Why profit is listed with the liabilities in the Balance Sheet?

Assets and Liabilities in the Balance Sheet

• Assets in the Balance Sheet are the debit balances in the bookkeeping system.
• Liabilities in the Balance Sheet are credit balances in the bookkeeping system.

Credit and Debit Balances in the Profit Statement

• In the Profit Statement, sales and income are the credit balances.
• In the Profit Statement, costs are the debit balances.
• The net total of all the balances is the profit or loss.
• This one figure (profit or loss) goes into the Balance Sheet as a single item.
• A profit is a credit which is listed with the liabilities.

Explanation on why profit (a credit balance in the Profit Statement) is listed with liabilities in the Balance Sheet

• The explanation is that the profit belongs to someone outside the business. 
• If the Balance Sheet is for a company, the profit belongs to the shareholders.
• It may one day be paid to them in the form of a dividend or by return of capital on the winding up of the company.

How do you identify an exceptional company with a durable competitive advantage from the INCOME STATEMENT?

How do you identify an exceptional company with a durable competitive advantage?

Financial statements are where you can search for companies with a durable competitive advantage that is going to make one super rich.


INCOME STATEMENT

Gross Profit

Gross Profit is a key number that helps determine whether or not the company has a long term competitive advantage.

Companies that have excellent long term economics working in their favour tend to have consistently higher gross profit margins than those that don't.

What creates a high gross profit margin is the company's durable competitive advantage, which allows it the freedom to price the products and services it sells well in excess of its cost of goods sold.

As a general rule (and there are exceptions):
Companies with gross profit margins of 40% or better tend to be companies with some sort of durable competitive advantage.

Companies with gross profit margins below 40% tend to be companies in highly competitive industries, where competition is hurting overall profit margins (there are exceptions here, too).

Any gross profit margin of 20% and below is usually a good indicator of a fiercely competitive industry, where no one company can create a sustainable competitive advantage over the competition.

The gross profit margin test is not fail-safe, it is one of the early indicators that the company in question has some kind of consistent durable competitive advantage.

You should track the annual gross profit margins for the last ten years to ensure that the consistency is there.


Operating Expenses

Selling, General and Administrative (SGA) expenses

In the search for a company with a durable competitive advantage the lower the company's Sales, General and Administrative (SGA) expenses, the better.

If they can stay consistently low, all the better.

Anything under 30% of Gross Profit is considered fantastic.

However, there are a number of companies with a durable competitive advantage that have SGA expenses  in the 30% to 80%range.

If you see a company that is repetitively showing SGA expenses close to, or in excess of 100%, the company is likely in a highly competitive industry where no one entity has a sustainable competitive advantage.

There are also companies with low to medium SGA expenses that destroy great long term business economics with high research and development costs, capital expenditures and/or interest expense on their debt load.

Steer clear of companies with consistently high SGA expenses.

The economics of companies with low SGA expenses can be destroyed by expensive research and development costs, high capital expenditures, and/or lots of debt because the inherent long-term economics are so poor that even a low asking price for the stock will not save investors from a lifetime of mediocre results.

Research &Development expenses

Companies that have to spend heavily on R&D have an inherent flaw in their competitive advantage that will always put their long term economics at risk, which means they are not a sure thing.


Depreciation

Depreciation is a very real expense and should always be included in any calculation of earnings.  It is a cost that cannot be ignored.

The companies that have a durable competitive advantage tend to have lower depreciation costs as a percentage of gross profit than companies that have to suffer the woes of intense competition.

Less depreciation always means more when it comes to increasing the bottom line.


Interest Expense

Interest expense is a financial cost, not an operating cost and it is isolated out on its own in the income statement because it is not tied to any production or sales process.

Interest is reflective of the total debt that the company is carrying on its books.

Companies with high interest payments relative to operating income (EBIT) tend to be in a fiercely competitive industry, where large capital expenditures are required for it to stay competitive, or a company with excellent business economics that acquired the debt when the company was bought in a leveraged buyout.

The companies with a durable competitive advantage often carry little or no interest expense.

Even in highly competitive businesses like the airline industry, the amount of the operating income paid out in interest can be used to identify companies with a competitive advantage.

Warren's favourite durable competitive advantage holders in the consumer products category all have interest payouts of less than 15% of operating income.

The percentage of interest payments to operating income varies greatly from industry to industry.

The investment banking business, the average interest payments are in the neighbourhood of 70% of its operating income.

The ratio of interest payments to operating income can also be very informative as to the level of economic danger that a company is in.

A simple rule:  In any given industry the company with the lowest ratio of interest payments to operating income is usually the company most likely to have a competitive advantage.

Investing in the company with a durable competitive advantage is the only way to ensure that we are going to to get rich over the long term.

Gain (or Loss) on Sale of Assets and Other

Non-recurring, non-operating, unusual and infrequent income and expense events (e.g. sale of assets) can significantly affect a company's bottom line.

Since these are nonrecurring events, they should be removed from any calculation of the company's net earnings in determining whether or not the company has a durable competitive advantage.


Income before tax (Pretax earnings)

Income before tax is also the number that Warren uses when he is calculating the return that he is getting when he buys a whole business or when he buys a partial interest in a company through the open-market purchase of its shares.

[With the exception of tax-free investments, all investment returns are marketed on a pre-tax basis.  And since all investments compete with each other, it is easier to think about them if they are thought about in equal terms.]

Warren has always discussed the earnings of a company in pre-tax terms.  This enables him to think about a business or investment in term relative to other investments.

It is also one of the cornerstones of his revelation that a company with a durable competitive advantage is actually a kind of "equity bond" with an expanding coupon or interest rate.

Income Tax paid

One of the ways to see if the company is telling the truth is to look at the documents they file and see what it is paying in income tax.  If this doesn't equal the amount according to the tax rate, better start asking some questions.

Companies that are busy misleading the IRS are usually hard at work misleading their shareholders as well.

The beauty of a company with a long-term competitive advantage is that it makes so much money it doesn't have to mislead anyone to look good.


Net Earnings

Net earnings that are consistent and showing a historical long term upward trend can be equated to durability of the competitive advantage.

The ride doesn't have to be smooth but it should be a historical upward trend.

A company's historical net earnings trend may be different from its historical per share earnings trend due to changes in the number of shares outstanding (e.g. share buyback programs will increase per share earnings even though actual net earnings haven't increased.)

Look at the business's net earnings to see what is actually going on.

Companies with a durable competitive advantage will report a higher percentage of net earnings to total revenues than their competitors will.

Net profit margins tell us a lot about the economics of the business compared with other businesses.

High net profit margins reflect the companies' superior underlying business economics.

Low net profit margins reflect the highly competitive nature of the business.

A simple rule (and there are exceptions) is that if a company is showing a net earnings history of more than 20% on total revenues, there is a real good chance that it is benefiting from some kind of long term competitive advantage.

If a company is consistently showing net earnings under 10% on total revenues it is - more likely than not - in a highly competitive business in which no one company holds a durable competitive advantage.

Those companies that earn between 10% to 20% on total revenue may also have companies with long term competitive advantage yet to be discovered.

One of the exceptions to this rule is banks and financial companies, where an abnormally high ratio of net earnings to total revenues usually means a slacking off in the risk management department.    In the game of lending money, this is usually a recipe for making quick money at the cost of long term disaster.


Per-Share Earnings

The more a company earns per share the higher its stock price is.

A per share earnings figure for a ten year period can give us a very clear picture of whether the company has a long term competitive advantage working in its favour.

Look for a per share earning picture over a ten year period that shows consistency and an upward trend - an excellent sign that the company in question has some kind of long term competitive advantage working in its favour.

Consistent earnings are usually a sign that the company is selling a product or mix of products that don't need to go through the expensive process of change.

The upward trend in earnings means that the company's economics are strong enough to allow it either to make the expenditures to increase market share through advertising or expansion, or to use financial engineering like stock buybacks.

Erratic earnings picture that shows a downward trend, punctuated by losses tells that this company is in a fiercely competitive industry prone to booms and busts.

There are thousands of companies like this and the wild price swings in shares, caused by each company's erratic earnings, create the illusion of buying opportunities for traditional value investors.  But what they are really buying is a long, slow boat ride to investor nowhere.

The Five Rules for Successful Stock Investing 6

Financial Statements Explained

[...] reading financial statements is the foundation for analyzing companies.

The balance sheet [...] tells you how much a company owns (its assets), how much it owes (its liabilities), and the difference between the two (its equity). Equity represents the value of the money that shareholders have invested in the firm [...].

"Cash and equivalents" usually contains money market funds or anything that can be liquidated quickly and with minimal price risk, whereas "short-term investments" is similar to cash – usually, bonds that have less than a year to maturity and earn a higher rate of return than cash but would take a bit of effort to sell.

[...] accounts receivable are bills that the company hasn't yet collected but for which it expects to receive payment soon.

Comparing the growth rate of accounts receivable with the growth rate of sales is a good way to judge whether a company is doing a good job collecting the money that it's owed by customers.

You'll often see an "allowance for doubtful accounts" just after accounts receivable on the balance sheet. This is the company's estimate of how much money it's owed by deadbeat customers, and which it's consequently unlikely to collect.

There are several types of inventories, including raw materials that have not yet been made into a finished product, partially finished products, and finished products that have not yet been sold. 

Inventories are especially important to watch in manufacturing and retail firms, and their value on the balance sheet should be taken with a grain of salt. Because of the way inventories are accounted for, their liquidation value may very well be a far cry from their value on the balance sheet.

Inventories soak up capital – cash that's been converted into inventory sitting in a warehouse can't be used for anything else. The speed at which a company turns over its inventory can have a huge impact on profitability because the less time cash is tied up in inventory, the more time it's available for use elsewhere. You can calculate a metric called inventory turnover by dividing a company's cost of goods sold by its inventory level.

Noncurrent assets are assets that are not expected to be converted into cash or used up within the reporting period. The big parts of this section are property, plant, and equipment (PP&E); investments; and intangible assets.

The most common form of intangible assets is goodwill, which arises when one company acquires another. Goodwill is the difference between the price the acquiring company pays and tangible value – or equity – of the target company.

[...] the value of goodwill that shows up on the balance sheet is very often far more than the asset is actually worth.

Accounts payable: These are bills the company owes to somebody else and are due to be paid within a year.

Noncurrent liabilities are the flip side of noncurrent assets. They represent money the company owes one year or more in the future.

Retained earnings is a cumulative account; therefore, each year that the company makes a profit and doesn't pay it all out as dividends, retained earnings increase. Likewise, if a company has lost money over time, retained earnings can turn negative and is often renamed "accumulated deficit" on the balance sheet. Think of this account as a company's long-term track record at generating profits.

Be sure to check the "revenue recognition policies" buried in the financial statements so you know what you're looking at – companies can record revenue at different times depending on the business that they're in.

Cost of sales, also known as cost of goods sold, represents the expenses most directly involved in creating revenue, such as labor costs, raw materials (for manufacturers), or the wholesale price of goods (for retailers).

Gross profit is simply revenue minus cost of sales. Once you have gross profit, you can calculate a gross margin, which is gross profit as a percentage of revenue. Essentially, this tells you how much a company is able to mark up its goods.

[...] the more differentiated a company's products are, the more it can mark up its good over what it costs to manufacture them.

Selling, General, and Administrative Expenses (SG&A), also known as operating expenses, includes items such as marketing, administrative salaries, and, sometimes, research and development. (Research and development is usually broken out as a separate line item, as is marketing for firms that spend large amounts on advertising.) You'll often see a relationship between SG&A and gross margin – firms that are able to charge more for their goods have to spend more on salespeople and marketing. You can get a feel for how efficient a firm is by looking at SG&A as a percentage of revenues – a lower percentage of operating expenses relative to sales generally means a tighter, more cost-effective firm.

Depreciation and Amortization: When a company buys an asset intended to last a long time, such as a new building or a piece of machinery, it charges off a portion of the cost of that asset on its income statement over a series of years. This number is occasionally broken out separately on the income statement, but it's usually rolled into operating expenses. It's always included in the cash flow statement, though, so you can look there to see how much a company's net income was affected by noncash charges such as depreciation.

Nonrecurring Charges/Gains is the catch-all area where companies put all the one-time charges or gains that aren't part of their regular, ongoing operations, such as the cost of closing a factory or the gain from selling a division. Ideally, you'd want to see this area of the income statement blank most of the time.

Operating Income is equal to revenues minus cost of sales and all operating expenses. Theoretically, it represents the profit the company made from its actual operations, as opposed to interest income, one-time gains, and so forth. In practice, companies often include nonrecurring expenses (such as write-offs) in figuring operating income, and you have to add back one-time charges (or subtract one-time gains) yourself.

Interest Income/Expense represents interest the company has paid on bonds it has issued or received on bonds or cash that it owns.

Net Income represents (at least theoretically) the company's profit after all expenses have been paid. [...] Although net income is the number you'll most often see companies tout in their press releases, don't forget that it can be wildly distorted by one-time charges and/or investment income.

Number of Shares (Basic and Diluted) represents the number of shares used in calculating earnings per share; it represents the average number of shares outstanding during the reporting period. Basic shares include only actual shares of stock, and you should pretty much ignore it – the fact that it's still recorded in financial statements is more of a historical legacy than anything else. Diluted shares, however, include securities that could potentially be converted into shares of stock, such as stock options and convertible bonds. Given the amount of egregious granting of stock options that has occurred over the past several years, it's the diluted number that you'll want to look at, because you want to know the degree to which your stake in the firm could potentially be shrunk (or diluted) if all those option-holders convert their options into shares.

The cash flow statement strips away all the abstract, noncash items such as depreciation that you see on the income statement and tells you how much actual cash the company has generated. [...] The cash flow statement is divided into three parts: cash flows from operating activities, from investing activities, and from financing activities.

If you can't understand how a dollar flows from a company's customers back through to shareholders, something's amiss. Either the company's business model is too confusing or you need to do more digging before committing any of your money.

When you're evaluating a company's liabilities, remember that debt is a fixed cost. A big chunk of long-term debt can be risky for a company because the interest has to be paid no matter how business is doing.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

How to create profit (Income statement)

Warren Buffett's Interpretation of Financial Statements and Analysis

Warren Buffett's Interpretation of Financial Statements and Analysis




Warren Buffett's Interpretation of the Income Statement and Analysis



Warren Buffett's Interpretation of a Balance Sheet and Analysis



Warren Buffett's Interpretation of Cash Flows and Analysis

Financial Statements: Introduction

Table of Contents

1. Financial Statements: Introduction
2. Financial Statements: Who's In Charge?
3. Financial Statements: The System
4. Financial Statements: Cash Flow
5. Financial Statements: Earnings
6. Financial Statements: Revenue
7. Financial Statements: Working Capital
8. Financial Statements: Long-Lived Assets
9. Financial Statements: Long-Term Liabilities
10. Financial Statements: Pension Plans
11. Financial Statements: Conclusion

Financial Statements:

Introduction
By David Harper

Whether you watch analysts on CNBC or read articles in The Wall Street Journal, you'll hear experts insisting on the importance of "doing your homework" before investing in a company. In other words, investors should dig deep into the company's financial statements and analyze everything from the auditor's report to the footnotes. But what does this advice really mean, and how does an investor follow it?

The aim of this tutorial is to answer these questions by providing a succinct yet advanced overview of financial statements analysis. If you already have a grasp of the definition of the balance sheet and the structure of an income statement, this tutorial will give you a deeper understanding of how to analyze these reports and how to identify the "red flags" and "gold nuggets" of a company. In other words, it will teach you the important factors that make or break an investment decision.

If you are new to financial statements, don't despair - you can get the background knowledge you need in the Intro To Fundamental Analysis tutorial. Read more: http://www.investopedia.com/university/financialstatements/#ixzz279MZnu00

Income Statement in Perspective

When problems exist in an income statement, they tend to distort earnings only in a single year, or over a short period of time.

To even out these short-term distortions, use average share price, annual earnings, and other numbers over a span of 7 to 10 years.

"Averaging" establishes typical numbers for the company.  The longer the time included in the average, the better.

Cash flow 3D

http://www.invalueable.net/fs_overview.html

Financial Statements 101

Table of Contents

1. Understanding Financial Statements
2. Balance Sheet
3. Income Statement
4. Statement of Cash Flows
5. Statement of Retained Earnings
6. Intrinsic Valuation Modeler™ and Putting it all Together

Income Statement Format with EBIT and EBITDA

Cooking the Books: Sweetening the Balance Sheet

Most often both the Balance Sheet and the Income Statement are involved in cooking the books.  A convenient cooking is exchanging assets with the purpose of inflating the Balance Sheet and showing a profit on the Income Statement as well!

For example, a company owns an old warehouse, valued on the company books at $500,000, its original cost minus years of accumulated depreciation.  In fact, the present value of the warehouse if sold would be 10 times its book value, or $5 million.  The company sells the warehouse, books a $4.5 million profit and then buys a similar warehouse next door for $5 million.

Nothing has really changed.  The company still has a warehouse, but the new one is valued on the books at its purchase price of $5 million instead of the lower depreciated cost of the original warehouse.  The company has booked a $4.5 million gain, yet it has less cash on hand than it had before this sell-buy transaction.

Why would a company exchange one asset for a very similar one ... especially if it cost them cash and an unnecessary tax payment?  The only "real" effect of this transaction is the sale of an undervalued asset and booking of a one-time gain.  If the company reports this gain as part of "operating income,": the books have been cooked - income has been deceptively inflated.  If the company purports that this one-time capital gain is reoccurring operating income, it has misrepresented the earning capacity of the enterprise.

Related:

• Cooking the Books: Why do managers cook the books?
• Cooking the Books: This is very different from "Creative Accounting"
• Cooking the Books: Puffing up the Income Statement
• Cooking the Books: Techniques to Puff Up the Income Statement
• Cooking the Books: Sweetening the Balance Sheet
• Cooking the Books: Techniques to Sweeten the Balance Sheet
• Cooking the Books: The Auditor's Job
• Cooking the Books: Investors, be warned.

Cooking the Books: Puffing up the Income Statement

Puffing up the Income Statement most often involves some form of bogus sales revenue that results in increased profit.

One of the simplest methods of cooking the books is padding the revenue; that is, recording sales before all the conditions required to complete a sale have occurred.  The purpose of this action is to inflate sales and associated profits.  A particularly creative technique is self-dealings such as increasing revenue by selling something to yourself.

Revenue is appropriately recorded ONLY after all these conditions are met:

1. An order has been received.
2. The actual product has been shipped.
3. There is little risk the customer will not accept the product.
4. No significant additional actions are required by the company.
5. Title has transferred and the purchaser recognizes his responsibility to pay.

The other common route to illegal reporting of increased profit is to lower expenses or to fiddle with costs.  A simple method to accomplish this deception involves shifting expenses from one period into another with the objective of reporting increased profits in the earlier period and hoping for the best in the later period.

Related:

• Cooking the Books: Why do managers cook the books?
• Cooking the Books: This is very different from "Creative Accounting"
• Cooking the Books: Puffing up the Income Statement
• Cooking the Books: Techniques to Puff Up the Income Statement
• Cooking the Books: Sweetening the Balance Sheet
• Cooking the Books: Techniques to Sweeten the Balance Sheet
• Cooking the Books: The Auditor's Job
• Cooking the Books: Investors, be warned.

Cooking the Books: Why do managers cook the books?

Managers most often cook the books for personal financial gain -

• to justify a bonus, 
• to keep stock prices high and options valuable or 
• to hide a business's poor performance.

Companies most likely to cook their books have weak internal controls and have a management of questionable character facing extreme pressure to perform.

"Cooking the books" means intentionally hiding or distorting the real financial performance or actual financial condition of a company.

Cooking is most often accomplished by moving items that should be on the Income Statement onto the Balance Sheet and sometimes vice versa.

A variety of specific techniques can be used to raise or lower income, raise or lower revenue, raise or lower assets and liabilities, and thereby reach whatever felonious objective the businessperson desires.  A simple method is outright lying by making fictitious transactions or ignoring required ones.

Related:

• Cooking the Books: Why do managers cook the books?
• Cooking the Books: This is very different from "Creative Accounting"
• Cooking the Books: Puffing up the Income Statement
• Cooking the Books: Techniques to Puff Up the Income Statement
• Cooking the Books: Sweetening the Balance Sheet
• Cooking the Books: Techniques to Sweeten the Balance Sheet
• Cooking the Books: The Auditor's Job
• Cooking the Books: Investors, be warned.

Cooking the Books: Techniques to Sweeten the Balance Sheet

C. Improperly increased or shifted period income.

D. Improperly increased assets and equity.

C.  Improperly increased or shifted period income

C1.  Current expenses shifted into later period

• C1a.  Improperly capitalized costs as inventory.
• C1b.  Assets depreciated or amortized too slowly.
• C1c.  Worthless asset not written off immediately.

C2.  Shift revenue and income into later periods with reserves.

D.  Improperly increased assets and equity.

D1.  Increased equity through one-time gains

• D1a.  Report gains on exchange of similar assets
• D1b.  Report gains by selling undervalued assets
• D1c.  Retire debt.

D2.  Report revenue rather than liability on receipt of cash.

"Cooking the books" means intentionally hiding or distorting the real financial performance or actual financial condition of a company.

Related:

• Cooking the Books: Why do managers cook the books?
• Cooking the Books: This is very different from "Creative Accounting"
• Cooking the Books: Puffing up the Income Statement
• Cooking the Books: Techniques to Puff Up the Income Statement
• Cooking the Books: Sweetening the Balance Sheet
• Cooking the Books: Techniques to Sweeten the Balance Sheet
• Cooking the Books: The Auditor's Job
• Cooking the Books: Investors, be warned.

Cooking the Books: Techniques to Puff Up the Income Statement

A.  Improperly increased revenue
B.  Improperly lowered cost or expenses.

A.  Improperly increased revenue

A1.  Sales recorded before completed and final

• A1a.  Goods shipped before sale final
• A1b.  Revenue recorded while future services still due

A2.  Bogus revenue recorded

• A2a.  Supplier refunds recorded as revenue
• A2b.  Revenue recorded from self-dealing
• A2c.  Revenue recorded from asset exchanges.

B.  Improperly lowered costs or expenses

B1.  Current expenses shifted into later periods

• B1a.  Period expenses capitalised onto Balance Sheet
• B1b.  Assets depreciated too slowly.
• B1c.  Probable liabilities not accrued.

B2.  Operating losses masked in discontinued operations

"Cooking the books" means intentionally hiding or distorting the real financial performance or actual financial condition of a company.

• 
  
• Related:
• Cooking the Books: Why do managers cook the books?
• Cooking the Books: This is very different from "Creative Accounting"
• Cooking the Books: Puffing up the Income Statement
• Cooking the Books: Techniques to Puff Up the Income Statement
• Cooking the Books: Sweetening the Balance Sheet
• Cooking the Books: Techniques to Sweeten the Balance Sheet
• Cooking the Books: The Auditor's Job
• Cooking the Books: Investors, be warned.

How the Financial Statements Tell a Story: Stocks and Flows

Articulation is the way in which the statements fit together, their relationship to each other.

 

The articulation of the income statement and balance sheet is through the statement of shareholders' equity and is described by the stocks and flows relation.

 

Beginning equity
+ Comprehensive income
- Net payout to shareholders
= Ending equity

 

Balance sheets give the stock of owners' equity at a point in time. The statement of shareholders' equity explains the changes in owners' equity (the flows) between two balance sheet dates, and the income statement, corrected for other comprehensive income in the equity statement, explains the change in owners' equity that comes from adding value in operations.

 

By recognising the articulation of the financial statements, the reader of the statements understands the overall story that they tell. That story is in terms of stocks and flows. (Stocks here refere to stocks of value at a point in time). The statements track changes in stocks of cash and owners' equity (net assets).

 

----

 

Consolidated Balance Sheet of Company A (in millions)

 

February 1, 2008
Cash and cash equivalent 7764
Total shareholders' equity 3735

 

February 2, 2008
Cash and cash equivalent 9546
Total shareholders' equity 4328

 

Consolidated Statement of Income (in millions)

 

Net Revenue 61133
Total Operating expenses 8231
Operating income 3440
Investment and other income, net 387
Income tax provision 880
Net income 2947

 

 

Consolidated Statement of Cash Flows (in millions)

 

Cash flows from operating activities 3949
Cash flows from investing activities (1763)
Cash flows from investing activities (4120)
Effects of exchange changes on cash and cash equivalents 152
Net (decrease) increase in cash and cash equivalents: (1782)
Cash and cash equivalents at beginning of year 9546
Cash and cash equivalents at end of year 7764

 

Consolidated Statements of Shareholders' Equity (in millions)

 

Balances at (February 2, 2007) 4328
Net income 2947
Impact of adoption of SFAS 155 6
Cahnge in net unrealised gain on investments, net of taxes 56
Foreign currency translation adjustments 17
Change in net unrealised loss on derivative instruments, net of taxes (38)
________________________________________________
Total comprehensive income 2988 (Total of all the above)
Impact of adoption of FIN 48 (62)
Stock issuances under employee plans 153
Repurchases (4004)
Stock-based compensation expense under SFAS 123(R) 329
Tax benefit from employee stock plans 3
Balance at (February 1, 2008) 3735

 

 

----

A Summary of Accounting Relations

The Balance Sheet (in millions)

 

Assets
- Liabilities
=Shareholders' equity

 

Beginning of 2008 fiscal year:
9546 in cash
4328 in equity

 

Ending of 2008 fiscal year:
7764 in cash
3735 in equity

 

Cash decreased by 1782 
Equity decreased by 593

 

 

The Income Statement (in millions)

 

Net revenue 61133
- Cost of goods sold
= Gross margin
- Operating expenses 57693
= Operating income before interest and taxes (ebit)
- Interest expense & other incomes 387
= Income before taxes
- Income taxes 880
= Income after tax and before ordinary items
+ Extraordinary items
= Net income 2947
- Preferred dividends
= Net income available to common 2947

 

or

 

Net revenue 61133
Operating expenses 57693
Other Income & Expenses 387
Pretax Income
Taxes 880
Net Income 2947

 

 

Cash Flow Statement (and the Articulation of the Balance Sheet and Cash Flow Statement) (in millions)

 

Cash flow from operations 3949
+ Cash flow from investing -1763
+ Cash flow from financing -4120
+ Effect of exchange rate 152
= Change in cash 1782

 

Statement of Shareholders' Equity (and the Articulation of the Balance Sheet and Income Statement) (in millions)

 

Beginning equity 4328
+ Comprehensive income 2988
- Net payout 3581
= Ending equity 3735

 

Net Income 2947
+ Other comprehensive income 41
= Comprehensive income 2988

 

Dividend
+ Share repurchases 4004
= Total payout
- Share issues 153
- Others 270
= Net payout 3581

 

----

 

Comments:

 

The cash flow statement reveals that the $1782 million decrease came from a cash inflow of $3949 million in operations, less cash spent in investing of $1763 million, net cash paid out to claimants of $4120 million, and an increase in the US dollar equivalent of cash held abroad of $152 million.

 

But the main focus of the financial statements is on the change in the owners' equity during the year.

 

The Company A owners' equity decreased from $4328 million to $3735 million over the year by earning $2988 million in its business actiivities and paying out a net $3851 million ($4004 million - $153 million) to its owners (plus those other items in the equity statement $270 million).

 

The income statement indicates that the net income portion of the increase in equity from business actiivities ($2947 miillion) came from revenue from selling products and financing revenue of $61133 million, less expenses incurred in generating the revenue of $57693 million, plus investment and other income of $387 million, less taxes of $880 million.

 

So Company A began its fiscal 2009 year with the stocks in place in the 2008 balance sheet to accumulate more cash and wealth for shareholders. Fundamental analysis involves forecasting that accumulation.

 

For analysis of the fundamentals, the ability to see how the accounting relations is important in developing forecasting tools.

• Understand how the statements fit together.
• Understand how financial reporting tracks the evolution of shareholders' equity, updating stocks of equity value in the balance sheet with value added in earnings from business activities.
• And understand the accounting equations that govern each statement.