TOPIC 2

ANALYSIS OF FINANCIAL
STATEMENTS AND CASH
FLOWS
 CONTENTS
• Needs of financial statements
• Financial statements
• Income Statement
• Balance Sheet
• Statement of Cash Flows
• Financial statement analysis
• Liquidity ratios
• Asset management ratios
• Profitability ratios
• Leverage ratios
• Limitations of ratio analysis
 Needs of Financial Statements

• In Malaysia, the Company Act 1965 requires

companies to provide their annual reports to
Companies Commission of Malaysia

• Among the content of the report is FINANCIAL

STATEMENT which covers Income Statement,
Balance Sheet, Cash Flow Statement, and
explanation notes about those accounts.
Needs of Financial Statements

Financial statements users can be classified into 2 types:

• Internal users
Internal users are people within a business organization who
use financial information. Examples of internal users are owners,
managers, and employees.
• External users
External users are people outside the business entity
(organization) who use accounting information. Examples of
external users are suppliers, banks, customers, investors,
potential investors, and tax authorities.
Income Statement

• Also known as Profit and Loss Statement.

• It measures the results of a firm’s operation over a

specific period.

• The bottom line of the income statement shows the

firm’s profit or loss for a period.

• Usefulness of income statement:

-Evaluate the past performance of the firm.
-Provide a basis for predicting future performance.
Income Statement Terms

• Revenue (Sales) - Income from sales of products or services

• Cost of Goods Sold (COGS) - Cost of producing the
goods/services to be sold
• Operating Expenses - Expenses related to marketing and
distributing the product or service and administration cost
(Example: marketing & selling, general & administrative,
depreciation expenses)
• Financing Costs - The interest paid to creditors/bondholders
• Tax Expenses - Amount of taxes owed, based upon taxable
income
Income Statement: Basic Structure

SALES
- Cost of Goods Sold (COGS)
GROSS PROFIT Operating Activities
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT) Financing
- Income Taxes Activities
NET INCOME (EARNINGS AVAILABLE FOR STOCKHOLDERS)
Example of Income Statement
Three additional important issues

• Operating income (EBIT) is NOT affected by how the

firm is financed.

• Interest expense is subtracted from income before

computing the firm’s tax liability, i.e. Interest is NOT
taxable expenses.

• Firms that has a positive net income does NOT

necessarily mean it has lots of cash
 Balance Sheet
• Provides an overview of a firm’s financial position at a
particular date [e.g. Financial Year End (FYE 31st December
2019]
• It includes three main parts: Assets, Liabilities and Equity.
Assets (A) - Productive sources that give return to the
company (what you own)
Liabilities (L) – Debts or Creditors’ claim (what you owe)
Equity (E) – Owners’ or shareholders’ claim (capital)
A = L + E
• Liabilities and Equity indicate how those resources are financed

• The items are recorded at historical cost, so the book value

of a firm may be very different from its market value.
 Balance Sheet: Example

 YOUR ASSET (A): LAPTOP (RM3,500)

HOW DO YOU PURCHASE IT?

 YOUR OWN MONEY FOR DOWNPAYMENT (E): RM500

 YOUR BORROWING OR BUYING ON CREDIT (L) : RM3,000

A (RM3,500) = L (RM3,000) + E (RM500)

 Balance Sheet : Basic Structure
Assets [A] Liabilities [L] & Equity [E]
Current Assets Current Liabilities
Cash Accounts Payable
Accrued Expenses
Accounts Receivable Short-term notes
Inventories Long-Term Liabilities
Prepaid Expenses Long-term notes
Fixed Assets Mortgages
Equity
Machinery & Equipment Preferred Stock
Buildings and Land Common Stock (Par value)
Other Assets Paid in Capital
Copyrights, Goodwill & patents Retained Earnings
Treasury Stock

TOTAL ASSETS TOTAL LIABILITIES + EQUITY

 Balance Sheet Terms: Assets

• CURRENT ASSETS
The assets will not stay in the business for long (relatively liquid),
or expected to be converted into cash within 12 months.
 Cash – currency or coins owned by company either in bank
account or in hand.
 Marketable securities – investment on short-term financial
assets with high liquidity. Example: T-bill, bankers
acceptance, etc. (refer to Money Market products)
 Accounts receivables – payments due from customers who
buy on credit.
 Inventory – raw materials, working-in-process and final
products that will be sold.
 Prepaid expenses – Items paid for in advance
Balance Sheet Terms: Assets

• FIXED ASSETS
The assets are held for more than one year.
Fixed assets typically include: plant and
machinery, building and land [plant, property &
equipment (PPE)]

• OTHER ASSETS
Assets that are neither current assets nor fixed
assets. They may include intangible assets that
can’t be touched or saw physically such as
patent, rights and goodwill.
 Balance Sheet : Basic Structure
Assets [A] Liabilities [L] & Equity [E]
Current Assets Current Liabilities
Cash Account Payables
Accrued Expenses
Marketable Securities Short-term notes
Account Receivables Long-Term Liabilities
Inventories Long-term notes
Prepaid Expenses Mortgages
Equity
Fixed Assets Preferred Stock
Machinery & Equipment Common Stock (Par value)
Buildings and Land Paid in Capital
Other Assets Retained Earnings
Treasury Stock
Copyrights, Goodwill & patents
TOTAL LIABILITIES + EQUITY
 Balance Sheet Terms: Liabilities (debt)
• LIABILITIES are money borrowed and must be repaid at a
predetermined date.
• CURRENT LIABILITIES (Short-term Liabilities)
Liability that must be paid within 12 months.
 Account payables (Credit extended by suppliers to a firm when it
purchases inventories)
 Accrued expenses (Short term liabilities incurred in the firm’s
operations but not yet paid for)
 Short-term notes (Borrowings from a bank or lending institution due
and payable within 12 months)

• LONG-TERM LIABILITIES/DEBTS
Covers loan from bank or other sources that provide capital for liability
term more than 1 year.
(Example: Using bank loan to buy a machinery for a period of 10 years or
buy a building for period of 25 years)
 Balance Sheet Terms: Equity
• EQUITY
Shareholders' investment in the firm in the form of common
stock and preferred stock.
 Common Stock (ordinary shares in private or public listed
companies)
 Preferred Stock (received dividend in fixed amount)
 Treasury Stock (stock that has been re-purchased by the
firm)
 Retained Earnings (earnings which are retained by the
company after dividends have been paid, if any [from Net
Income in the Income Statement] and will be reinvested in
the firm)
 Paid-in Capital (money that a firm gets from potential
investors in addition to the stated value of the stock)
 Balance Sheet : Basic Structure
Assets [A] Liabilities [L] & Equity [E]
Current Assets Current Liabilities
Cash Account Payables
Accrued Expenses
Marketable Securities Short-term notes
Account Receivables Long-Term Liabilities
Inventories Long-term notes
Prepaid Expenses Mortgages
Equity
Fixed Assets Preferred Stock
Machinery & Equipment Common Stock (Par value)
Buildings and Land Paid in Capital
Other Assets Retained Earnings
Treasury Stock
Copyrights, Goodwill & patents
TOTAL LIABILITIES + EQUITY
Example of Balance Sheet
STATEMENT OF CASH FLOWS

• Definition: Shows the changes of cash for the company in a certain

period of time.

• Sources and uses of cash comprise of THREE components:

 Cash flow from operations (e.g. Sales revenue, labor expenses)
 Cash flow from investment (e.g. Purchase of new equipment,
invest in new technology)
 Cash flow from financing (e.g. Borrowing funds, payment of
dividends)
• Increasing(decreasing) of net cash is total cash flow from operating,
investing and financing activities. This changes [Net Changes in Cash]
will be added to the Beginning Cash Balance in order to get the
Ending Cash Balance.
Beginning Cash Balance + Net Changes in Cash =
Ending Cash Balance
Statement Of Cash Flows