2.

4 Cash Flow
2.3 Sources & Uses
2.2 Income
Statement
2.1 Balance Sheet

2
UNDERSTANDING
FINANCIAL STATEMENTS
CHAPTER
 What is Financial Statement

Financial statements are a collection of reports about an

organization's financial results, financial condition and
cash flows.
 2.1 Balance Sheet
(Statement of Financial Position)
It is a statement or a snapshot of a
firm’s financial position at a specific point of time.

2.1 Balance Sheet

Current Liabilities
Long term liabilities
1. Current Assets
2. Fixed Asset
3. Intangible Asset ASSET LIABILITIE
S

EQUITY

Shareholders
equity
 Asset - what the business OWNS
1. CURRENT ASSET 1 Cash - actual money
• the assets that can be converted into cash
in less than 1 year.
• It represent - working capital which Mktb. Sec - short term
2
provide support for day to day operations. investment in financial
• Without working capital the firm cannot securities
operate efficiently. 50% Inventories - needed for productions
3 eg. raw material, work in progress
and finished goods
A/C Receivables - amount owed by
4 customers on credit sales

5 Prepaid - paid for in advance

 Fixed Asset & Intangible Asset
2. FIXED ASSET 3. INTANGIBLE ASSET
• asset acquired for l/term use to generate • asset that is not physical in nature
income. • Goodwill occurs when a company
• not easily converted into cash within a purchases another business that has an
short period economic value greater than the value
of the individual assets.
50%
1 Goodwill

2 Pattern

3 Trademarks
 Liabilities - what the business
1. CURRENT LIABILITIES OWES
1 A/c Payable - amount owed to
• Current liabilities - Debts that are due and supplier
payable within 1 year period or less.
2 Accruals - wages accruals, Tax
accruals, amount owed to
employees and tax authority

Notes payable - amount owed

3
to lender (bank).
 Long Term Liabilities – Debts which are due or
payable beyond 1 year.
1 Term loan - medium to long 4 Mortgage- represent a loan or
term loans from financial a bond that is backed by the
institutions for capital pledged of specific asset of the
firm
2 Debentures - any unsecured 5 Lease - a legal contract
long-term debt. The earning whereby having to actually is
ability of the issuing corporation able to use certain assets
is of great concern to the without having to actually
bondholder. purchase the assets

Bond - a promissory notes

3
issued to investors
 Equity– represents the owners claim on the firm.

1 Common Equity - Stockholders 2 Preferred equity - equity that

Equity or Owners Equity has certain priority over
Common equity consists of: common stock
1. Common stock – Share issue by the
company
2. Premium - as the difference between
the par value of a company’s shares
and the total amount a company
received for shares
3. Retained earning – the amount of net
income left over for the business
after it has paid out dividends to its
shareholders.
 2.2 Income Statement
(Statement of Comprehensive Income)
The income statement provides a financial summary of a company’s operating
results during a specified period

2.2 Income
includes sales and
other income
REVENUES PROFIT OR
LOSS
profit or loss after
subtracting expenses from
COST & revenues.
Expenses used In The net profit after interest
the process of
EXPENSES
and taxes are available for
generating the dividend to p/s and c/s
revenues. holders as dividends.

**Depreciation does not involve actual cash flow but it reflects the usage of assets in producing the goods
and services.
Income Statement (Statement of Comprehensive Income) Format

NET SALES
Less: Cost of Good Sold
Gross profit (GP)
Less: General and Administrative Expenses (Operating Expenses)
Earnings before interest & taxes (EBIT) (Operating Profit/Income)
Less: Interest expenses
Earnings before taxes (EBT)
Less: Taxes (%)
Earnings after Taxes (EAT/ NPAT / NI )
Less: Preferred Stock Dividend
Earnings available to common stockholders
Less: Common stock dividends
Addition to retained earnings
2.3 Sources And Uses Of Funds Statement

2.3 Sources & Uses

• a summary of the firm’s operating, investment

Balance Sheet
and financing cash flow and reconciles them
with changes in its cash and marketable

2.2 Income
2.1Statement
Definition securities over a certain period.
• useful tools to ensure that firm will continue to
have SUFFICIENT FUNDS and to use the EXCESS
FUNDS and make MORE INVESTMENT.

Sources • how the firm finances its day to day

operations

Uses • how firm uses their resources and funds

 SOURCES OF FUNDS USES OF FUNDS

1. decrease in assets account ( - )

Eg: an asset is sold by the firm, the 1. increase in assets account ( + )
cash from sales is included as inflow. Eg: firm purchases its assets, firms used
2. increase in liabilities & equity funds to pay for it.
accounts (+) 2. decrease in liabilities and equity
Eg: when a company borrows money accounts (-)
from external sources, sale of shares Eg: refered as uses because firm use the
(mean for firm to generate funds funds to pay off debts, purchased of
externally) preferred stock
3. net profit after taxes – the profit 3. net loss from operation – losses
from the firm’s operations incurred by firm
4. depreciation and other non-cash 4. cash dividend payment
expenditures
 Why depreciation - sources?
Depreciation** An increase in depreciation is
Uses actually a decrease in the asset
account
Sources Decrease in asset, means that
sources of funds.
Even though depreciation is
sources, BUT it does not really
provide funds because it is a
Sources & Uses of funds non-cash expenses
Features Sources Uses
Asset - +
A. Cash Basis
Liability + -
Profit/ Net Profit Net Loss
Loss
Depreciation* Cash
*
Other non-cash dividend B. Net Working Capital Basis
expenditure payment
A. Cash Basis
Step 1
Analyze the balance sheets

Step 2
Analyze the income statement

Step 3
Combine the information from these two
statements to form the S & U statement
A. Cash Basis
Step 1
Analyze the balance sheets
i. Find the changes in the Balance Sheet (t1– t0 ).
ii. Write down the value of the changes in Current Assets and Current
Liabilities.
• Indicates (+) when changes increase this year from previous year
• Indicate (-) when changes decrease this year from previous year.
iii. Identify the changes either sources & uses of fund
 A. Cash Basis
Step 2
Analyze the income statement. Determine the:
i) Depreciation expenses
• Always take the figure on depreciation expenses from I/S (Note 1)
• If NONE in income statement than take it from B/S = (t1 – t0 )
ii) Net income
• Refer to I/S, current year (t1). If NONE, then calculate as follows:
Net income1 = dividend + changes in retained earnings (R/E t1 - R/E t0)
iii) Dividend = net income – changes in retained earnings
*If Dividend Payout Ratio (DPR) is given, to find dividend, DPR = dividend/net income
iv) Gross Fixed assets (capital investment)
Refer to B/S, Net fixed assets (t1) - net fixed assets (t0) + depreciation exp. (t1)
A. Cash Basis
Step 3
Combine the information from these two
statements to form the S & U statement
SOURCES RM USES RM
Net Income XX Dividend Payment XX
Depreciation XX Increase in Assets XX
Increase in Liabilities XX Decrease in Liabilities XX
Decrease in assets XX XX
TOTAL SOURCES XX TOTAL USES XX
Tips – Total Sources = Total
 Notes
Why depreciation should
1 not be taken from B/S?

• figure in b/s is an accumulated depreciation account, if changes in

accumulated depreciation (t1 – t0 ) is used, the figure may be understate
the depreciation account if depreciable asset is sold during the year
References :
Foundations of Finance: The Logic and Practice of Financial Management, 9th Edition,
ISBN 978-0-13-408328-5 by Arthur J. Keown, John D. Martin and J. William Petty,2017.

https://www.accountingtools.com/articles/the-difference-between-depreciation-on-the-income-statement.html)
Notes
Why R/E SHOULD NOT BE IN
2 the funds flow statement?

• R/E is neither sources nor uses because the current amount of

retained earnings is already being included in the net profit after tax
or net income
• to avoid DOUBLE COUNTING, because net profit (sources) and
dividend payment (uses) are already stated in the statement.
• Thus, the balance between the two represents a sources of funds
from retained earnings.
• Retained earnings = net profit (Sources) – dividend payment (Uses)
B. Net Working Capital (NWC) Basis
Step 1
Calculate the changes in Net Working
Capital
Step 2
Follow the 2nd step as per cash basis

Step 3
Substitute changes in NWC for all
changes in the S & U statement.
B. Net Working Capital (NWC) Basis
Step 1

Calculate the changes in Net Working Capital

= Changes in Current Asset – Changes in C.Liabilities
= (CAt1 - CAt0) – (CLt1 - CLt0) or (CAt1 - CLt1) – (CAt0 - CLt0)

❑ If Changes in NWC is (+) = Uses because:

Increase in Current Assets = Uses
❑ If Changes in NWC is (-) = Sources because:
Decrease in Current Assets = Sources
 B. Net Working Capital (NWC) Basis
Step 2
Analyze the income statement. Determine the:
i) Depreciation expenses
• Always take the figure on depreciation expenses from I/S (Note 1)
• If NONE in income statement than take it from B/S = (t1 – t0 )
ii) Net income
• Refer to I/S, current year (t1). If NONE, then calculate as follows:
Net income1 = dividend + changes in retained earnings (R/E t1 - R/E t0)
iii) Dividend = net income – changes in retained earnings
*If Dividend Payout Ratio (DPR) is given, to find dividend, DPR = dividend/net income
iii) Gross Fixed assets (capital investment)
Refer to B/S, Net fixed assets (t1) - net fixed assets (t0) + depreciation exp. (t1)
B. Net Working Capital (NWC) Basis
Substitute changes in NWC for all
Step 3 changes in the S & U statement.
SOURCES RM USES RM
Net Income XX Dividend Payment XX
Depreciation XX Increase in Asset (Fixed Assets) XX
Decrease in Asset (Fixed XX Decrease in Long Term Liabilities XX
Assets) & Equity
Increase in Long Term XX
Liabilities & Equity
* If decrease in NWC XX * If increase in NWC XX
TOTAL SOURCES XX TOTAL USES XX

Tips – Total Sources = Total

Uses
Past Year Questions

1. FIN420 Dec 2013 2a

2. FIN420 Dec 2014 2a
2.4 Cash flow Statement
• Provides a summary of the cash
flows over the period of the year
just ended.
• Provides insight into the firm’s
operating activities, investment
activities and financing
activities **
• Reconciles them with the
changes in cash and marketable
securities during the period
concern
 What are operating activities, investment
activities and financing activities?
i. net income
ii. Depreciation
iii. changes in current assets and
liabilities other than cash
Operating • short-term investments
• short-term debt.

i. raising cash by issuing

short-term debt i. investments in or sales
(notes payable), of fixed assets
Financing Investment ii. short-term financial
long-term debt, or
stock. investments
ii. dividends paid (marketable securities)
 Steps in Preparing
Cash flow Statement
• Step 1 – 3 (refer to step in
preparing sources & uses of
funds)
• Step 4 – Classify relevant data
into these categories:
i. C/F from operating activities
ii. C/F from investment activities
iii. C/F from financing activities

To check!– the ending value should reconcile with the actual

change in cash & marketable securities for the year