany for goods and ser­vices pro­vided in the nor­mal course of busi­ness. The re­ceiv­ables cat­e­gory of­ten shows an en­try called “less al­lowance for doubt­ful ac­counts”, which presents an es­ti­mate of what the com­pany ex­pects will not be paid. It is es­sen­tially a bad debt es­ti­mate. Amounts are based on past ex­pe­ri­ence and/or in­dus­try av­er­ages.

In­ven­to­ries: Goods on hand avail­able for sale or ma­te­ri­als on hand for pro­duc­ing those goods. In­ven­tory is usu­ally iden­ti­fied as be­ing in one of three cat­e­gories: raw ma­te­ri­als; work-in-process; or fin­ished goods. The rand amount al­lo­cated to each cat­e­gory is usu­ally shown on the bal­ance sheet or in the foot­notes to the fi­nan­cial state­ments.

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