Two commonly misunderstood financial statements

There are two commonly misunderstood financial statements which tend to generate loads of questions for people. So i decided to write a little article about them and clarify what they mean. I hope this will be helpful.

The profit and loss account

P&L Account
Sales Revenue						48,782
Cost of Sales						33,496
Gross Profit						15,286
Selling, General and Administrative Expenses						10,029
Earnings before Interest, Tax, Depreciation and Amortization						5,257
Depreciation and Amortization						1,368
Earnings before Interest and Tax						3,889
Interest expenses						257
Income Tax						1,064
Net Profit						2,568

Companies' annual reports contain a profit and loss account (commonly referred as P&L). This is a financial statement which shows the difference between the revenues and expenses of a period. Non-profit ( or not-for-profit) organizations such as charities, public universities and museums generally produce an income and expenditure account. If they have more income than expenditure this is called a surplus rather than profit.
At the top of these statements is total sales revenue or turnover: the total amount of money received during a specific period. Next is the cost of sales, also known as cost of goods sold (COGS): the costs associated with making the products that have been sold, such as raw materials, labour, and factory expenses. The difference between the sales revenue and the cost of sales is gross profit. There are many other costs of expenses that have to be deducted from gross profit, such as rent, electricity and office salaries. There are often grouped together as selling, general and administrative expenses (SG&A).
The statement also usually shows EBITDA (earnings before interest, tax, depreciation and amortization) and EBIT (earnings before interest and tax). The first figure is more objective because depreciation and amortization expenses can vary depending on which system a company uses.
After all the expenses and deductions in the net profit, often called the bottom line. This profit can be distributed as dividends (unless the company has to cover past losses), or transferred to reserves.

The cash flow statement

British and American companies also produce a cash flow statement. This gives details of cash flows - money coming into and leaving the business, relating to:

• operations - day-to-day activities
• investing - buying or selling property, plant and equipment
• financing - issuing or repaying debt, or issuing shares.

The cash flow statement shows how effectively a company generates and manages cash. Other names are sometimes used for it, including funds flow statement and source and application of funds statement.
British companies also have to produce a statement of total recognized gains and losses (STRGL), showing any gains and losses that are not included in the profit and loss account, such as the revaluation of fixed assets.

The balance sheet, part III

This is the last part of the balance sheet series. I'm hoping to get into more detail about liabilities in this part. Hopefully this can be helpful. Read the previous part here.

Liabilities

Liabilities are amounts of money that a company owes, and are generally divided into two types - long-term and current. Long-term liabilities or non-current liabilities include bonds.
Current liabilities are expected to be paid within a year of the date of the balance sheet. They include:

• creditors - largely suppliers of goods or services to the business who are not paid at the time of purchase.
• planned dividends
• deferred taxes - money that will have to be paid as tax in the future, although the payment does not have to be made now.

Current liabilities
Short-term debt 1,555
Accounts payable	5,049
Accrued expenses 8,593
Total current liabilities	$15,197
Non-current liabilities
Deferred income taxes 950
Long-term debt	4,603
Total non-current liabilities Total liabilities	5,553 $20,750
Shareholders' equity Common stock Retained earnings Total shareholders' equity	10,309 3,900 14,209
Total liabilities and stockholders' equity	$34,959

Accrued expenses

Because of the matching principle, under which transactions and other events are reported in the periods to which they relate and not when cash is received or paid, balance sheets usually include accrued expenses. These are expenses that have accumulated or built up during the accounting year but will not be paid until the following year, after the date of the balance sheet. So accrued expenses are charged against income - that is, deducted from profits - even though the bills have not yet been received or the cash paid. Accrued expenses could include taxes and utility bills, for example electricity and water.

Shareholders' equity on the balance sheet

Shareholders' equity is recorded on the same part of the balance sheet as liabilities, because it is money belonging to the shareholders and not the company.
Shareholder's equity includes:

• the original share capital (money from stocks or shares issued by the company
• share premium: money made f the company sells shares at above their face value - the value written on them
• retained earnings: profits from previous years that have not been distributed to shareholders
• reserves: funds set aside from share capital and earnings, retained for emergencies or other future needs.

The balance sheet, part II

This is the second part of the balance sheet series. I'm hoping to get into more detail about assets in this part. Hopefully this can be helpful. Read the previous part here.

Current assets
Cash and equivalents 3,415
Accounts receivable	8,568
Inventory	5,699
Other current assets	5,562
Total current assets	$23,244
Non-current assets
Property and plant	6,700
Goodwill	5,015
Total non-current assets	$11,715
Total assets	$34,959

Fixed and current assets

In accounting, assets are generally divided into fixed and current assets. Fixed assets (or non-current assets) and investments, such as buildings and equipment, will continue to be used by the business for a long time. Current assets are things that will probably be used by the business in the near future. They include cash -money available to spend immediately, debtors - companies or people who owe money they will have to pay in the near future, and stock.
If a company thinks a debt will not be paid, it has to anticipate the loss - take action in preparation for the loss happening, according to the conservatism principle. It will write off, or abandon, the sum as a bad debt, and make provisions by charging a corresponding amount against profits: that is, deducting the amount of the debt from the year's profits.

Valuation

Manufacturing companies generally have a stock of raw materials, work-in-progress - partially manufactured products - and products ready for sale. There are various ways of valuing stock or inventory, but generally they are valued at the lower of cost or market, which means whichever figure is lower: their cost - the purchase price plus the value of any work done on the items - or the current market price. This is another example of conservatism: even if the stock is expected to be sold at a profit, you should not anticipate profits.

Tangible and intangible assets


Assets can also be classified as tangible and intangible. Tangible assets are assets with a physical existence - things you can touch - such as property, plant and equipment. Tangible assets are generally recorded at their historical cost less accumulated depreciation charges - the amount of their cost that has already been deducted from profits. This gives their net book value.
Intangible assets include brand names - legally protected names for a company's products, patents - exclusive rights to produce a particular new product for a fixed period, and trade marks - names or symbols that are put on products and cannot be used by other companies. Networks of contacts, loyal customers, reputation, trained staff or 'human capital', and skilled management can also be considered as intangible assets. Because it is difficult to give an accurate value for any of these things, companies normally only record tangible assets. For this reason, a going concern should be worth more on the stock exchange than simply its net worth or net assets: assets minus liabilities. If a company buys another one at above its net worth - because of its intangible assets - the difference in price is recorded under assets in the balance sheet as goodwill.

You can find the next part here.