Step 4 - Chapter 3 - Introducing Financial Statements

Chapter 3 – Introducing Financial Statements

The first issue/difficult I have with this chapter is getting my head about the different names of Balance Sheets and Income Statement. I always get confused when I see Statement of Financial Position or a Statement of Financial Performance. This goes back to my personal experience at High School. When we were going Financial Statements at High School we always called them “Balance Sheets and Income Statements” now they have two different names. I know that throughout my course at university I am going to have difficulties remembering Statement of Financial Position means Balance Sheets and Statement of Financial Performance means Income Statement. The third statement called Changes of Equity I remember briefly doing a simpler statement in High School in regards to Petty Cash. But now coming to think about it, I think it would be reconciliation of the Cash at Bank account. So the Statement of Changes in Equity and Cash Flow Statement are completely new to me. Hopefully they are easy to understand and get my head around.

Secondly, a firm’s business sheet shows its financial position on a particular day. I thought the Balance Sheet was the financial position over the financial year but it is not. A balance sheet could be done monthly, quarterly, semi-annually, annually or daily. I personally, thing Balance Sheets in Australia should automatically done on the 30 June each year to make it easier for the accountants and businesses. Otherwise companies would have to do adjustments to record the correct amount for the assets, liabilities, equity, revenue and expenses. I know from personally experiences at Dimmey’s that they do a physical stocktake on 1 July every year. Companies do this to actually account of the inventories the company has on a specific data. From other person’s experience I know Woolworths and Coles do a stocktake ever quarter to ensure they have accurate figures on inventory. Balance sheets are an important aspect of a business and they need to be accurate figures.

Thirdly, I realised what the term consolidate means and how it relates to the company I was given. Basically, consolidate means it is the ‘parent’ entity and it has subsidiary companies. This means that Oz Brewing Limited has the majority shares in another company which means it the ‘child’ company to Oz Brewing Limited. Until I read this Chapter I always thought a Consolidate Statement of Financial Position and Statement of Financial Position means the same think. The difference is that a Statement of Financial Position would have one company such as a sole trader and Consolidate Statement of Financial Position would have other assets, liabilities and equity that do not directly relate to Oz Brewing Limited, it may be attached to one of the subsidiary companies. For my company that I have been assigned over the last four years it has sold some of the subsidiary companies off and has tried to buy new subsidiary companies. One of the subsidiary companies Oz Brewing Limited sold was Mad Monks Proprietary Limited to another company. However, when trying to buy new subsidiary companies the deal fell through. Overall, my company needs to aim to get a balance sheet rather than a negative number for equity.

The following statement is so true that ‘businesses are active, doing things all the time, firms are currently changing all the time and can often be very fast-moving’. My personally experience of this would be when Dimmey’s went into Voluntary Administration. In less than 4 months of being in Voluntary Administration they had another company that was interested in buying Dimmey’s. When the new company bought Dimmey’s there whole direction of Dimmey’s change. One product line that they did not want to carry was groceries but then when Crazy Clark’s and Sam’s Warehouse went into Voluntary Administration the Director of Dimmey’s changed their mind. The Director decided to have a small product line in groceries because Crazy Clark’s and Sam’s Warehouse had a huge selection of groceries so Dimmey’s decided to try and capitalised in this line. I can also relate this to the company I got assign - Oz Brewing Limited. If the acquisitions deal with 333D goes head Oz Brewing Limited direction is going to change from brewing, distribution and producing beer to printing 3D objects. Directors of business and managers change direction all the time, employees have to decide whether to change with the business or to find a new job in the similar field.

Fifthly, the Income Statement shows how things are changing in a firm, this is extremely important in business. From the experience at looking at Oz Brewing Limited you can have one fantastic year and then three horrible years. If we are looking at the Oz Brewing Limited financial statements they had a profit in 2011 and then ever sense they have made losses. In one financial year everything can change from stating a flow to going broke. In Oz Brewing Limited case it was the cost of trying to open a Café that sent them broken and from then on that have had miss-management in regards to business decisions. For Oz Brewing Limited to stay operating they need to make a profit this financial year otherwise we will see Oz Brewing Limited in Voluntary Administration again.

The bit I found confusing would be the ‘Other Comprehensive Income’ and Statement of Changes in Equity. If the accounts are supposed to be in the Statement of Changes in Equity why do they have to make it difficult and add an extra statement in? The Australian Accounting Standards Board should make it mandatory that the Comprehensive Income Statement be a part of the Statement in Changes in Equity. I think it would make more sense there. Another question if they do not want to do that than just record it as one big statement of the Income Statement. Do we really need a separate Comprehensive Income Statement?

The Cash Flow Statement is extremely important because it shows the opening cash balance at the beginning of the period, cash inflows and outflows during the period and the closing cash balance. As the Lecturer said in Week 3 “the Cash Flow Statement is the only statement companies cannot forge because money does not lie”. What Maria said is so true, the business bank account can either be a positive or negative number, the business will not liar because they have rules and regulations they are bind to by the Government. In Companies if they are defrauding the Government they will be in huge trouble because they have specific taxation agents whose job is to find people how are defrauding the Government. The Taxation Agents can also do an audit on the company if they think something ‘fishy’ is going on. Anyway, the Cash Flow Statement is the statement that always tells the truth.

To interpret, systemically analyse and assess a business people need to use ratios to get an accurate view of four or more financial statements. Managers and directors can calculate different ratios and compare one company’s ratios to another company in the same or similar line of work to see if the company is working effectively, efficiently and making a reasonable profit for a particular financial year. I personally would use ratios every year and compare a year that has a significantly loss with another company because it could be due to an environment factor, financial factor or any other reasons. If everyone’s figures in that particular financial year dropped then you have nothing to worry about but if it was only your company then you should be looking at the possible reasons as to why it dropped. I personally think ratios are extremely important in business because it helps you compare your figures with someone else in the same industry.

The bit that I found unless was in the ‘Ratios’, ‘Just do what ‘works’’ and ‘Use a Structure’ section when it was talking about centuries. I understand that you need to know how it was created to fully understand how to apply it. But I think this section could have been shortened and Martin could have got quicker to the point rather than talking about Euclid’s Elements, United States Economy and so on. Martin should have spoken about the Australian Economy instead of the United States Economy.

Finally, the Dividends and Cash Flow sections for Chapter 3 is important and it shows how to actually calculate the dividends and cash flow. After reading this chapter I realised you need to calculate the dividends before you can do the cash flow because they are related, even in the formula. Some of the aspects of the formulas I am having trouble with such as: the Capital Outlays and how to calculate the Present Value of Expected Future Dividends. However, this is a significant problem because I have to get my head around Present Value of Expected Future Dividends because it is the key practical difficulty of valuing the equity in a firm using the Discounted Dividend (DD) model. I understand what net dividend is and what the cash flow is it is just specific pieces in the formula on how to calculate it that I do not understand. By when I actually have to calculate the dividend and cash flow I am should I will under the formula more because I can apply the theory I know.  

To me the author is trying to tell me that here are two key financial statements business needs to prepare that shows the five key elements of accounting accounts which are the Balance Sheet and the Income Statement. Then there are two other financial statements that are interconnected to the firms Balance Sheet and Income Statement those statements are: Statement of Changes in Equity and Cash Flow Statement. The final point Martin is trying to get across is that businesses can use ratios to compare a company in the same or similar industry to see how well they are performing.

To summary my key concepts and questions would be the following: 

• What are their so many different names for the Balance Sheet and Income Statement?
• Balance Sheet shows its financial position on a particular day. This day can be anytime through the financial year. There is no set date or day for this.
• What does ‘consolidate’ mean?
• What is the difference between Consolidate Statement of Financial Position and Statement of Financial Position?
• What is the difference between Consolidate Statement of Financial Performance and Statement of Financial Performance?
• What is the difference between Consolidate Statement of Changes in Equity and Statement of Changes in Equity?
• Does Oz Brewing Limited have any subsidiary companies?
• Business are active, doing things all the time, firms are currently changing all the time and can often be very fast-moving.
• Income Statement shows how things are changing in a firm.
• Why is the ‘Other Comprehensive Income’ underneath the Income Statement if some of the accounts relate to the ‘Statement of Changes in Equity’?
• Cash Flow Statement shows the opening chase balance at the beginning of period, cash inflows and outflows during the period and the closing cash balance.
• To interpret, systemically analyse and assess a business people need to use ratios to get an accurate view over four or more financial statements.
• Businesses use ratios to compare companies that are similar or the same in a particular industry.
• Did you real need to go into background knowledge in the ‘Ratios’, ‘Just do what ‘works’’ and ‘Use a Structure’ section?
• Dividends and Cash Flows show how to actually calculate the dividends and cash flow.
• Dividend and Cash Flow are related.
• How do you calculate the Present Value of Expected Future Dividends?
• How do you calculate the Capital Outlays?
• How do you calculate the Discounted Dividend?
• Two key financial statements that shows the five key elements of accounting which are the Balance Sheet and Income Statement.
• Two other financial statements that are interconnected to the firms Balance Sheet and Income Statement those are: Statement of Changes in Equity and Cash Flow Statement.

Above are my key concepts and questions about Chapter 3 – Introducing Financial Statements.