The story of a business

This week I set out to read and contemplate Chapter Three of the Study Guide. The Chapter revolved around financial statements, the different kinds of statement required from a business and the story these statements can tell about the reality of the business they represent.

I found it interesting that there are no specific rules about how financial statements are set out. It's no wonder that analyzing financial statements seems to be more of an art than a science.

KCQ: The fact that a firm's annual report is a marketing document was a new concept for me. This explains why I am currently wading through hundreds of pages of pictures, executive profiles and just a whole lot of fluff. The K + S Group definitely have their Marketing department working overtime. I can't help wondering if this is an attempt to hinder analysis and queries from shareholders.

The Study Guide has also reaffirmed what I've observed so far during the recorded lectures and analyzing K + S Group reports. There are four main types of financial statement:

1. Comprehensive Income Statement.
2. Balance Sheet.
3. Cash Flow Statement.
4. Statement of Changes in Equity.

A Comprehensive Income Statement reflects how things like revenue and expenses are changing over a period of time, usually one year. The bottom line of the statement reflects the income for that period.

A Balance Sheet is a snap shot of the financial position on a particular day. The same date is compared each year. In fact, all financial statements include data from the previous year to assist with analysis.

The Balance Sheet and Income Statement set out all five elements of accounting: assets, liabilities, equity, revenue and expenses. 

A Statement of Changes in Equity shows the various changes in shareholders’ equity over a 12 month period. 

A Cash Flow Statement shows the opening cash balance at the beginning of the 12 months, cash inflows and outflows during the period and the closing cash balance.

These four statements should be used to engage with and consider the economic and business realities. Only a complete analysis of all four statements within the context of the driving economic and business realities will tell the story of a business.

KCQ: Seems a little bit time consuming to me. I still don't quite understand why I need four separate statements to tell me all this. What is the benefit of using one statement over another or a specific purpose for each? Thankfully Chapter Four of the Study Guide had some answers for me:

1. We restate the Income Statement to clearly separate operating and financial revenue and expenses, and to clearly identify comprehensive operating income after tax (OI) and also net financial expenses after tax (NFE).
2. Restating the Balance Sheet helps us separate the operating and financial assets and liabilities of a firm. It facilitates an assessment of the long-term and short-term liquidity of a firm.
3. Analysts look at the Cash Flow Statement to observe the net investments needed to generate future operating income. The Free Cash Flow refers to operating income - net investments (or capital outlays). The Cash Flow Statement provides insight into a firm's operating activities.
4.  The Statement of Changes in Equity shows how a firm’s income statement and balance sheet inter-connect. Restating a firm’s statement of changes in equity helps us to clearly identify all of a firm’s earnings and to make sure its equity only includes genuine equity.

Ok so Chapter Four in general was really helpful. Anyone struggling should read it ASAP!