Financial Statements

Collin Brandon O. Asio

BSME – 2
ESC 15 EF
 • Formal records of a company's,
individual's, or other entity's
financial actions and status are
What are called financial statements. They
give stakeholders (such as
financial creditors, investors, and
statements? management) a clear picture of
an organization's financial
health and help them make wise
decisions.

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 Following terminologies and their
definitions

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Income Statement –

- A company's revenues, expenses, and profits or losses during a given period, such as a
month, quarter, or year, are displayed in an income statement, also known as a profit and
loss statement or P&L.
 Purpose Income Statement

To show how much money a company earned or lost during a

given period. It answers questions like:
• Is the company making a profit?
• Where is the company spending its money?
• Is revenue growing over time?

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 Basic Structure of an Income
Statement
1. Revenue (Sales) 4. Operating Expenses

The total income from selling goods Costs required to run the business,
or services. like:
2. Cost of Goods Sold (COGS) •Rent, Salaries, Marketing, and
The direct costs of producing the Utilities
goods or services sold (e.g., raw
materials, labor). 5. Operating Income

3. Gross Profit Formula:

Operating Income = Gross Profit −
Formula: Operating Expenses
Gross Profit = Revenue − COGS
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 Why It Matters

•Business Owners use it to track profitability.

•Investors use it to evaluate performance and growth.

•Banks use it when deciding whether to give loans.

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 Statement of cash flows

The Statement of Cash Flows is a

financial statement that shows how cash
and cash equivalents move in and out of
a business over a specific period of time.
It breaks down cash flows into three main
categories:

1.Operating Activities

2.Investing Activities

3.Financing Activities

This statement helps users understand

how a company generates and uses cash,
highlighting its liquidity, solvency, and
financial flexibility.
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 Key terminology

Operating Activities
Cash flows related to the core business operations — selling products or
providing services.
Includes:
•Cash received from customers
•Cash paid to suppliers and employees
•Interest paid/received
•Income taxes paid

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 Terminology

Net Cash Flow Indirect Method

The net total of cash inflows A common method of preparing the

minus outflows for each operating section of the cash flow
activity. It can be: statement:
• Positive (inflow): Company •Starts with net income
is generating more cash
than it's spending. •Adjusts for non-cash items (like
depreciation)
• Negative (outflow):
Company is spending more •Adjusts for changes in working
cash than it's generating. capital

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 Statement of Equity Changes

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 Definition
The Statement of Changes in Equity (also called the Statement of
Shareholders’ Equity or Statement of Retained Earnings) is a
financial statement that shows the movements in equity during an
accounting period.

• It tracks how components of owners’ equity (such as retained earnings,

share capital, and reserves) have changed due to: Profits or losses, Share
issues or buybacks, Dividend payments, Revaluation adjustments, and
Other comprehensive income.
Purpose:
• To explain the reconciliation between the opening and closing
balances of equity, providing transparency on how a company is using
12 its profits and managing equity-related transactions.
 Key terminologies
1. Opening Balance of Equity
• The equity balance at the start of the reporting period.
2. Share Capital (Common/Ordinary Stock)
• The amount shareholders invest in exchange for ownership (shares) in the
company. Eg. Common stock. Basic ownership shares
3. Share Premium (Additional Paid-in Capital)
The amount received from issuing shares above their par (nominal) value.
• ➡️Formula:
Share Premium = Issue Price – Par Value

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 Terminologies
4. Retained Earnings
Cumulative net profits that have not been distributed to
shareholders as dividends, but are retained for reinvestment or to
cover future losses.
• ➡️Formula:
Retained Earnings (End) = Retained Earnings (Start) + Net
Income – Dividends Paid
5. Dividends
• Payments made to shareholders from the company’s earnings.
Reduces retained earnings.
6. Revaluation Reserve
• An equity account that holds the increase in value of assets (like
property) due to a revaluation. It’s a part of other comprehensive
14 income.
 Accrual Accounting

Accrual accounting is an
accounting method where
revenues and expenses are
recorded when they are earned
or incurred, not when cash is
received or paid.

This approach provides a more

accurate picture of a company’s
financial position and
performance than cash basis
accounting, especially for larger or
more complex businesses.
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 Key concept & terminologies

1. Revenue Recognition 6. Accrued Revenues

Under accrual accounting, revenue is
recorded when it is earned, regardless of Revenue that has been earned
when payment is received. but not yet received in cash. For
example, services provided but not
➡️Example: If a company delivers a service
yet invoiced.
in March but gets paid in April, revenue is
still recorded in March.
7. Deferred Revenue (Unearned
2. Expense Recognition (Matching Principle) Revenue)
Expenses are recognized in the period they
help generate revenue, even if payment Cash received before revenue is
happens in a different period. earned. Recognized as a liability
➡️Example: If inventory is sold in June, but paid until the service/product is
for in July, the expense is recorded in June. delivered.
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 Cash Basis Accounting

Cash basis accounting is a method

of accounting where revenues
and expenses are recorded only
when cash is received or paid,
regardless of when the transaction
actually occurs.
1. It’s simple and often used by small
businesses, freelancers, or
individuals who don’t need to follow
strict accounting rules (like GAAP or
IFRS).

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 Key Concepts and Terminologies:

1. Revenue 2. Expense Recognition (Cash Paid)

Recognition (Cash
Received) Expenses are recorded only when cash is
paid, even if the service or product was used
Revenue is recorded
earlier.
only when cash is
actually received, ➡️Example: If you receive a bill in March but
not when the sale is pay it in April, the expense is recorded in April.
made.
1. ➡️Example: If you 3. No Matching Principle
perform a service in
May but get paid in Because expenses are not necessarily
June, you record the matched with related revenues, the income
18 revenue in June. statement might not reflect the true
profitability for a given period.
 Historical Cost

Historical cost is an accounting

principle that records assets and
liabilities at their original
purchase price at the time of
acquisition, not adjusted for
changes in market value over
time.

This method is based on

objective, verifiable evidence,
like an invoice or contract, making
it a reliable and consistent
measure.
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 Key Concepts and Terminologies

1. Original Cost Example:

The amount paid for an asset, If a company buys a

including: machine for $100,000 in
•Purchase price 2020, it continues to
report the asset at
•Shipping fees
$100,000 on the balance
•Installation or setup costs sheet (less any
depreciation), regardless
•Taxes directly related to
acquisition of its current market
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value.
 Key concept & Terminologies

2. Depreciation 3. Impairment

A systematic allocation of the If an asset’s market value drops

historical cost of a tangible asset permanently below its historical
over its useful life. cost, an impairment loss is
recognized, adjusting its book
➡️Though the historical cost stays value downward.
the same, the book value of the
asset decreases annually through 4. Amortization
depreciation.
Similar to depreciation but applies
to intangible assets (e.g.,
patents, licenses) based on their
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historical cost.
 Fair Value

Fair value is the estimated price

at which an asset or liability
could be sold or settled
between informed, willing
parties in an orderly
transaction in the current
market.

It reflects the current market

conditions, not the original
purchase price (unlike historical
cost accounting).

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 Key Concepts and Terminologies

1. Market-Based Measurement 2. Active Market

Fair value is determined by referencing market A market with:
prices, if available, rather than internal
estimates. •Frequent transactions

• ➡️Example: The fair value of a stock is its •Transparent pricing

current trading price on a stock exchange. •Willing buyers and
sellers
➡️Active markets make
it easier to determine
fair value reliably.
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 Key Concepts and Terminologies

3. Fair Value Hierarchy (IFRS & GAAP) 4. Mark-to-Market

Standards like IFRS 13 and ASC 820 define a 3- A method of valuing
level hierarchy to assess how fair value is assets or liabilities at
measured: their fair value on the
balance sheet date.
• Level 1: Quoted prices in active markets (e.g., Common in:
stock market)
•Trading securities
• Level 2: Observable inputs (e.g., similar
assets, interest rates) •Derivatives
• Level 3: Unobservable inputs (e.g., internal •Investment portfolios
models, estimates)
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 Key Concepts and Terminologies

5. Unrealized Gain or Loss Benefits of Fair

Value Accounting:
A change in value of an asset based on fair
value, even if the asset hasn’t been sold yet. •Up-to-date
These are often reported in: valuation: Reflects
current economic
• Other Comprehensive Income or conditions
• Income Statement (depending on the asset •More relevant for
type) decision-making
•Helps investors
evaluate true worth
of assets and liabilities
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 Gross Profit

1. Gross profit is the

amount a company
earns from its core
operations after
deducting the
direct costs of
producing or
purchasing the
goods it sells.
It reflects how
efficiently a
company can
produce and sell
its products.
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 Key Concepts and Terminologies

1. Revenue (or Net 2. Cost of Goods Sold (COGS)

Sales)
The direct costs of producing the goods sold
The total income
by a company.
from goods sold or
Includes:
services provided
during a specific •Raw materials
period, before any
expenses are •Direct labor
deducted.
•Manufacturing costs

❗ Does not include operating expenses like

rent or marketing.
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 Key Concepts and Terminologies

Why Gross Profit Is Limitations:

Important:
•Doesn’t account for overhead (e.g., rent,
• Helps assess
salaries, admin expenses)
product
profitability •Not a complete picture of profitability — it’s
• Indicates how well a just the first step in analyzing a company’s
company controls income
production costs
• Used to calculate
Operating Income
and Net Profit
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 Operating Expenses

Operating expenses
(OPEX) are the costs
required to run a
business’s day-to-
day operations,
excluding the cost of
goods sold (COGS).
These expenses are
recurring and are
necessary for
maintaining the
company’s core
business functions.
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 Key Concepts and Terminologies

1. Selling, General, and Administrative Expenses 2. Depreciation and

(SG&A) Amortization
This includes a wide range of expenses like:
•Depreciation:
• Salaries and wages (for non-production staff) Allocation of the cost of
• Office rent and utilities tangible assets (e.g.,
buildings, equipment)
• Advertising and marketing over their useful lives.
• Insurance
•Amortization: Similar
• Legal and accounting fees to depreciation but for
• Travel expenses
intangible assets
(e.g., patents, software
• Telephone and internet licenses).
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 Key Concepts and Terminologies

3. Research and Development (R&D) Formula Context:

• Expenses related to developing new products or Operating income =
services (especially in tech and pharma industries). Gross Profit –
Why Operating Expenses Matter: Operating Expenses

• OPEX directly affects operating income and net

profit
• Companies try to manage OPEX efficiently to
increase profitability
• Investors monitor OPEX to assess cost control and
efficiency

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 Operating Income

Operating income, also known as

operating profit or earnings
before interest and taxes
(EBIT), is the profit a
company generates from its
core business operations
after deducting operating
expenses like wages, rent, and
raw materials, but before
deducting interest and
taxes.
1. Operating income provides
insight into how well a company
is performing in its main
business activities, excluding
any external factors like interest
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or tax changes.
 Key Concepts and Terminologies

Formula: 1. Gross Profit

Operating Income = Gross
Profit – Operating Expenses The amount left after subtracting the cost of
goods sold (COGS) from revenue. It's the
Where: first step in determining a company’s
Gross Profit = Revenue - profitability.
Cost of Goods Sold (COGS)
2. Operating Expenses (OPEX)
Operating Expenses include
things like selling, general, The recurring costs of running a business,
and administrative such as:
expenses (SG&A),
depreciation, and R&D
costs.
•Salaries
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•Rent
 Key Concepts and Terminologies

3. Non-operating Why Operating Income Matters:

Items
•Focus on Core Operations: It reflects a
1. Income or expenses company's ability to generate profit from its main
that are not business activities, excluding external factors like
related to core interest and tax.
operations (like
investment income, •Operational Efficiency: A higher operating
interest expenses, income indicates efficient management of
operating expenses and revenue generation.
or gains/losses on
asset sales). These •Investor Insight: Investors and analysts often
are not included in look at operating income to gauge how well a
operating income. company is managing its costs and operations,
independent of financial structure.
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 Key Concepts and Terminologies

Operating Income
vs. Net Income:
• Operating Income:
Only reflects the
earnings from core
operations.
• Net Income:
Reflects all factors,
including interest
and taxes.

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 Interest Expense

Interest expense is the cost

incurred by a company for
borrowing funds, typically through
loans, bonds, or other forms of
debt. It represents the amount
paid to lenders or creditors for
the use of their capital over a
specific period.

Interest expense is typically

reported on the income
statement and is a crucial factor in
calculating a company’s net
income.
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 Key Concepts and Terminologies

Formula for Interest Expense: 2. Interest Rate

Interest Expense = Loan Amount X The percentage charged by the

Interest Rate X Time Period lender for using their capital,
typically expressed as an annual
1. Principal percentage rate (APR).

The original loan amount or the ➡️Example: A loan with an interest

initial sum borrowed, on which the rate of 5% means the company will
interest is calculated. pay 5% of the principal as interest
each year.
➡️Example: If a company borrows
$1,000,000, the principal is
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$1,000,000.
 Key Concepts and Terminologies

3. Debt 4. Coupon Rate

The borrowed funds that the For bondholders, the coupon rate is
company must repay with interest. the interest rate on the bond's face
Debt can be: value. It's typically paid periodically
(e.g., annually or semi-annually).
•Short-term debt: Due within one
year 5. Amortization of Debt

The process of gradually repaying

•Long-term debt: Due in more
debt through scheduled payments
than one year
over time, reducing the principal
balance and adjusting interest
expenses.
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 Key Concepts and Terminologies

Importance of Interest Expense: Key Takeaways:

•Impact on Profitability: Interest •Interest expense is a financial
expense reduces operating income and cost incurred on borrowed funds.
affects net profit.
•It is an important factor in
•Debt Management: Helps evaluate
how well a company is managing its assessing a company’s financial
debt. High interest expenses may health and ability to manage
signal high leverage and financial risk. debt.

•Tax Deductibility: In many •High interest expense may

jurisdictions, interest expenses are indicate high leverage, which
tax-deductible, which can provide a could increase risk, but could also
tax shield. benefit from tax advantages.
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 Income Tax Expense

Income tax expense is the

amount of tax a company must
pay to the government based on its
taxable income. It is calculated
according to the tax laws in the
company's jurisdiction and is a
crucial element in determining a
company’s net income.

Income tax expense is typically

recorded on the income
statement, after operating
income and before arriving at net
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income.
 Key Concepts and Terminologies

Formula for Income Tax Expense: 1. Taxable Income

Income Tax Expense = Taxable The income amount that is subject

Income X Tax Rate to tax, which may differ from
accounting profit due to
Where: differences in tax rules and
accounting principles (like
•Taxable Income is the income on depreciation methods or revenue
which the company is required to recognition).
pay taxes (which can differ from
accounting profit). ➡️Example: A company may have
a higher taxable income than its
•Tax Rate is the percentage of accounting profit if tax rules allow
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income that is paid as tax. for tax deductions or credits.
 Key Concepts and Terminologies

2. Deferred Tax 3. Tax Provision

A future tax obligation or asset An estimate of the tax liability for

resulting from timing differences the period, which the company
between how income or expenses are sets aside in anticipation of paying
recognized for accounting and tax
taxes.
purposes. It is classified as:

•Deferred Tax Liabilities: Taxes

owed in the future due to temporary
differences.

•Deferred Tax Assets: Taxes to be

refunded in the future due to
differences.
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 Key Concepts and Terminologies

Why Income Tax Expense Matters: Key Points to Remember:

•Impact on Profitability: Income tax •Income tax expense is an

expense reduces net income, essential part of net income
affecting shareholder returns. calculation.
•Tax Planning: Companies use •Taxable income can differ from
various tax strategies (e.g., credits, accounting profit, so tax expense
deductions) to minimize tax burden. might not match exactly with the
accounting income reported.
•Investor Insight: Investors analyze
income tax expense to evaluate the •Companies aim for tax efficiency
effective tax rate and how well the
through tax credits, deductions,
company is managing its taxes.
and deferred tax strategies.
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 Net Profit Margin

Net Profit Margin is a key

profitability ratio that shows the
percentage of revenue that
remains as net profit after all
expenses, including operating
expenses, interest, taxes, and
other costs, have been deducted.
It measures how efficiently a
company turns its revenue into
actual profit.

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 Key Concepts and Terminologies

1. Net Income 2. Revenue

The final profit a company earns The total sales or income

after all operating costs, interest, generated by the company from its
taxes, and other expenses have primary operations, such as
been subtracted from total product sales or service fees,
revenue. before any expenses are deducted.

➡️Example: If a company has

$100,000 in revenue and $10,000
in expenses, the net income
would be $90,000.

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 Key Concepts and Terminologies

3. Profitability 4. Operating Expenses, Interest,

and Taxes
Net profit margin is a key indicator
of a company’s profitability. A These are costs that are deducted
from revenue to calculate net profit:
higher margin indicates that a
company is keeping a larger •Operating Expenses: Costs of
portion of its revenue as profit, running the business, such as
which is typically a good sign of salaries, rent, and utilities.
operational efficiency.
•Interest: Payments made on
borrowed funds.

•Taxes: Income tax expenses levied

by the government.
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 Key Concepts and Terminologies

Why Net Profit Margin Matters: Key Takeaways:

•Efficiency Indicator: It reveals how •Net Profit Margin is an essential

well a company manages its costs and metric to assess a company’s
expenses relative to its revenue. profitability after all costs.
•Comparative Measure: It allows for
•A high net profit margin indicates
easy comparison of profitability across
effective cost control and higher
companies in the same industry.
profitability, while a low margin
•Investor Insight: Investors use net might suggest inefficiency.
profit margin to assess how much profit
a company is making for every dollar of •It can vary significantly across
revenue, helping to evaluate the overall industries, so it’s important to
financial health and potential for returns. compare companies within the same
sector.
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 Gross Profit Margin

Gross Profit Margin is a financial

metric that represents the
percentage of revenue remaining
after subtracting the Cost of
Goods Sold (COGS) from total
revenue. It measures how
efficiently a company is producing
its goods or services, indicating the
profitability of its core business
activities before accounting for
operating expenses, taxes, and
interest.

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 Key Concepts and Terminologies

1. Gross Profit 2. Cost of Goods Sold (COGS)

The difference between revenue and The direct costs associated with
Cost of Goods Sold (COGS). Gross producing the goods or services a
profit represents the money left after company sells. It includes:
covering the direct costs of
•Raw materials
producing goods or services but
before accounting for operating •Direct labor (labor directly involved in
expenses like marketing, rent, or production)
salaries.
•Manufacturing costs
➡️Example: If a company generates
$500,000 in revenue and has It excludes operating expenses like
$300,000 in COGS, the gross profit rent, utilities, and salaries for
would be $200,000. employees not involved in production.
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 Key Concepts and Terminologies

3. Revenue Why Gross Profit Margin Matters:

•Operational Efficiency: A higher gross

The total sales or income profit margin indicates that a company is
generated by the company from its able to generate more profit from each
core business activities, before dollar of sales while controlling production
costs efficiently.
subtracting any expenses.
•Profitability Indicator: It highlights how
much of a company’s revenue is left after
covering production costs, which is a
precursor to overall profitability.

•Industry Comparison: Different industries

have varying gross profit margin norms. For
example, tech companies often have higher
margins than retail or manufacturing firms.
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 Current Assets

Current assets are assets that a

company expects to convert into
cash, sell, or consume within
one year or within the company’s
normal operating cycle,
whichever is longer. These assets
are important for assessing a
company’s short-term financial
health and its ability to meet
short-term obligations.

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 Key Concepts and Terminologies

Key Characteristics of Current Common Types of Current

Assets: Assets:
•Liquidity: Current assets are typically
1.Cash and Cash Equivalents
highly liquid, meaning they can be
easily converted to cash.
1.Cash: Physical currency on
•Short-term: They are intended to be hand.
used or converted to cash in the near
future, generally within a year. 2.Cash Equivalents: Short-
term, highly liquid
•Increased Cash Flow: These assets investments (e.g., Treasury
are critical in evaluating a company’s bills, money market funds)
ability to meet its short-term
that can be easily converted
liabilities and fund daily operations.
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into cash.
 Key Concepts and Terminologies

2. Accounts Receivable 3. Short-Term Investments

•Money owed by customers for •Investments in securities or assets

goods or services that have been that are expected to be liquidated or
converted into cash within one year.
delivered but not yet paid for. This
is expected to be collected within a 4. Prepaid Expenses
short period (typically within 30 to
90 days). •Payments made for goods or services
that will be received in the future,
•Goods or materials that a such as insurance premiums, rent, or
company holds for the purpose of subscriptions. These are considered
selling or using in production. current assets because they will be
Includes raw materials, work-in- used up or consumed within a year.
53 progress, and finished goods.
 Key Concepts and Terminologies

Other Receivables Why Current Assets Matter:

•Liquidity Assessment: Current assets

•Any other short-term amounts
help investors and creditors assess a
owed to the company, such as tax company’s liquidity and its ability to
refunds, loans, or advances to cover short-term liabilities. A
employees. company with sufficient current assets is
better positioned to meet its
obligations as they come due.

•Working Capital: The difference

between current assets and current
liabilities is known as working capital,
which is a key indicator of a company’s
operational efficiency and financial
health.
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 Key Takeaways

•Current assets are essential for assessing a company’s ability

to pay off short-term obligations and continue operations
smoothly.

•Liquidity and working capital are key metrics derived from

current assets that help analyze financial health.

•Balance Sheet Analysis: Current assets, when compared to

current liabilities, provide valuable insights into a company’s
short-term solvency.

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 Non-current assets

Non-current assets (also called

long-term assets or fixed
assets) are assets that a company
expects to hold for more than
one year or beyond its normal
operating cycle. These assets are
not expected to be converted into
cash or used up within the short
term and are essential for long-
term business operations and
growth.

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 Key Concepts and Terminologies

Key Characteristics of Non-Current Property, Plant, and

Assets:
Equipment (PP&E)
•Long-term Investment: These assets are
typically held for long-term use in business •These are physical, long-term
operations, not for immediate resale or
conversion to cash.
assets used in business
operations, such as land, buildings,
•Depreciation/Amortization: Many non- machinery, vehicles, and
current assets, such as property and
equipment, lose value over time due to wear
equipment.
and tear (depreciation) or obsolescence.
However, intangible assets like patents are •Depreciation: These assets lose
amortized over time. value over time due to wear and
•Not Easily Liquidated: Non-current assets tear, and depreciation is recorded
are not easily turned into cash, making them to reflect this decline.
less liquid compared to current assets.
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 Key Concepts and Terminologies

Intangible Assets Long-Term Investments

•Non-physical assets with a long- •Investments in stocks, bonds, real

term value, such as patents, estate, or other assets that the
trademarks, copyrights, goodwill, company intends to hold for more
and brand names. than a year. These are not
intended to be sold in the short
•Amortization: Intangible assets term.
are generally amortized over their
useful life, reflecting a reduction in •Examples include investments in
their value over time. other companies or joint ventures.

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 Key Concepts and Terminologies

Goodwill Deferred Tax Assets

•The premium a company pays •These represent taxes that a

when acquiring another company company has overpaid or deferred
for a price higher than the fair and expects to recover in future
value of its net assets. It periods.
represents the value of the
acquired company's brand Other Long-Term Assets
reputation, customer base, and
other intangible benefits. •Any other assets that the
company does not expect to
convert into cash within the next
year, such as long-term
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receivables or certain
prepayments.
 Key Concepts and Terminologies
Why Non-Current Assets Matter: Key Takeaways:
•Long-Term Investment: Non-current assets are
often tied to the company’s ability to generate
•Non-current assets are key to a
revenue over the long term. They represent the company’s long-term growth, capacity,
company’s infrastructure and capacity to and operational sustainability.
continue operations, such as machinery, real
estate, and intellectual property. •These assets are essential for companies
•Depreciation/Amortization: Non-current assets looking to expand operations or invest
like property and intangible assets are subject in long-term initiatives.
to depreciation and amortization, which impacts a
company’s net income and tax liabilities over •Depreciation and amortization reduce
time.
the book value of these assets over time,
•Business Stability: These assets provide long- which is reflected in the income
term value to a company, offering security and statement and affects tax liabilities.
the ability to support sustained business
operations, even though they are not easily
converted into cash.
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 Notes payable

Notes payable are written

promises by a company to pay a
specified amount of money to a
lender or creditor at a future date,
typically with interest. These
liabilities arise when a company
borrows funds or incurs debt in the
form of a formal agreement (note)
that specifies the repayment terms,
including the amount, interest rate,
and due date.
Notes payable are classified as either
current liabilities (due within one
year) or non-current liabilities
(due beyond one year) depending on
the repayment schedule.

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 Key Concepts and Terminologies

Key Characteristics of Notes Payable: Short-Term Notes

Payable (Current
• Formal Agreement: Unlike informal debts (like Liabilities)
accounts payable), notes payable are formal
written contracts that outline repayment terms. •Notes that are due
within one year or within
• Interest: Notes payable generally carry an the company’s normal
interest rate. The amount of interest payable is operating cycle.
determined by the terms of the agreement.
•Example: A company
• Fixed Repayment Schedule: The company borrows $50,000 for 6
must repay the borrowed amount at specific months with an
times, often on a monthly or quarterly basis, as agreement to repay
per the terms set in the note. within that time frame.

62
 Key Concepts and Terminologies
Why Notes Payable Matter:
1.Long-Term Notes Payable (Non-Current
Liabilities) •Debt Financing: Notes payable
represent a form of debt
financing, allowing companies to
1. Notes that are due beyond one year or the raise funds for operations,
normal operating cycle. expansion, or other purposes.
•Cash Flow Management: The
2.Example: A company borrows $200,000 repayment of notes payable affects
with a repayment period of 5 years. a company’s cash flow, as the
business needs to allocate funds to
pay off the debt.
•Creditworthiness: A company’s
ability to manage its notes
payable and meet repayment
terms is an important indicator of
its financial health and
creditworthiness.

63
 Bonds payable

Bonds payable refer to long-term

debt securities issued by a
company, government, or other
organizations to raise capital. When
a company issues bonds, it is
borrowing money from bondholders,
agreeing to pay back the face value
of the bonds at a specified maturity
date along with periodic interest
payments (referred to as coupon
payments). Bonds payable are
classified as non-current
liabilities because they are
generally due in more than one year.

64
 Key Concepts and Terminologies
Key Characteristics of Bonds Payable: Convertible Bonds
•Fixed Interest Payments: Bonds usually
come with a fixed interest rate (coupon rate), •Bonds that can be converted into
which is paid to bondholders periodically the issuing company's stock at
(usually semi-annually or annually).
the bondholder’s discretion,
•Maturity Date: Bonds have a maturity date, usually at a pre-determined
which is the date on which the principal (face
value) must be repaid to bondholders.
conversion rate.

•Face Value: The principal amount of the bond, •Example: A company issues
also known as its par value, is the amount that
will be repaid to the bondholder at maturity.
$1,000 bonds, which can be
converted into 50 shares of stock
•Issuer: The company or government entity at the bondholder's choice.
issuing the bonds is the borrower, and
bondholders are the creditors.
65
 Key Concepts and Terminologies

Callable Bonds Zero-Coupon Bonds

•Bonds that the issuer can redeem •Bonds that do not pay periodic
(buy back) before the maturity interest but are issued at a
date, usually at a premium. discount to their face value. The
investor receives the face value at
•Example: A company issues maturity.
bonds but retains the right to buy
them back after 5 years if interest •Example: A company issues a
rates decrease. $1,000 bond for $700. The investor
receives $1,000 at maturity.

66
 Key Concepts and Terminologies

Government Bonds vs. Why Bonds Payable Matter:

Corporate Bonds •Capital Raising: Bonds are an important tool
for companies to raise capital for expansion,
•Government Bonds: Issued by acquisitions, or operational needs without
diluting ownership (unlike issuing shares).
government entities (local, state,
or national governments) and •Long-Term Debt: Bonds payable represent
long-term debt obligations, impacting a
typically considered lower risk. company’s financial leverage and overall
capital structure.
•Corporate Bonds: Issued by
•Interest Expense: The interest payments
companies and typically offer made to bondholders are considered a fixed
higher interest rates due to higher cost and impact the company’s profitability.
risk. These payments are recorded as an interest
expense on the income statement.

67
 Common stock

Common stock represents

ownership in a company.
When investors purchase
common stock, they are
buying a share of ownership
in the company. Common
stockholders have voting
rights in the company’s
decisions (such as electing
the board of directors) and
may receive dividends.
However, they are last in
line to receive any
remaining assets if the
company is liquidated, after
creditors and preferred
stockholders.

68
 Key Concepts and Terminologies

Key Characteristics of Common Stock: Authorized Stock

• Ownership: Common stockholders are the owners of the
company and benefit from the company’s profits and growth. •The maximum number
of shares a company is
• Voting Rights: Common stockholders typically have the right
to vote on major corporate decisions, such as mergers, legally allowed to
acquisitions, and electing board members. issue, as specified in
• Dividends: While common stockholders may receive its corporate charter.
dividends, these are typically variable and not guaranteed. Not all authorized
The company’s board of directors decides whether to stock is necessarily
distribute dividends based on company performance.
issued or outstanding.
• Residual Claims: In the event of liquidation, common
stockholders are paid last, after creditors and preferred
stockholders. They are entitled to any remaining assets.

69
 Key Concepts and Terminologies

Issued Stock Why Common Stock Matters:

•Capital Raising: By issuing common stock, a company can raise
• The number of capital for expansion, new projects, or reducing debt without taking
shares that the on additional liabilities.
company has •Ownership & Control: Common stock represents the equity or
actually sold to ownership interest in the company, and shareholders have voting
investors, whether rights that influence the direction of the company.
through an IPO •Dividends and Profit Sharing: Common stockholders may receive
(Initial Public dividends if the company performs well, but dividend payments are
Offering) or not guaranteed. They may also benefit from capital gains if the
private offerings. stock price rises.
•Risk & Reward: Common stockholders assume the highest risk
because they are last to be paid in case of liquidation. However, they
also stand to gain the most if the company performs well and its
70 stock price increases.
 Preferred Stock

Preferred stock (also called

preference shares) is a type of
equity security that represents
ownership in a company, but with
certain privileges over common
stock. Preferred stockholders
generally have a higher claim on
the company’s assets and
earnings, particularly in terms of
receiving dividends, but they
usually do not have voting rights
like common stockholders.

71
 Key Concepts and Terminologies

Key Characteristics of Preferred Stock: •Cumulative vs. Non-Cumulative:

•Priority Dividends: Preferred stockholders
receive dividends before common • Cumulative Preferred
stockholders, and these dividends are often at Stock: If dividends are
a fixed rate. missed, they accumulate and
•No Voting Rights: Preferred stockholders must be paid in the future
typically do not have the right to vote on before common stockholders
company matters, such as electing directors, receive any dividends.
which is a key distinction from common
stockholders. • Non-Cumulative Preferred
•Liquidation Preference: In the event of Stock: Missed dividends do
liquidation, preferred stockholders have a not accumulate, and there is
higher claim on the company’s assets than no obligation to pay them in
common stockholders but are paid after debt
holders.
the future.
72
 Key Concepts and Terminologies

Cumulative Preferred Stock Non-Cumulative Preferred

Stock
•The most common form of preferred
stock. If dividends are not paid in any •If dividends are missed, they do
given year, they accumulate and must
not accumulate, and the company
be paid in full before any dividends
is not obligated to make up for the
are paid to common stockholders.
missed payments.
•Example: A company owes $100,000
in preferred dividends. If it only pays •Example: A company skips
$50,000 in one year, the remaining dividend payments for one year.
$50,000 will be carried over and must The preferred shareholders are not
be paid in subsequent years. entitled to receive these unpaid
dividends in future years.
73
 Key Concepts and Terminologies

Why Preferred Stock Matters:

•Stable Income: Preferred stock is often seen as a more stable investment

compared to common stock because of the fixed dividends.

•Lower Risk: Preferred stockholders are higher in the capital structure than
common stockholders, so they have a better chance of receiving dividends and
recovering investment if the company liquidates.

•Company Flexibility: Issuing preferred stock allows companies to raise capital

without diluting the ownership control that common stockholders have.

•Hybrid Nature: Preferred stock has qualities of both debt (in terms of fixed
dividends) and equity (in terms of ownership), making it attractive to investors
seeking both income and a stake in the company’s growth.
74
 Cash equivalents

Cash equivalents are short-

term, highly liquid
investments that are easily
convertible into known
amounts of cash with an
insignificant risk of
changes in value. These
assets are typically very
short-term (generally
maturing within three months
or less) and are considered as
almost equivalent to cash
for accounting purposes.

75
 Key Concepts and Terminologies

Key Characteristics of Cash Equivalents: Treasury Bills: Short-

1.Short-Term Investments: Cash equivalents are term government
investments that mature in three months or less securities with
from the date of purchase. maturities of one year
or less.
2.High Liquidity: These investments are highly liquid,
meaning they can be quickly converted to cash with Money Market
little or no risk of price fluctuations.
Funds: Mutual funds
3.Low Risk: Cash equivalents typically carry very low that invest in short-
risk, with little potential for loss in value. term, low-risk
4.Near Cash Nature: They are treated as cash on the securities like
balance sheet because they are almost as accessible government bonds and
as actual cash. certificates of deposit
76
(CDs).
 Key Concepts and Terminologies

• Commercial Paper: Short-term unsecured Cash Equivalents on

debt issued by corporations, typically with the Balance Sheet:
maturities of up to 270 days. On the balance sheet,
• Certificates of Deposit (CDs): Short-term cash equivalents are
typically listed under the
bank deposits that typically mature in less than "Cash and Cash
three months and offer a fixed interest rate. Equivalents" category,
alongside actual cash, as
• Repurchase Agreements (Repos): Short-
part of current assets.
term loans where securities are sold with an This is because they are
agreement to repurchase them at a higher considered easily
price in a very short period, usually within 3 accessible and nearly as
months. liquid as cash itself.

77
 Investing Activities

Investing activities refer to the

section of a company’s statement
of cash flows that shows cash
inflows and outflows related to
the acquisition and disposal of
long-term assets and other
investments not classified as
cash equivalents. These
activities are essential for
understanding how a company is
using its cash to grow and
maintain its business over time.

78
 Key Concepts and Terminologies

Key Characteristics of Investing Cash Outflows (Uses of Cash):

Activities:
•Purchase of property, plant, and
•Long-Term Focus: Typically involve non-
equipment (e.g. buying machinery or
current assets like property, plant, and
equipment (PP&E), and financial
buildings)
investments.
•Purchase of intangible assets (e.g.
•Capital Expenditures: Includes patents or trademarks)
purchases or sales of physical assets
that are used to generate long-term •Purchase of long-term investments
revenue. (e.g. bonds, stocks in other
companies)
•Cash-Based: Only cash transactions
are reported—non-cash investing activities
•Loans made to other companies or
(like asset swaps) are disclosed separately.
individuals
79
 Key Concepts and Terminologies

Cash Inflows (Sources of Cash): Why Investing Activities Matter:

•Business Growth Indicator: Significant

•Sale of property, plant, and
cash outflows for asset purchases often
equipment signal business expansion, while
inflows from asset sales might suggest
•Sale of intangible assets downsizing or asset restructuring.

•Sale or maturity of long-term •Capital Allocation Insight: Shows how

effectively a company is using its funds
investments to generate future returns.

•Collection on loans receivable •Investor Interest: Investors watch this

section to evaluate the sustainability
and direction of a company’s long-term
strategy.
80
 Financing Activities

Financing activities are the part

of a company’s cash flow
statement that shows the
inflows and outflows of cash
related to transactions with the
company’s owners and
creditors. This section reveals
how a business raises capital and
repays it, including issuing stock,
borrowing money, repaying loans,
and paying dividends.

81
 Key Concepts and Terminologies

Key Characteristics of Financing Cash Inflows (Sources of

Activities: Cash):
•Capital Structure Focus: Involves
debt and equity financing.
•Issuance of common or
preferred stock
•Cash-Based Transactions Only:
Reflects only actual cash flows—non- •Borrowing through bonds
cash financing items (like issuing stock payable or notes payable
in exchange for assets) are disclosed
elsewhere. •Proceeds from loans or credit
•Not Operational or Investing: It does lines
not include day-to-day business
operations or long-term asset
transactions.
82
 Key Concepts and Terminologies

Cash Outflows (Uses of Cash): Why Financing Activities Matter:

•Repayment of loans, bonds, or •Capital Health: Helps assess how a

notes company is funding its operations
and growth—via debt or equity.
•Repurchase of company shares
•Dividend Policy Insight: Shows
(treasury stock)
how much cash is being returned to
•Payment of dividends to shareholders.
shareholders •Debt Management: Indicates how
a company is managing its
obligations and whether it's taking
on or reducing financial risk.
83
 Key Takeaways

Common Accounts Related to •Financing activities focus on

Financing Activities: how a business raises and
repays capital.
•Common stock / Preferred
stock •Positive cash flow in this section
means the company is raising
•Treasury stock funds; negative cash flow often
means it is paying off debt or
•Bonds payable / Notes payable returning capital.

•Dividends payable •This section gives investors

insight into the company’s
•Additional paid-in capital financial strategy, capital
84 structure, and long-term
sustainability.
 Operating Activities

Operating activities** represent the

core business activities of a
company—those that relate to
producing and selling goods or
services. In the statement of cash
flows, operating activities include the
cash inflows and outflows resulting
from a company’s day-to-day
operations.

These activities are the primary

source of a company’s cash
generation, and they are crucial for
assessing its operational health and
sustainability.
85
 Key Concepts and Terminologies

Key Characteristics of Cash Inflows:

Operating Activities:
•Cash received from customers
•Focuses on revenues and for sales of goods or services
expenses from normal business
operations. •Interest and dividends received
(in some cases)
•Uses either the direct or indirect
method to calculate cash flow. •Other operating receipts (e.g.,
royalties, fees, commissions)
•Reflects how well the company
generates cash from its core
functions, without relying on
investments or financing.
86
 Key Concepts and Terminologies

Cash Outflows: Why Operating Activities Matter:

•Cash Flow Quality: Strong positive

•Payments to suppliers for
cash flow from operations indicates the
inventory or services company can generate sufficient cash
from its core business without relying
•Payments to and on behalf of on outside funding.
employees
•Short-Term Liquidity: It helps assess
the company's ability to pay bills,
•Payments for operating suppliers, and employees.
expenses (e.g., rent, utilities)
•Performance Indicator: It’s a critical
•Payments for interest and metric for analysts and investors to
income taxes evaluate business efficiency and
operational success.
87
 Auditor's Report

An auditor’s report is a formal

opinion issued by an independent
external auditor after examining a
company’s financial statements. It
provides assurance to stakeholders—
such as investors, creditors, and
regulators—about whether the financial
statements are free from material
misstatements and are presented in
accordance with applicable accounting
standards (e.g., IFRS or GAAP).

It is typically included in a company’s

annual report alongside the financial
statements.
88
 Key Concepts and Terminologies

Key Components of an Opinion Paragraph

Auditor's Report:
•The auditor states their opinion
1.Title and Addressee on the fairness and accuracy of the
financial statements.
1. Clearly identifies the report
as an independent •This is the most important
auditor’s report and states
section—it tells users whether
to whom it is addressed they can trust the financial
(usually shareholders or the data.
board of directors).

89
 Key Concepts and Terminologies

Basis for Opinion Why the Auditor’s Report Matters:

•Describes the auditing •Investor Confidence: A clean

auditor’s report gives investors
standards followed and confirms
confidence in the company’s reported
that the audit was conducted financial results.
independently and
professionally. •Regulatory Compliance: Public
companies are required by law to
•Highlights the most significant have independent audits and publish
risks and areas of focus during the the auditor’s report.
audit (e.g., revenue recognition,
•Transparency & Trust: The report
asset valuation).
improves corporate governance and
stakeholder trust.
90
 Materiality

Materiality is a fundamental accounting

and auditing concept that refers to the
significance of financial information or
errors in financial statements. Information is
considered material if omitting or
misstating it could influence the
economic decisions of users (such as
investors, creditors, or regulators) who rely
on the financial statements.

In simpler terms, materiality determines

what matters—both in preparation and
audit of financial reports.

91
 Key Concepts and Terminologies

Key Aspects of Materiality: Qualitative Materiality

1.Quantitative Materiality •Based on the nature or context

of the information, even if the
1. Based on the size or
dollar amount is small.
amount of a financial item.
2. Example: A $5,000 error •Example: Misclassifying executive
might be immaterial for a compensation or failing to disclose
large company with billions a legal investigation could still be
in revenue but material for a material.
small business.

92
 Key Concepts and Terminologies

User Perspective Key Takeaways:

•Materiality is judged based on •Materiality determines what

what is important to the users matters in financial statements.
of the financial statements—not
the company or auditor alone. •It helps ensure users get
relevant, reliable, and
complete information for
decision-making.

•Materiality is both quantitative

and qualitative—size matters,
but so does context.
93
 Going concern

The Going Concern principle is an

accounting assumption that a
company will continue its operations
into the foreseeable future and not
liquidate or shut down. It underlies
the preparation of financial statements,
allowing businesses to defer
recognition of certain expenses
and revenues to future periods.

If an entity is not a going concern, its

financial reporting must
fundamentally change to reflect the
possibility of liquidation or severe
financial distress.
94
 Key Concepts and Terminologies

Key Features of the Going Concern When Going Concern is in

Assumption: Doubt:
•Assumes the company has no intention
or need to cease operations. Accountants and auditors must
evaluate whether there is
•Financial statements are prepared with substantial doubt about a
the expectation of ongoing company’s ability to continue as a
operations.
going concern for at least 12
•Allows for assets to be recorded at months from the financial
cost and depreciated over time, rather statement date.
than valued at liquidation prices.

•It supports long-term planning and

decision-making.
95
 Key Concepts and Terminologies

Auditor's Responsibility: Effects on Financial Reporting:

•The auditor must assess If the going concern assumption does

management’s evaluation of not hold:
going concern and disclose any
•Assets may be revalued at
material uncertainties. liquidation value.
•If doubt exists, the auditor may •Liabilities may be presented as
include a “Going Concern” immediately payable.
paragraph in the audit report,
even with a clean opinion. •Notes to financial statements must
disclose uncertainties or plans for
recovery (e.g., refinancing, cost
reduction).
96
 Consistency
Consistency is a fundamental
accounting principle that requires a
company to use the same
accounting methods and
policies across reporting
periods, ensuring that financial
statements are comparable over
time. It does not mean never
changing methods, but any change
must be justified, disclosed, and
explained in the financial
statements.

97
 Key Concepts and Terminologies

Why Consistency Matters: Changes in Accounting Policy:

•📊 Comparability: Enables users Companies can change accounting
(investors, analysts, auditors) to methods only if:
compare financial results across
periods and spot real trends. •The change is required by a
•📈 Transparency: Prevents new accounting standard, or
manipulation of results through
frequent changes in accounting •The change provides more
methods. relevant or reliable
information.
•📚 Reliability: Increases the
credibility and usefulness of financial
statements for decision-making.
98
 Key Concepts and Terminologies

📌 Disclosure is mandatory: The Example Disclosure for

company must explain the nature Inconsistency:
of the change, its reason, and its
financial impact in the notes to “During the year, the company
the financial statements. changed its method of inventory
valuation from LIFO to FIFO to
better reflect the physical flow of
goods. The change resulted in an
increase of $150,000 in net
income. Prior year financials have
been restated for comparability.”

99
 Comparability

Comparability is a
fundamental qualitative
characteristic of financial
information that enables
users to identify similarities
and differences between
financial statements of
different companies or
across different time
periods. It ensures that
accounting information is
presented in a standardized
and consistent manner,
making analysis and decision-
making more effective.

100
 Key Concepts and Terminologies

Why Comparability Matters: Threats to

Comparability:
• 📈 Helps investors and stakeholders compare
performance across companies or time •Use of different
periods. accounting policies
for similar transactions
• 🔍 Enhances the usefulness and
transparency of financial information. •Frequent changes in
estimates or
• 🧾 Encourages uniform application of methods without clear
accounting standards (such as IFRS or disclosure
GAAP).
•Non-compliance with
accounting standards
101
 Key Concepts and Terminologies

How Comparability Is Achieved: Key Takeaways:

•Comparability makes
• Applying uniform accounting standards
financial information
(e.g., IFRS/GAAP) meaningful across
companies and time.
• Maintaining disclosure requirements
•It supports better
• Providing clear explanations for any changes benchmarking, risk
in accounting methods analysis, and investment
decisions.
• Promoting industry-specific practices
•Consistency within a
company enhances
comparability between
companies.
102
 Working Capital

1. Working capital is a
financial metric that
measures a company’s
short-term liquidity
and operational
efficiency. It is calculated
as:
Working Capital = Current
Assets – Current Liabilities
This figure indicates
whether a company has
enough short-term assets
to cover its short-term
obligations.
103
 Key Concepts and Terminologies

📊 Working Capital Why Working Capital Matters:

Management:
Good working capital •📈 Liquidity Indicator: A positive working
management includes: capital means the company can easily pay off
• Speeding up accounts its debts and continue daily operations.
receivable collections
•🔄 Operational Efficiency: Shows how
• Reducing inventory
holding costs effectively a company is managing its
resources, including inventory, receivables,
• Extending accounts
and payables.
payable without
harming relationships
•⚠️Risk Signal: A negative working capital
• Monitoring cash flow
may indicate financial distress or liquidity
cycles
104
problems, especially if sustained over time.
 Liquidity

Liquidity refers to a
company's ability to meet
its short-term financial
obligations using its most
readily available assets—
primarily cash or assets that
can be quickly converted
into cash without
significant loss in value.

In short, liquidity measures

how easily a business can
pay its bills on time.
105
 Key Concepts and Terminologies

📊 Types of Liquidity: Examples of Liquid

Assets:
1.Market Liquidity
1. How easily an asset can be bought or sold •Cash and bank
in the market without affecting its price. balances
2. Example: Stocks are highly liquid; real estate is •Marketable
less liquid. securities
2. Accounting Liquidity
•Accounts receivable
• A business’s ability to pay off short-term
liabilities with short-term assets. •Short-term
investments
• Focus of financial analysis.
🚫 Inventory and
106
prepaid expenses
are often less liquid.
 Key Concepts and Terminologies

📌 Why Liquidity Is Important: 🧩 Key Takeaways:

• Ensures smooth daily operations •Liquidity reflects a
company’s short-term
• Reduces financial risk financial strength.
• Helps meet unexpected expenses or •High liquidity = Better
downturns ability to meet
• Builds trust with creditors and investors obligations and
avoid default.
•Measured through
ratios, especially the
current, quick, and
107 cash ratios.
 Solvency

1. Solvency is a financial
metric that indicates a
company's ability to
meet its long-term
financial obligations. It
refers to the company’s
overall financial health
and capacity to
continue operating in
the long term. Unlike
liquidity, which focuses
on short-term obligations,
solvency is concerned
with a company's long-
term viability and its
ability to cover all of its
liabilities.

108
 Key Concepts and Terminologies

🧩 Key Takeaways: 📊 Why Solvency Matters:

• Solvency is a measure of
a company's long-term •🔒 Long-Term Financial Stability: It assesses
financial health and whether the company can survive in the long
ability to meet long-term run, even if it faces short-term challenges.
obligations.
• It is evaluated through •📉 Risk Management: A solvency issue often
solvency ratios like signals that a company may be at risk of
debt-to-equity and
interest coverage.
defaulting on its debts, which can lead to
bankruptcy or restructuring.
• A company with good
solvency has the ability
•💼 Investor Confidence: Investors and creditors
to survive long-term,
even during economic look at solvency to assess creditworthiness
downturns. and sustainability of a business.
109
 Return on Equity

Return on Equity
(ROE) is a key
financial metric that
measures the
profitability of a
company in relation
to shareholders'
equity. It indicates
how effectively a
company is using the
capital invested by its
shareholders to
generate profits.
110
 Key Concepts and Terminologies

📊 Why ROE Matters: 🧩 Key Takeaways:

•ROE measures a company's
• 🔍 Profitability Indicator: ROE shows how well a efficiency in generating
company is using shareholders’ equity to generate profits from shareholders'
profits. A higher ROE means the company is equity.
efficiently generating income from its equity. •A high ROE is generally
viewed as a sign of effective
• 📉 Efficiency: It helps investors assess how management and a
efficiently a company is using its resources to profitable business.
increase wealth. •DuPont Analysis helps
break down ROE into factors
• 💼 Investor Confidence: A consistently high ROE like profitability, efficiency,
suggests that the company is generating strong and leverage, offering deeper
returns, which can attract more investment. insights into what drives ROE.

111
 Return on Assets

1. Return on Assets
(ROA) is a financial
metric that
measures a
company’s ability to
generate profit from
its total assets. It
reflects how
effectively a
company is using its
assets to produce
earnings.

112
 Key Concepts and Terminologies
📌 Why ROA Matters: 🧩 Key Takeaways:
• 🔍 Asset Efficiency: ROA
shows how effectively a •ROA measures how well a company utilizes its
company is utilizing its assets
to generate profit. A higher assets to generate profits.
ROA means the company is
using its resources efficiently •A higher ROA indicates more efficient use of
to create earnings.
assets, while a lower ROA could signal inefficiency.
• Operational Performance:
It highlights the relationship
between a company's earnings
•ROA can vary significantly by industry, so
and its asset base, reflecting comparisons should be made within the same sector.
operational effectiveness.
• 💼 Investor Insight: Investors •It's a useful tool for investors to assess a
look at ROA to gauge how well company's operational performance and asset
the company is using its assets
to generate profits. High ROA
management.
indicates more efficient use of
resources.
113
 Earnings per share (EPS)
Earnings per Share (EPS)
is a financial metric that
measures the profitability
of a company on a per-
share basis. It indicates
how much profit a company
generates for each
outstanding share of its
common stock. EPS is a key
indicator of a company's
financial health and is
widely used by investors to
assess the company's
performance and make
investment decisions.

114
 Key Concepts and Terminologies

Where:
• Net Income is the company’s profit after all expenses, taxes, and
costs.
• Preferred Dividends are dividends paid to preferred stockholders
(if any).
• Weighted Average Shares Outstanding is the average number
of shares outstanding during the period, adjusted for stock splits or
share repurchases.

115
 Key Concepts and Terminologies

📌 Why EPS Matters: 🧩 Key Takeaways:

• 💼 Investor Insights: EPS provides a per-share •EPS measures how much profit is
generated per share of stock,
profit figure, which is crucial for investors when
providing an indicator of profitability
valuing a company's stock. It helps assess whether a and performance.
company is generating sufficient profit relative to the
number of shares in circulation. •Basic EPS reflects earnings without
considering potential dilution, while
• 📊 Profitability Indicator: A higher EPS indicates a Diluted EPS accounts for the
company is more profitable and is generating more impact of convertible securities.
income per share for its shareholders. •Investors use EPS to gauge a
company’s profitability, growth
• 📉 Performance Comparison: EPS is often used to potential, and stock valuation.
compare the performance of companies within
the same industry. •A higher and growing EPS often
indicates strong financial
performance and is a key factor in
116
investment decisions.
 Price-to-earnings ratio
1. The Price-to-Earnings
(P/E) ratio is a commonly
used valuation metric
that compares a company's
market price per share
to its earnings per share
(EPS). It is an indicator of
how much investors are
willing to pay for each
dollar of the company’s
earnings. A higher P/E ratio
typically suggests that
investors expect future
growth, while a lower P/E
may indicate that the
company is undervalued or
facing difficulties.
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 Key Concepts and Terminologies

1. Trailing P/E (Most 📌 Why the P/E Ratio Matters:

Common)
•Valuation: The P/E ratio helps investors assess
Uses historical whether a stock is overvalued, undervalued, or
earnings from the most fairly priced relative to its earnings.
recent 12-month period
(also known as trailing •Growth Expectations: A high P/E ratio typically
suggests that investors expect high future growth or
twelve months or
that the company has strong growth potential, while a
TTM). low P/E ratio may indicate lower growth expectations
or undervaluation.
2. Uses projected
earnings for the next •Investment Comparison: It allows for comparisons
12 months, providing between companies within the same industry, giving
insight into the market’s investors insight into which companies are more highly
expectations of future valued in relation to their earnings.
118
performance.
 Key Concepts and Terminologies

P/E Ratio and Growth ⚠️Limitations of the P/E Ratio:

Expectations:
• A high P/E ratio suggests •Earnings Manipulation: The P/E ratio relies on
that investors believe the reported earnings, which can be manipulated or
company’s future earnings affected by accounting practices, such as
growth will be strong. depreciation or amortization.
However, if the company
fails to meet these •Industry Comparisons: The P/E ratio is more useful
expectations, the stock when compared to peers in the same industry. A
price could fall. high P/E in one sector (e.g., tech) might be normal,
• A low P/E ratio may while the same P/E in another sector (e.g., utilities)
indicate that the company could indicate overvaluation.
is undervalued or that
investors expect slow •Growth Assumptions: The forward P/E depends
growth or potential risks in on earnings estimates, which may be inaccurate or
the future.
overly optimistic.
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 Market Capitalization
Market Capitalization
(often referred to as market
cap) is the total market
value of a company's
outstanding shares of stock.
It is used to measure a
company’s size and overall
value in the market. Market
cap is a key indicator for
investors to assess the
company’s position in the
stock market and determine
its relative size compared to
other companies.
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 Key Concepts and Terminologies

📌 Why Market Capitalization Matters: 🧩 Key Takeaways:

• Company Size: Market cap is a simple way to gauge a •Market Cap helps assess a
company's size in the stock market. It is often used to company's size, stability,
categorize companies into various size segments (e.g., and growth potential.
large-cap, mid-cap, small-cap). •It is an important factor in
• Risk Assessment: Market cap helps investors evaluate a risk assessment and
company’s risk and stability. Typically, large-cap choosing investments based
companies are more stable, while small-cap companies on individual risk tolerance.
may have higher growth potential but also higher risk. •Large-cap companies are
• Investment Strategy: Different market cap segments typically stable, while small-
cap companies have higher
appeal to different types of investors. For example, large-
growth potential but may
cap stocks are generally favored by conservative investors,
also be more volatile.
while small-cap stocks attract more aggressive investors
seeking growth.

121
 Goodwill
Goodwill is an intangible asset that
arises when a company acquires
another company for a price higher
than the fair value of its net
identifiable assets. Essentially,
goodwill represents the premium paid
for a business above the value of its
tangible assets (like cash, buildings,
equipment) and identifiable intangible
assets (like patents or trademarks).
1. Goodwill typically reflects factors like
the company’s brand reputation,
customer relationships, employee
skills, and other elements that
contribute to its long-term profitability.

122
 Key Concepts and Terminologies

📌 Why Goodwill Matters: 🧾 Key Components of Goodwill:

• Acquisitions and Mergers: Goodwill
is often created during mergers or 1.Brand Name and Reputation
acquisitions when a company buys
another for more than the fair value of
its assets. 1. A company with a well-known
• Intangible Value: It represents the
brand or strong customer loyalty
value of intangible assets that are not may have significant goodwill
easily quantified, such as customer because of its reputation in the
loyalty, brand recognition, and market
market.
positioning.
• Financial Reporting: Goodwill
2. Established relationships with
appears on the balance sheet as an
intangible asset, and it can impact a customers or a loyal customer
company’s overall financial health base add value to the company
and valuation. and can contribute to goodwill.
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 Key Concepts and Terminologies

📊 Goodwill and 🧩 Key Takeaways:

Impairment:
• Goodwill •Goodwill represents the premium paid
Impairment: If the during an acquisition for intangible assets like
carrying amount of brand reputation, customer relationships,
goodwill exceeds its and employee expertise.
fair value during
impairment testing, •It is recorded on the balance sheet and not
the company must amortized but is subject to annual
record an impairment impairment testing.
loss. This means the
company reduces the •If the value of goodwill decreases, an
value of goodwill on impairment loss must be recorded, affecting
the balance sheet. the company's financial statements.
124
 Contingent Liabilities
A contingent liability is a potential
financial obligation that may arise
depending on the outcome of a
future event. It is not certain
whether the liability will actually
materialize, but if the specified
event occurs, the company will be
required to settle the obligation.
Contingent liabilities are often
disclosed in the notes to financial
statements, but they are not
recognized on the balance sheet
unless the liability is probable and
can be reasonably estimated.
125
 Key Concepts and Terminologies

📌 Key Characteristics of Contingent 📊 How Contingent Liabilities

Liabilities:
Are Reported:
1.Uncertainty: The liability is contingent
on a future event that may or may not Contingent liabilities are classified
happen. based on the likelihood of the
event occurring:
2.Potential Obligation: If the event
occurs, the company may be required to
pay or provide assets. If the liability is probable and the
amount can be reasonably
3.Disclosure: Even though contingent estimated, it must be recorded
liabilities are not always recorded on the
balance sheet, they must be disclosed in
on the balance sheet as a
the footnotes if the chance of occurring is liability and an expense.
more than remote and the potential loss
can be reasonably estimated.
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 Key Concepts and Terminologies

Example: A company is involved 🧾 Contingent Liabilities and

in a lawsuit where the likelihood of Financial Statements:
losing is high, and the potential
•Balance Sheet Impact: If a
settlement amount can be contingent liability is probable and the
estimated at $1 million. The amount is reasonably estimable, it is
company would record a $1 million recognized on the balance sheet.
liability on its balance sheet. Otherwise, it is disclosed only in the
notes to the financial statements.
The liability is not recorded on the
balance sheet, but it must be •Income Statement Impact: If a
disclosed in the footnotes of contingent liability is recognized, an
expense will be recorded on the
the financial statements. The income statement, impacting the
potential amount of the liability company’s net income.
127 must also be disclosed if it can be
estimated.
 Fair Presentation
Fair presentation in financial reporting
refers to the requirement that a
company’s financial statements should
provide a truthful, accurate, and
unbiased view of its financial position,
performance, and cash flows. The
concept ensures that the financial
statements reflect the company’s true
financial condition without misleading
users, adhering to relevant accounting
standards and principles.
1. In other words, fair presentation
ensures that the financial statements
are free from material misstatements
and errors, and that they are prepared
using consistent accounting
methods that provide a realistic and
comprehensive view of the company’s
128 finances.
 Key Concepts and Terminologies

Key Takeaways: Example of Fair Presentation:

• Fair presentation •A company’s financial statements show the
ensures that current liabilities correctly, including any
financial statements
long-term debt due within the next year,
give a true and and disclose all material contingent
fair view of the
liabilities. This ensures that the financial
company’s financial statements accurately reflect the company’s
situation, adhering
financial obligations, without underestimating
to accounting future risks.
standards and
disclosure
requirements.
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 Financial Disclosure

Financial disclosure refers to the process

of providing transparent, comprehensive,
and accurate financial information in a
company’s financial statements, reports,
and notes. This disclosure is intended to
inform stakeholders, such as investors,
creditors, regulators, and analysts, about
the company’s financial health,
performance, and risk exposure.

Financial disclosures typically include not

only the financial statements (balance
sheet, income statement, cash flow
statement, etc.) but also the notes that
accompany them, providing deeper insights
into specific items or events that may affect
130
the company’s financial position.
 Key Concepts and Terminologies

Mandatory Disclosures: By disclosing relevant financial

information, companies enable
•These disclosures are required by stakeholders to make informed
law, accounting standards (like decisions. It helps build trust
GAAP or IFRS), or regulatory between the company and its
agencies. They include essential investors, ensuring they have a
financial information that clear understanding of its financial
companies must report periodically health.
(e.g., quarterly or annually).

131
 Key Concepts and Terminologies

🧩 Key Takeaways:

•Financial disclosure involves providing accurate, clear, and detailed financial

information in the financial statements and the notes to those statements.

•It ensures transparency, helping stakeholders assess the financial health,

performance, and risks of a company.

•Mandatory disclosures are required by accounting standards (like GAAP or IFRS) and
regulatory bodies (like the SEC), while voluntary disclosures are additional insights
that companies may choose to share.

•Key disclosures include accounting policies, contingent liabilities, related-party

transactions, risk factors, and subsequent events.

•The purpose of financial disclosure is to provide investors, creditors, and other

stakeholders with the necessary information to make informed decisions.
132
 Statement on Comprehensive Income

The Statement of
Comprehensive Income is a
financial statement that provides a
detailed overview of a company’s
total comprehensive income
during a specific period. It includes
all changes in equity that are not a
result of transactions with the
company’s owners (like issuing
stock or paying dividends).
Essentially, this statement
combines both net income (from
the income statement) and other
comprehensive income (OCI) to
give a full picture of a company's
133
financial performance.
 Key Concepts and Terminologies

📌 Components of the Other Comprehensive Income

Statement of Comprehensive (OCI):
Income:
- Other comprehensive income
Net Income: includes revenues, expenses,
gains, and losses that are not
This is the traditional measure of a recognized in the net income but
company's profit, calculated as still affect a company’s equity.
revenues minus expenses, OCI is generally reported in the
including costs like taxes and equity section of the balance
interest. It comes from the income sheet.
statement and represents a
company’s performance for a
134 specific period.
 Key Concepts and Terminologies

Key Takeaways:

•The Statement of Comprehensive Income is crucial because it includes

both net income and other comprehensive income (OCI), providing a
more complete picture of a company’s performance.

•Other comprehensive income (OCI) includes items like unrealized

gains and losses, foreign currency translation adjustments,
pension-related adjustments, and cash flow hedges.

135
 Other Comprehensive Income

Other Comprehensive Income

(OCI)** refers to gains and losses
that are excluded from net income
on the income statement but still
affect a company’s equity. OCI
represents items that are not part
of the regular business operations
but still have an impact on a
company’s overall financial
performance. These gains and
losses are typically recorded in a
separate section of the Statement
of Comprehensive Income,
contributing to the total
comprehensive income for the
136
period.
 Key Concepts and Terminologies

These refer to changes in the 🧩 Key Takeaways:

market value of investments that
are not sold during the reporting •Other Comprehensive Income
period. These gains and losses are (OCI) includes gains and losses
unrealized because the asset has that are not recognized in the net
not been converted into cash. income but affect equity.
Available-for-sale securities
(under IFRS or GAAP) are typically •The major items in OCI are
included in OCI unrealized gains/losses on
investments, foreign currency
Example: A company holds translation adjustments,
stocks in another company. If the pension adjustments, and cash
market value of those stocks flow hedge adjustments.
137 increases, the unrealized gain is
recorded in OCI.
 Reporting Period

A reporting period is the span

of time for which financial
statements and other accounting
reports are prepared and
presented. The period can vary
depending on the nature of the
company, regulatory
requirements, or internal policies,
but it generally refers to the
timeframe in which a company
measures its financial
performance and position.
Common reporting periods
include quarterly, annually, or
even monthly.
138
 Key Concepts and Terminologies

This is the most common reporting Many publicly traded companies

period, where a company prepares are required to report their
its annual financial statements financial performance on a
for a 12-month period. It is quarterly basis (i.e., every three
typically required by regulatory months). These quarterly reports
bodies like the Securities and allow investors and stakeholders to
Exchange Commission (SEC), track a company’s performance
International Financial throughout the year.
Reporting Standards (IFRS), or
Generally Accepted Accounting
Principles (GAAP).

139
 Key Concepts and Terminologies

Financial reporting periods ensure 🧩 Key Takeaways:

companies meet the legal •The reporting period refers to the
requirements of financial timeframe for which a company prepares
reporting under local and and presents its financial reports, including
international standards (like income statements, balance sheets, and
cash flow statements.
GAAP or IFRS). Companies must
align their reports with regulatory •Common reporting periods include annual
deadlines to remain compliant. (12-month), quarterly (three-month), and
monthly reports, though companies may
also issue interim reports.
The income statement covers a
specific reporting period (usually •Regulatory bodies often require
quarterly or annually) and shows companies to report on specific intervals,
with quarterly and annual reports being
a company’s revenues, expenses, the most common for public companies.
140 and profits