Financial Reporting & Analysis Introduction

Dr.T.P.Ghosh

Meaning

• Financial reporting is presentation of the formal record of the financial activities of a business, person, or other entries.

• It is primarily an accounting function.

• Financial reports are prepared for external as well as internal users. Various external users are – (1) present and prospective shareholders ( owners) (2) Lenders (3) Suppliers , (4) Customers (5) Government and its agencies (6) Financial analysts (7) Employees and their organisations

• Internal user is the management.

Corporate Financial Reporting for External Users

• Main component of the financial reports for external users is Annual Report .

• Annual report contains inter alia:-Directors’ report ( which is also termed as management commentary) and - Financial statements

Before we proceed further you would need to go beyond financial reporting. You should understand how a company is formed , manages its capital , commences functioning.

Company form of business

• Four important forms of business organisation are -

(i) Sole Proprietorship, (ii) Partnership, (iii) Cooperative Society, and(iv) Joint Stock company

Know yourself about first three forms of business in details.

Joint Stock Company : Features

• A company is formed under the Companies Act • Artificial person : It is an artificial person created by law,

having a separate legal entity, with a perpetual succession • Separate Legal Entity: Being an artificial person, a

company exists independent of its members. It can make contracts, purchase and sell things, employ people and conduct any lawful business in its own name. It can sue and can be sued in the court of law. A shareholder cannot be held responsible for the acts of the company.

Joint Stock Company

• No physical existence : A company has no physical existence ,it must act through its Board of Directors.

• Common Seal : But all contracts entered by them shall have to be under the common seal of the company.

This common seal is the official signature of the company. Any document with the common seal and duly signed by an officer of the company is binding on the company. • Perpetual existence : It has perpetual existence. Since

it is created by law, it can only be dissolved by law.

Joint Stock Company : Features• Membership: To form a joint stock company, a minimum of two

members are required incase it is private limited company and seven members incase of public limited company. The maximum limit is fifty incase of private limited company. There is no maximum limit of membership for a public limited company.

• Limited Liability of Members: The company form of business is able to attract large number of people to invest their money in shares because it offers them the facility of limited risk and liability. The liability of a member is limited to the extent of the amount of shares he holds.

• In other words, a shareholder can be held liable only to the extent of the face value of the shares he holds, and if he has already paid it, which is normally the case, he cannot be asked to pay any further amount. For example, if ‘A’ holds one share of Rs. 100 and has paid Rs. 75 on that share, his liability would be limited only upto Rs. 25.

Joint Stock Company : Features

• Transferability of Shares: The members of the company (Public company) are free to transfer the shares held by them to others as and when they like. They do not need the consent of other shareholders to transfer their shares.

• Elected Management: You know that people of different categories and areas contribute towards the capital of a company. So, it is not possible for them to look after the day-to-day management of the company. They may take part in deciding the general policies of the company but the day-to-day affairs of the company are managed by their elected representatives, called Directors.

Company Shareholders

• Number of shareholders of a joint stock company vary depending upon the size of its share capital.

A view of the shareholders meeting

Share Capital of Reliance Industries

Shareholding Pattern of Reliance Industries

Financing ActivitiesShareholders provide Share capital and also money is borrowed which is called borrowed capital

Investment activitiesCapital is invested in various types of assets – long lived assets like plant , machinery, equipment and short lived assets like inventories , trade receivables

Operating activitiesOperating activities of business are manufacturing , rendering services , trading or financial services

Revenues are generated from operations . Expenses are incurred for generating such revenue . There can be other income .

Long lived assets are consumed in the revenue generation process . They get depreciated

Business Activities – At a Glance

Objective of Financial Reporting• The objective of general purpose financial reporting is to provide financial

information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

• Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.

• Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need.

• Consequently, they are the primary users to whom general purpose financial reports are directed.

Source : IFRS Conceptual Framework 2011

Limitations of Financial Reporting

• General purpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders and other creditors need.

• Therefore those users need to consider pertinent information from other sources.

• Other parties, such as regulators and members of the public other than investors, lenders and other creditors, may also find general purpose financial reports useful. However, those reports are not primarily directed to these other groups.

Five Elements of Financial Statements

• An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

• A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

• Equity is the residual interest in the assets of the entity after deducting all its liabilities.

Five Elements of Financial Statements

• Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

• Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Fundamental Accounting Equation

Assets = Liabilities + Equity

This a core principle of preparation and presentation of financial statements.

Money measurement concept

• In financial accounting , measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement. This involves the selection of the particular basis of measurement.

Going Concern

An important accounting assumption• The enterprise is normally viewed as a going

concern, that is, as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations.

• We shall discuss in a subsequent class the purpose of this assumption

Accrual Basis

• Corporate financial reports are prepared on accrual basis

• Accrual - Revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. (The considerations affecting the process of matching costs with revenues under the accrual assumption are not dealt with in this Statement.)

Accrual …

• Two principal methods of keeping track of a business's income and expenses: cash method and accrual method (sometimes called cash basis and accrual basis).

• These methods differ only in the timing of when income and expenses are recognised in the accounts.

• In cash method, income is recognised when cash is actually received, and expenses are recognised when actually paid.

• In general all transactions are recognised when they occur regardless of when the money is actually received or paid.

Annual Financial Reporting• Annual Accounts and Balance SheetAt every annual general meeting of a company held in pursuance of

section 166, the Board of directors of the company shall lay before the

company—(a) a balance-sheet as at the end of the period specified in sub-

section (3); and(b) a profit and loss account for that period. • In the case of a company not carrying on business for profit, an

income and expenditure account shall be laid before the company at its annual general meeting instead of a profit and loss account.

Standalone versus Consolidated Financial Statements

• Standalone : Financial statements of a reporting company alone

• Consolidated : Financial statements of a reporting company and its subsidiaries

• Listed companies internationally present consolidated financial statements as the main reporting format

• Whereas in India standalone financial statements is the main reporting format. Listed Indian companies present consolidated financial statements as supplementary .

Quarterly Financial Information

• In addition , listed companies present quarterly financial information in the format

prescribed by the SEBI.