KCQ's - Chapter 3

Key Concepts

Please find below the key concepts I have gathered from Chapter 3.

·         A firm’s annual report is a marketing document.

·         There are four general purpose financial statements: the balance sheet, income statement, statement of changes in equity and cash flow statement.

·         A firm’s balance sheet shows its financial position on a particular day: it is a statement of the assets, equity and liabilities of a business.

·         Almost all listed companies are not just one company, but a group of companies.  This means that there is a parent company and they control a number of subsidiary companies.

·         The income statement shows the revenue and expenses and therefore the profit of a firm over a period.

·         The statement of changes in equity shows the various changes in shareholders’ equity over a period of time.

·         The cash flow statement shows the opening cash balance at the beginning of the period and the closing cash balance.

·         Ratios were used as a key part of analysis, by helping one to focus on the relationship between different items in a firm’s financial statements.

·         The equity value of a firm is the present value (PV) of expected future dividends:

Equity value = PV of expected future dividends

·         The relationship between dividends and cash flow can be expressed as:

Dividends = Operating cash flow – Capital outlays + Net cash flow from debt owners

Key Questions

Please find listed three questions that relate to Chapter 3.

1.    Why can financial statements be called a range of different names?  Wouldn’t it be easier to have the names standardized across the board?

2.    Do firms try to hinder our analysis of financial statements by using happy photos and optimistic comments?

3.    Should it be a requirement that firms disclose all of their expenses in the income statement?

Summary

As I started to read Chapter 3, I was surprised to learn that there are no specific rules governing how firms set out their financial statements, including what they call or name different items and more specifically the financial statements themselves.  I also noted that there are a range of balance dates used by different companies.  I understand that the concepts and ideas embedded in the accounting numbers are basically all the same, however I am still curious as to why the format, names, balance dates etc of financial statements are not standardized across the board.

It wasn’t until after I viewed IR’s annual reports that I realized how much content and detailed information they actually contain.  I more or less assumed that these reports consisted of a very brief summary of the firm and their financial statements.  Consequently, I deemed annual reports as boring documents filled only with numbers and limited information.  My perception has changed dramatically.  Also, what I found extremely interesting to learn is that companies use their annual report as a marketing document.  Although I didn’t consider this theory earlier, it is now very apparent when I read different firm’s annual reports.  

In Chapter 3, one of the most interesting and beneficial concepts for me to discover was ‘parent companies’.  My understanding of a parent company is that it is generally a large firm that has subsidiaries, which are wholly or partially owned separate businesses.  I work for Ergon Energy, however our ICT services are provided by a different company known as SPARQ Solutions and I have always wondered where SPARQ fits into the business model.  SPARQ is jointly owned by Ergon Energy and Energex, so does this mean that SPARQ is a subsidiary of Ergon?

Another interesting area that I really enjoyed learning more about was dividends.  As a result, I am considering buying shares and have been analyzing different firm’s annual reports to help me with my decision.  Overall, Chapter 3 emphasizes the importance of using a firm’s financial statements to help us engage with key aspects of the firm’s economic and business realities.  By seeking to understand the reading and connecting it to my prior knowledge, I have been able to make better sense of IR’s financial statements.