Key Concepts
There are four
general purpose financial statements: balance sheets, income statements,
statements in changes of equity and cash flow statements. I never knew there
was more to a company’s financials than the straight up income and end profit
they have.
The balance sheet
is the one statement that shows a snapshot of the business on a particular day
at a particular time. It details the company’s assets, liabilities and equity
on a possible two sheets – the consolidated balance sheet which includes the
company’s subsidiary financials and the standard balance sheet which is just
the parent company on its own.
The income statement,
on the other hand, shows how the company has changed over time since the
previous report. It shows the company’s revenue and expenses. To me, this seems
like the most loved and common statement in company’s reports. All people,
well… I, tend to care about is the bottom line, whether the company is making
money or losing it and this statement shows me exactly where all the good stuff
is coming from and then where they’re throwing it away. A nice healthy stream
of revenue is just what anyone would like to see (especially in my own bank
account, please).
The statement in
changes in equity is the third financial statement. It details the change
in the shareholders’ equity over the period. I personally don’t have much
interest in this statement as I am not an investor and it’s not my equity being
tossed around the place, so the only people who would really have a vested
personal interest would be those that had a financial stake.
The fourth financial statement is the cash flow statement which shows the opening and closing cash
balances for the period and the cash inflows and outflows for the period. I had
always wondered (since I commenced my accounting course two weeks ago) what the
importance of the cash flow statement was and the study guide finally
enlightened me. The biggest breaker of a business is going bankrupt (going into
liquidation) and that’s the result of running out of cash, the most important
asset. At the end of the day, that’s the measure of a business’ value and if it
runs out, it means the business is unsuccessful. The cash flow statement, as I
now realise, helps keep track of the inflows and outflows of cash so as to
monitor how the business is maintaining and enhancing its most valuable asset.
It’s not just good enough to have these financial statements
just sitting there doing nothing except looking pretty confusing, you
have to be able to make sense of
them. One way is ratios, which
analyses the relationships between different items in the financial statements.
It’s just like baking a cake, where when you increase or decrease the amount of
mixture you need or how many cakes you have to make, the numbers/amounts of the
ingredients/items change in proportion with each other. You don’t double the
number of eggs without doubling the sugar as well. It’s all about proportion
and structure, you need a certain combination of ingredients, a framework of
what you need, in order to successfully make the cake.
All in all, every business works on the same basic
ideologies and values, trying their best to make their business profitable and
successful. Through financial statements, users – be it individuals,
shareholders, businesses, creditors and anyone else so inclined – can look and
understand the basics of a company and what makes it tick. The annual report
and its financial statements illustrate the essence of what has occurred during
the time elapsed since the previous report and allows for users to interpret
meaning and understanding from the information presented.
Things I Find Confusing
What I find confusing is how a company’s financials can be
separated into ‘Parent’ and ‘Group’ categories. Isn’t a company a sum of the
whole? Essentially a company IS each of its components, so the group is the
parent in my interpretation. If a company is made up by its subsidiaries, how
do you separate the subsidiaries from the company as the subsidiaries make up
the company?
It states that “An
item called non-controlling interests or minority interests in the equity of
your firm’s balance sheet represents the equity in the subsidiary companies not
owned by the parent company (and thus not owned by the equity investors in the
parent company).” So does that mean that if a company does own the entire 100% of a subsidiary company, than the equity
investors also in a sense own the subsidiary as well? And if so, why doesn’t
the parent company just absorb the subsidiaries into itself and its own
operations? It is essentially the same company now as it’s owned by them?
Things I Find Difficult to
Understand/Believe
What I find difficult to believe is how in the blazes this
phrase “As a guy, I am determined to do my bit to reverse this worrying
statistic in the future” ended up in my study guide. Really, really? I feel
like I’ve launched from a study guide into someone’s diary.
Back on a more serious note, the whole cash flow and
dividends concept is a little hard to grasp. Having never encountered dividends
and the share market beyond that annoying thirty second update on the news, it
is a foreign topic to me. Buying shares in itself is a rather confusing
process, and dividends aren’t any easier. I understand that dividends are paid
to shareholders – equity investors – but how and when and why they distribute them
is unclear. Isn’t giving away all of your profits a bad idea in case of
misfortune? And then, not rewarding shareholders discourages investment, right?
The study guide includes the formula Dividends (d) = Operating cash flow (C) – Capital outlays (I) + Net
cash flow from debt owners (F) and then goes on to change the formula in a
way I don’t quite comprehend. It then goes on to say cash flow which makes up
the ‘C’ variable can mean completely different things and numbers. Combining
all these different aspects that don’t quite click for me, just makes for a
super confusing experience.
Things I Find Boring
Sometimes I find the text again goes off on a tangent of
flowery, descriptive language that doesn’t really add to the topic, it just
makes it more longwinded and on occasion hard to read. It also restates the
same phrase again and again, just in different words – exactly how my English
teacher always told me not to write! It just makes it seem like there’s more
information, but it’s just sugar-coating nothing. It makes the text drag on and
on, and make it’s boring to read. Also, the repeated references to texts we’ve
never read that don’t even add to the topic at hand add to the longwindedness
of the text.
The whole section on ratios was rather monotonous as the
text never really got to the point of ratios; the definition of what they
actually are, what their purpose is and why they’re specifically relevant to
accounting and decision making.
Things I Find Exciting/Surprising
I really like the comparison to introductions at parties. At
just a quick introduction, you smile and say hi, but after ten minutes you’re
whisked off in the excitement of dancing and music (and alcohol, if you’re so
inclined) and you tend to forget all about them. But, if you get to know them
better, you remember them and have the beginnings of a relationship.
I remember being invited to my friend Shane’s 12th
birthday party a few years ago (okay, more than a few). He had gone to a
different school for about a year and a half and, as expected, had made new
friends that I didn’t know. There were two girls, one I talked to all night and
one that I didn’t. The girl I talked to was Rebecca and I could tell you a
number of things about her. The other, I couldn’t even tell you her hair colour.
The point is, after spending a few hours getting to know Rebecca; I knew so
much more about her and built a friendship that lasted years that involved me
learning things about her I never would have guessed in the beginning. Even now
that I haven’t spoken to her in 12 months or so, I still remember all these
things.
The same goes for financial statements; if you spend the
time getting to know them, you’ll learn more about them slowly but surely, and
even if you don’t go near accounting for the next ten years, you’ll still
remember the main important things about them (and even some things not so
important) and have a ‘relationship’ with them.
To further the analogy of financial statements being like
people, they all have similarities and differences, as Martin points out when
he says “But just as we each have a different face, so our faces also have some
similarities.” Financial statements can also have different names, just like
people have different nicknames they respond to; like Emily can be referred to
as Em, Emmy, Emse, Emsey, Emsalee, etc. etc. They still refer to the same
person just as different names for a specific financial statement still refers
to the same thing. And just like people, you can get along with some financial
statements better than others, for example; the balance sheet and I are best
buddies, love hanging out with that guy, but the statement in changes in
equity, he and I are best kept at a hundred paces unless you want a restraining
order brought out.
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