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Chapter 6Financial Reporting and Analysis

By Kong Ratanak-MBA

Course facilitator

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OBJECTIVES

1. Define objectives of financial reporting

2. Qualitative Characteristics of accountinginformation and its interrelationship

3. Accounting convention ofcomparability andconsistency, materiality, conservatism, full

disclosure and cost-benefit.4. Explain management responsibility forethical

financial reporting and define fraudulencefinancial reporting

5. Basic components ofclassified balance sheet6. Multiple step Vssingle step income statement7. Use classified financial statements forevaluation

ofliquidity and profitability.

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Objectives of Financial reporting

Investment and credit decision

Assessing Cash flow prospect

Business resources, claim andchanges in those resources.

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Qualitative characteristics

FINANCIAL STATEMENTS

QUALITATIVE CHARACTERISTICSQUALITATIVE CHARACTERISTICS

UnderstandabilityDecisionmakers must be ableto interpret accountinginformation.

UsefulnessAccountant must provide information that isuseful in making decision

CONVENTION THAT

HELP ININTERPRETATIONComparability &Consistency Materiality Conservatism Full Disclosure Cost-benefit

RelevanceFeed back valuePredictive ValueTimeliness

ReliabilityFaithful representationVerifiabilityNeutrality

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Conventions that help in interpretation ofFinancial Statement

Comparability and Consistency:

similarity, differences, trend over different timeperiod and companies to companies

Procedures of accounting are kept unless it isinformed of the change.

Materiality

Relative important of an Item or event

Conservatism

When facing the uncertainty, accountant will choosethe procedures that is least likely overstated assetsand income.

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Conventions..cont.

Full Disclosure

Financial statements and their notes present allinformation that is relevant to the users.

Cost benefit Benefit to be gained from providing new

accounting information should be greater thanthe Cost of providing it.

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Managements responsibility for EthicalReporting

Preparation of Financial statements comply toGAAP

Internal Control (the assurance that the

objective is achieved)

Fraudulent financial reporting is the intentionalpreparation of misleading financial

statements.

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Tools for Analysis of Financial Statements

LIQUIDITY AND DEBT SERVICES RATIOCurrent Ratio Current Assets /

Current LiabilityA measure of Liquidity; theability to meet near-termobligation

Quick Ratio (Cash + Short-terminvestment + A/R)/Current Liabilities

A narrow measure of liquidity;the ability to meet near-termobligation

Debt to TotalAssets Ratio

Total Debt / TotalAssets

Percentage of Assets finance bylong-term and short term debt

Debt to Total

Equity ratio

Total Debt / Total

Equity

Proportion of financing that is

debt relatedTime interest earnratio

Income before incometaxes and interest /Interest Charged

Ability to meet interest obligation

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Tools for Analysis of Financial Statements

TURNOVER RATIOAccount Receivableturnover ratio

Net Credit Sales / AverageNet Account Receivable

Frequency of collection cycle tomonitor credit policy

Inventory turnoverratio

Cost of Goods Sold /Average inventory

Frequency of inventory rotation;to monitor inventorymanagement

PROFITABILITY RATIONet profit on Sales ratio Net income / Net Sales Profitability on sales for

comparison and trend analysisGross profit marginratio

Gross Profit / Net Sales Gross profit rate; for comparisonand trend analysis.

Return on Assets Ratio (Net income+ Interestexpenses) / AverageAssets

Assets utilization in producingreturns

Return on Equity Ratio (Net income - PreferredDividend)/ Averagecommon Equity

Effectiveness of equityinvestment in producing returns

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Classified Financial Statements

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Ratio for Emerson CorporationDecember 31, 19x5

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Review Problem19x2 19x1

Current Assets 200,000.00 170,000.00

Total Assets 880,000.00 710,000.00

Current Liabilities 90,000.00 50,000.00

Long-term Liabilities 150,000.00 50,000.00

Stockholders Equity 640,000.00 610,000.00

Sales 1,200,000.00 1,050,000.00

Net Income 60,000.00 80,000.00

Beginning Total Asset 19x1= $690,000 & Equity = $590,000

Liquidity Analysis? & Profitability Analysis ?

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Answer to Review problemsLiquidity Analysis Current Asset Current

Liabilities

Working Capital Current Ratio

19x1 170,000 50,000 120,000 3.40

19x2 200,000 90,000 110,000 2.22

Increase (Decrease) in working capital (10,000)

Decrease in current ratio 1.18

Profitability Analysis NetIncome

Sales ProfitMargin

Average totalAssets

AssetsTurnover

ReturnonAssets

AverageStockHolders'Equity

ReturnonEquity

19x1

80,000 1,050,000

7.6% 700,000 1.50 11.4%

600,000

13.3%

19x260,000 1,200,000

5.0% 795,000 1.51 7.5%625,000

9.6%

Increase(Decrease)(20,000)

150,000

-2.6% 95,000.000 0.01 -3.9%25,000

-3.7%

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Welcome to

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Total Liability StockholdersEquity

Debt to EquityRatio

19x1 100,000.00 610,000.00 16.4%

19x2 240,000.00 640,000.00 37.5%Increase 140,000.00 30,000.00 21.1%