CHAPTER 2

FINANCIAL STATEMENTS
Chapter outline

Introduction
The objectives of financial statements
Who are the users of financial statements?
Requirements for financial statements
The standardisation of financial statements
Statement of financial position
Statement of comprehensive income
Statement of cash flows
Conclusion
Learning outcomes

By the end of this chapter, you should be able to:

Discuss the objectives and requirements of financial
statements
Identify the users of financial statements
Identify the components included in the main types of
financial statements
Distinguish between the three main types of financial
statements
Describe the formats of a statement of financial
position, statement of comprehensive income and
statement of cash flows.
Introduction

Companies provide annual report at end of

financial year
Annual report provides analysts with
information
Includes a set of financial statements:
Statement of financial position
Statement of comprehensive income
Statement of cash flows
Indicates financial performance and position of
company for analysis and comparison
The objectives of financial
statements
Main objective:
Provide summary of financial position
Financial performance
Change in financial position
Financial position
Influenced by economic resources and the capital
structure used to finance these resources
Evaluated by focusing on assets, liabilities and
shareholders equity included in the statement of
financial position
The objectives of financial
statements (cont.)
Financial performance
Companys ability to generate income with its
available assets
Evaluated by focusing on the revenue and expenses
provided in the statement of comprehensive income
Change in financial position
Depends on the investment, financing and operating
activities during the year
The statement of cash flows provides a summary of
these activities
Users of financial statements
Stakeholders:
Shareholders Evaluate existing and expected
performance
Management Planning and control
Providers of debt capital Evaluate capital structure
and ability to pay interest
Government SARS, economic statistics
Other stakeholders Employees, clients, customers,
suppliers, competitors
Requirements for financial
statements
Understandable
Relevant
Significance
Timeliness
Accurate and objective
Comparable
The standardisation of financial
statements
Financial statements need to be comparable
Statements of companies may not be comparable
as a result of different accounting guidelines
SA companies converted to IFRS; comparison to
previous years where other accounting guidelines
were used may be problematic
Solution
Standardise published financial statements
Facilitates comparison between companies & over
time
Simplifies the calculation of financial ratios
Statement of financial position

Summary of a firms financial position at a

specific point in time
Statement of financial position
Ordinary
Current shares
assets Reserves
Preference
shares
Non-controlling
interest
Non-current Current liabilities
assets

Non-current
liabilities
Assets
Capital investment - apply assets to generate
revenue
Two types of assets:
Non-current
Current
Distinction based on how the assets are
applied, as well as the period of time over
which they will be applied
Non-current assets
PPE at cost price
Usually indicated at original purchase price of items
Accumulated depreciation
Accumulate depreciation provided on PPE in the
statement of comprehensive income
PPE at carrying value
Cost minus accumulated depreciation
Assets under construction
Asset not yet completed; no depreciation provided
Non-current assets
Intangible assets
Goodwill
Other intangible assets (software, licences)
Investment in associate
Owns 20% - 50% of shares in another company
Other long-term assets
Loans granted
Share investments < 20%
Deferred tax assets
Difference in accounting and tax treatment
Current assets
Inventories
Required for operations of a company
Trade and other receivables
Credit sales still outstanding
Short-term outstanding amounts
Short-term financial assets
Financial assets with lifetime of less than a year
Cash and cash equivalents
Other short-term assets
Assets for sale
Total equity

Breakdown of different forms of equity capital

to finance companys assets
Includes all capital provided by different
shareholders
Important to distinguish between contributions
of different types of shareholders
Components of total equity

Share capital
Proceeds from sale of ordinary shares to
shareholders
Reserves
Share-based payments
Share repurchases
Retained earnings
Accumulation of retained profits reinvested
Preference share capital
Proceeds from the sale of preference shares
Components of total equity

Shareholders equity
Total capital invested by all shareholders
Non-controlling interest
Financial statements of subsidiary companies
included
Liabilities

Breakdown of the different forms of debt capital

Two types of liabilities:
Non-current liabilities
Current liabilities
Distinction based on the period over which the
debt capital is obtained
Non-current liabilities

Long-term debt capital

Interest-bearing borrowings
Long-term loans
Mortgages
Debentures
Post-retirement obligations
Deferred tax liabilities
Current liabilities

Short-term debt capital

Trade and other payables
Outstanding amount on credit purchases
Other short-term obligations
Short-term debt
Loans redeemed in the next financial year
Current liabilities

Short-term financial liabilities

Tax payable to SARS
Bank overdraft
Other current liabilities
Liabilities in disposal groups, short-term provisions,
short-term deferred income
Statement of comprehensive
income
Summary of financial performance for the
financial year matching income and expenses
Income:
Turnover
Operating income
Investment income
Non-recurring income
Other
Statement of comprehensive
income (cont.)
Expenses:
Cost of sales
Operating expenses
Non-recurring expenses
Finance cost
Taxation
Non-controlling interest
Preference dividends
Ordinary dividends
Statement of comprehensive
income (cont.)

EXPENSES
INCOME

RETAINED
PROFIT
 2009 2008
(R million) (R million)
Turnover 137 836 129 943
Cost of sales and services rendered (88 508) (74 634)
Gross profit 49 328 55 309
Other operating income 1 021 635
Operating expenses (25 681) (22 128)
Operating profit 24 666 33 816
Investment income 2 060 989
Finance cost (1 917) (1 145)
Profit before tax 24 809 33 660
Tax (10 480) (10 129)
Profit after tax 14 329 23 531
Non-controlling interest (67) (1 111)
Preference share dividends (614) (3)
Attributable earnings 13 648 22 417
Ordinary dividends (7 193) (5 766)
Retained earnings (for the year) 6455 16651
Statement of comprehensive
income components
Turnover
Income received for products or services rendered
by the company during the financial year
Cost of sales and services rendered
All costs directly incurred to generate turnover
Purchases of inventory, transport costs, customs,
etc. incurred to deliver products to customers
Gross profit
Turnover minus cost of sales
Profit generated by sales activities of company
Statement of comprehensive
income components
Other operating income
Income items not part of the sales activities of the
company, but which are generated as part of the
operating activities
Operating expenses
Expenses incurred to support primary activities
Includes depreciation, employee costs, research
and development, operating lease charges, etc
Operating profit
Profit resulting from primary activities of business
Excludes income items not part of the businesss
normal activities
Statement of comprehensive
income components
Investment income
Income generated by financial investments
Dividends & interest received
Finance cost
Interest paid on debt financing
Profit before tax
Tax
Tax calculated on the profit before tax
Profit after tax
Statement of comprehensive
income components
Non-controlling interest
Portion of profit that belongs to non-controlling
interest shareholders
Preference share dividends
Dividends paid to preference shareholders
Preference above ordinary dividends
Attributable earnings
Portion of profit left after all expenses have been
allocated
Important to the ordinary shareholders: amount
available for ordinary dividend payments
Statement of comprehensive
income components
Ordinary share dividends
Total amount paid to ordinary shareholders in the
form of dividends
Retained earnings
Portion of profit not paid out as dividends to
shareholders but reinvested
Transferred to reserves of business and used to
finance businesss activities
Earnings still belongs to shareholders included as
part of shareholders equity
Statement of cash flows

Summary of a firms cash flows for the financial

year
Three major categories:
Cash from operating activities
Cash from investing activities
Cash from financing activities
Statement of cash flows

CASH AT CASH FROM

BEGINNING OPERATING
OF YEAR ACTIVITIES
+ +/-
MOVEMENT IN CASH FROM
CASH DURING INVESTING
THE YEAR ACTIVITIES

= +/-
CASH FROM
CASH AT END FINANCING
OF YEAR ACTIVITIES
Statement of cash flows
2009 2008
(R million) (R million)
Cash received from customers 144 963 123 452
Cash paid to suppliers and employees (96 776) (88 712)
Cash generated by operating activities 48 187 34 740
Finance income received 2 264 957
Finance expenses paid (2 168) (2 405)
Tax paid (10 252) (9 572)
Cash available from operating activities 38 031 23 720
Dividends paid (7 193) (5 766)
Cash retained from operating activities 30 838 17 954
Statement of cash flows
2009 2008
(R million) (R million)
Additions to assets under construction (13 047) (8 671)
Additions to other intangible assets (126) (17)
Non-current assets sold 697 184
Acquisitions of businesses (30) (431)
Disposal of businesses 3 486 693
Purchases of investments (89) (42)
Proceeds from sale of investments 7 0
Other cash flows from investing activities (917) (393)
Cash flow from investing activities (12 518) (10 844)
Statement of cash flows
2009 2008
(R million) (R million)
Share capital issued 1 189 475
Share capital repurchased (1 114) (7 300)
Proceeds from long-term debt 5 575 3 806
Repayments of long-term debt (4 820) (4 588)
Proceeds from short-term debt 280 1 942
Repayments of short-term debt (2 091) (2 292)
Other (212) (458)
Cash flow from financing activities (1 193) (8 415)

Translation effect of foreign operations (870) (448)

Increase/(decrease) in cash and cash equivalents 16 257 (981)
Cash and cash equivalents at the beginning of the year 4 335 6 088
Cash and cash equivalents at the end of the year 20 592 4 335
Cash flow from operating activities

Cash generated from normal operating

activities of the company
Cash received from customers
Cash amount that customers paid for products sold
and services rendered
Cash generated by operating activities
Cash received from customers minus cash paid to
suppliers and employees
Cash flow from operating
activities (cont.)
Finance income received on investments
Finance expenses paid on interest-bearing
debt capital
Tax paid in cash
Cash available from operating activities
Indicates if sufficient cash flow was generated to
afford a dividend payment
Negative value: indicates that cash dividend can
only be afforded if cash is obtained elsewhere
Cash flow from operating
activities (cont.)
Dividends paid
Cash payment of preference and ordinary dividends
Cash retained from operating activities
Negative operating cash flow no surplus cash flow
available to invest in replacement and expansion of
assets
Additional cash has to be generated from financing
activities or company may have to sell assets to
finance cash deficit
Consistent failure to generate positive cash flow can
be seen as indicator of serious financial problems
Cash flow from investing activities

Additions to PPE, to assets under construction

& to other intangible assets
Cash incurred to purchase additional assets
Non-current assets sold
Cash proceeds from sale of non-current assets
Acquisitions of businesses & disposal of
businesses
Cash effect of acquiring & selling business units
Proceeds from sale of investments and
purchases of investments
Cash result of increases & decreases in investment
Cash flow from financing activities

New share capital issued

Cash inflow
Share capital repurchased
Cash outflow
New long-term debt obtained
Cash inflow
Repayments of long-term debt
Cash outflow
Proceeds from short-term debt and repayments
of short-term debt
Cash inflows and outflows respectively
Conclusion

The main objectives of financial statements are to

provide information about the financial position,
financial performance and changes in the financial
performance of a company.

The users of financial statements include the existing

and potential shareholders; providers of debt capital;
the management of the company; government; and
other stakeholders.

The requirements for financial statements are that they

should be understandable, relevant, accurate, objective
and comparable.
Conclusion (cont.)

It is sometimes necessary to standardise the published

financial statements of a company to ensure that they
are comparable with other companies, and over time.

The statement of financial position provides a summary

of a companys financial position on a specific date.
The statement consists of two parts: the asset side,
and the equity and liabilities side. The asset part
provides an indication of the specific assets that the
company owns. The equity and liability part contains
the different sources of capital used to finance these
assets.
Conclusion (cont.)

The statement of comprehensive income provides a

summary of a companys financial performance over a
period of time. Within a statement of comprehensive
income the turnover generated during the financial year
is allocated to the different stakeholders up to a point
where only retained earnings are left.

The statement of cash flows provides a summary of a

businesss ability to generate cash and the application
of cash (i.e. how the cash is used). A distinction is
made between the cash results of operating, investing
and financing activities.