Financial Reporting and Analysis Part 1 - Accounting Principles

The role of financial reporting is to provide information about the companies performance, financial position, and changes in financial position over the reported period

• Income statement
• Balance sheet
• Cash flow statement

• statement of shareholder’s equity,
• financial notes and supplementary schedules,
• management’s discussion and analysis,
• the auditors’ reports,

• Evaluate past, current, and prospective performance
• Determine the creditworthiness of a company
• Assigning debt rating or compliance with debt covenants
• Forecasting future net income and cash flow

• USA: The Financial Accounting Standards Board (FASB) is the primary body setting the U.S. GAAP
• EU: International Financial Reporting Standards (IFRS) [...] issued by the International Accounting Standards Board (IASB)

Increasing globalization of capital markets raised the awareness for more uniform international reporting standard

• Timeliness describes the trade-off between timely information and the time it takes to prepare reliable and audited information
• The benefit from providing the information should exceed the cost of providing it
• Qualitative characteristics are not directly captured in financial statements, e.g. environmental respectfulness, creativity, or customer loyalty

• Accrual basis will reflect business transactions when they actually occur not necessarily when cash movement occurs
• Going concern refers to the assumption that the company will business for the foreseeable future

• Understandability
• Relevance
• Reliability
• Comparability

Understandability is defined that information should be understandable to users with basic knowledge of business, economic activities, accounting, and who have the willingness to study the information with reasonable diligence

Relevance is defined as the influence of a information at hand which must be material, i.e. that omission or misstatement of the information could make a difference to users’ decision

Reliability is defined as information free from material error or bias and includes following factors:

• Faithful representation
• Substance over form
• Neutrality
• Prudence
• Completeness

Comparability is defined in the way that information should be presented in a consistent manner over time and between entities

• Operating activities
• Investing activities
• Financing activities

Operating activities are part of the day-to-day business functioning of an entity, e.g. sale of meals for a restaurant or making loans by a bank

Investing activities are associated with the acquisition and disposal of long-term assets, e.g. sale or purchase of an surplus equipment such as an oven for a restaurant

Financing activities are those activities related to obtaining or repaying capital. The two primary sources are shareholders or creditors, e.g. taking a bank loan or issuing bonds

Balance sheet provides information about a company’s financial position at a point in time.

• It shows the entity’s assets, liabilities, and owner’s equity at particular date 
• Two years are usually presented so that comparison can be made
• Less significant accounts can be grouped into a single item

Income statement provides information about a company’s profitability over a period of time

• It shows revenue, expense, and net income during the period 
• Less significant accounts can be grouped

Statement of cash flows provides information about a company’s cash flows over a period of time

• Inflows (receipts) and outflows (payments) are shown
• The cash flows are categorized according to the business activity 

1.  Owner's equity = Assets - Liabilities
2.  Net Income = Revenue - Expenses 
3.  ΔCash = CFI + CFF + CFO

CFI stands for Cash Flow from Investing activities.

Examples:

• Purchases or sales of property, plant, and equipment (PP&E).
• Acquisitions or sales of long-term investments.
• Investments in or receipts from subsidiaries or joint ventures.

CFF stands for Cash Flow from Financing activities.

Examples: 

• Issuance or repurchase of common stock.
• Issuance or repayment of debt (bonds, loans).
• Payment of dividends to shareholders.
• Any capital transactions with the company's owners or creditors.

CFO stands for Cash Flow from Operating activities.

Examples:

• Receipts from customers for the sale of goods or services.
• Payments to suppliers for goods and services.
• Payments to employees.
• Payments for interest and taxes.
• Changes in working capital (e.g., changes in accounts receivable, accounts payable)

Statement of shareholder’s equity provides information about the composition and changes in owners’ equity during a period of time

• Contributed capital (preferred and common stock)
• Retained earnings

Notes explain accounting methods, assumptions, and estimates

• Additional information on fixed assets, inventory, income taxes, pensions, debt, significant customers, sales to related party, and export sales
• Contingent losses
• Subject to audit

Owners' equity =  Contributedcapital + Retained earnings