Financial AnalysisTutor: Dr. Anup ChowdhuryE-mail: a.chowdhury@leedsmet.ac.ukBefore applying the accounting informationfor decision making….• Let us explore the financial statements more in details andsome concepts related to those.The relationship between the major financial statementIncome statementStatement of cashflowsStatement offinancial positionStatement offinancial positionStatement offinancial positionStatement of cashflowsPeriod 1 Period 2 TimeIncome statementThe equation for the standard layout= EquityNoncurrentliabilitiesCurrentliabilitiescurrent Non- + +assetsCurrentassets+Decisionchart foridentifying anaccountingassetIs there a probablefuture benefit?Is there a right to controlthe resource?Does the economic benefit arisefrom a past transaction or event?Can the resource be reliablymeasured in financial terms?AccountingassetNot anaccountingassetYesYesYesYesNoNoNoNoCurrent assetsExpected to be sold withinthe next year (Exception..)Held principally for tradingHeld for sale or consumption duringthe business’s operating cycleThey are cash or nearequivalents to cashNon-current / Long-term / Fixed assetsDo not meet the definition ofcurrent assetsCurrent liabilitiesHeld principally for tradingpurposesDue to be settled within a year afterthe statement of financial positiondateExpected to be settled within thebusiness’s normal operating cycleNo right to defer settlement beyonda year after the statement offinancial position dateNon-current / Long-term / Fixed liabilitiesDo not meet the definition ofcurrent liabilitiesBusinessentityconventionDualaspectconventionPrudence(Conservatism)conventionHistoriccostconventionGoingconcernconventionStatementof financialpositionAccounting conventions influencing the statement offinancial positionUses of the statement of financial positionCan provide a basis for assessingthe value of the businessRelationships between assets andclaims can be assessedShows how the business is financedand how funds are deployedPerformance can be better assessedRelationship between the income statement and thestatement of financial positionThe above equation can be extended to:ProfitAssets Equity (Loss) Liabilities+= (-) ++ SalesrevenueAssets = Equity – Expenses + LiabilitiesMeasuring profitTotal revenue for the periodlessTotal expenses incurred in generating that revenueProfit(or loss)for theperiod=Better-Price StoresIncome statement for the year ended 31 December 2017 £Sales revenue232,000Cost of sales154,000Gross profit78,000Salaries and wages(24,500)Rent and rates(14,200)Heat and light(7,500)Telephone and postage(1,200)Insurance(1,000)Motor vehicle running expenses(3,400)Depreciation – fixtures and fittings(1,000)Depreciation – motor van(600)Operating profit24,600Interest received from investments2,000Interest on borrowings(1,100)Profit for the year25,500 Calculating gross profit and cost of sales for BetterPrice Stores ££Sales revenue232,000Cost of sales:Opening inventories40,000Goods bought189,000Closing inventories(75,000)(154,000)Gross profit78,000 Example of Revenue recognition and how it affectsother statementsRevenue Earned£9,000Income statementStatementof financialpositionat yearendCash £10,000Advance Income£1,000Statementof cashflowsExample of Expense recognitionRent payable expense£16,000Statementof financialposition atyear endCash £20,000Prepaid expense £4,000Statementof cashflowsIncome statementCalculation of depreciationThe useful life of the assetResidual value (disposal value)The cost (or fair value) of the assetTo calculate a depreciation charge for aperiod, four factors have to be considered:Depreciation methodsStraight-line method – an example Cost of machine£78,124Estimated residual value£2,000Estimated useful life4 years Annual depreciation charge = £78,124 – 20004= £19,031Reducing-balance methodP =where:P = the depreciation percentagen = the useful life of the asset (in years)R = the residual value of the assetC = the cost, or fair value, of the asset(1 – R/C x 100%)nDeriving the fixed percentageThe reducing-balance method – an example £Cost of machine78,124Year 1 depreciation expense (60% of cost)(46,874)Carrying amount31,250Year 2 depreciation expense (60% of carrying amount)(18,750)Carrying amount12,500Year 3 depreciation expense (60% of carrying amount)(7,500)Carrying amount5,000Year 4 depreciation expense (60% of carrying amount)(3,000)Residual value2,000 Break for 10 Minutes!Last in, first out (LIFO)Weighted average cost (AVCO)First in, first out (FIFO)Common assumptions used are:Inventory costing methodsFIFO and LIFO treatment of the inventoriesOpeninginventories100 tonnesat£100/tonneFIFOCost of sales (inventories used)900 tonnesClosinginventories500 tonnes2 MayPurchase 500 tonnesat £110 per tonne3 MayPurchase 800 tonnes at£120 per tonne500 tonnes 800 tonnes100 tonnesLIFOCost of sales (inventories used)900 tonnesClosinginventories500 tonnesBad debts written offIncrease expensesReduce trade receivablesUses of the income statementHow effective the business hasbeen in generating wealthHelps in providing information on:How the profit was derivedCashequivalentNot a cashequivalentAre the investmentsshort-term?NoIs there an insignificantrisk or changes in value?Are they readilyconvertible to cash? NoNoYesYesYesA definition of cash and cash equivalentsStandard layout of the statement of cash flowsequalsplus orminusNet increase (or decrease) incash and cash equivalents overthe periodCash flowsfrom operating activitiesCash flowsfrom investing activitiesCash flowsfrom financing activitiesplus orminusTesco plcSummarised statement of cash flows for the year ended 26 Feb 20xx £mCash generated from operations5,366Interest paid(614)Corporation tax paid(760)Net cash from operating activities3,992Net cash used in investing activities(1,859)Cash flows from financing activitiesDividends paid to equity owners(1,081) Other net cash flows from financing activities(1,955)Net cash from financing activities(3,036)Net decrease in cash and cash equivalents(903) Direct vs Indirect MethodCash versus profit• The following factors will result in a company’s profit figurebeing different from its cash figure:– Timing differences– Depreciation– Accounting transactions that bypass the income statement– Changes in working capital requirementsPurpose of cash flow statement• Information on cash receipts and cash payments for a given period• Cash is needed to :– Pay for assets– Settle debts– Pay employees– Pay dividends– Take advantage of investment opportunities• Information on liquidityThanks!See You Next WeekLet us see some realworld exampleThomson Reuters DataStream• Go to Start• Find Thomson Reuters• Select Thomson Reuters Eikon– student???@leedsbeckett.ac.uk– Reuters ???– You can use this up to ID 21• Let us find a company to explore
