Guide to Analysing the Value of a Company Via Their Financial Statements

There are many ways to analyse the value of a company, but the most effective is to look at the company’s financial statements. A company releases its financial statements as part of its half-year and full year reports required by ASIC.

There are three main financial statements; Statement of Financial Position, Statement of Financial Performance and Statement of Cash Flows.

We give a brief outline of each of these below.

Statement of Financial Position

This is more commonly referred to as a Balance Sheet, and details the company’s assets (what it owns), liabilities (what it owes) and shareholder’s equity.

The Statement of Financial Position is a snapshot, and reflects the company’s assets and liabilities at a specific date – usually at the end of, or half way through, a financial year.

This statement provides a range of information such as how much cash the company has in the bank, how much stock it has on hand, how much money the company is owed by customers, how much the company owes its suppliers, and of course how much it owes the bank.

The final figure at the bottom of the statement represents the net value of the company, once all assets are sold and liabilities paid off.

Statement of Financial Performance

This is more commonly referred to as a Profit & Loss Statement, or Income Statement, and details how much money the company made or lost during the year.

The Statement of Financial Performance reflects how much money the company has made or lost over a period of time, usually 6 or 12 months.

The statement is broken up into two parts; Income (sales and other revenue) and Expenses (costs).

This statement provides a range of information such as the value of sales during the period, other income such as bank interest, staff costs, marketing costs, research costs, and interest paid to the bank.

The final figure at the bottom of the statement represents the company’s profit or loss for the year (or period).

Statement of Cash Flows

This is more commonly referred to as a Cash Flow Statement, and details cash flowing in and out of the company.

The Statement of Cash Flows reflects where the company is generating or leaking cash over a period of time, usually 6 or 12 months.

The statement breaks cash flows into three parts; Operations (normal business activities), Investing (buying and selling of assets) and Financing (mostly loans and interest).

Many beginners confuse this statement with the Statement of Financial Performance, but they are quite different.

A clear is example is when a company buys a new piece of machinery. The company has not made or lost any money, but the transaction meant cash changed hands.

This statement provides a range of information such as money received from customers, money paid to suppliers, money paid to buy equipment, money received from selling assets, and money received or repaid to the bank.

The final figure at the bottom of the statement represents the company’s bank balance at the end of the year (or period), and how much it changed over the period.

Analyze Your Company’s Future With Pro Forma Financial Statements

Pro forma financial statements are a process of formally displaying financial projections for a given period of time and in a consistent layout. The word pro forma is derived from the Latin term which means “as a matter of form”. Most businesses make use of pro forma financial statements in the executive process for planning and control as well as for reportage to owners, investors, and creditors. A pro forma financial statement is utilized as the foundation stone while comparing and analyzing information in order to give a feel to the management, investment analysts, and credit officers about the nature of the business’s fiscal organization under different conditions. The American Institute of Certified Public Accountants (AICPA) and the Securities and Exchange Commission (SEC) both ask that standard formats be used when presenting or forming these types of statements.

For those who are interested in getting started in a business, the preparation of pro forma statements, both for income and for cash flow, is essential before investing any money, time and energy into the venture. Being an essential part of the planning process, these financial statements help reduce to the barest minimum, any risks associated with the start-up and operation of a business. It may be the basis of convincing lenders and investors to provide capital for a new business venture.

Pro forma financial statements must be reliable and accurate and should help those studying it to draw a true and accurate picture of the start-up firm. It should be based upon purposeful and dependable information that will go a long way in creating a true and concise projection of the expected profits of the business as well as its financial requirements in the first year of operation and after. Once the business has taken flight and the initial statements have been prepared, these should be regularly updated, both monthly as well as annually.

Most companies use pro forma statements for business planning and control. These pro forma financial statements are obtainable in homogeneous and columnar lay-outs and are used by management to evaluate and distinguish between other alternative business strategies. By judiciously presenting information concerning financial and operating statements adjacent to one another, the management is thus able to analyze the projected results of the various contending strategies and arrive at the best path and the most suitable plan of action.

While forming pro forma financial statements, companies should realize that these statements should be unique and each proposed plan or project has its own distinct features that should be accurately captured therein. The prime usage of these statements is for management to:

1. Recognize the assumptions that cause the financial and operating characteristics to produce different company scenarios

2. Build on the different sales and budget (income and expenses) projections

3. Bring together the results in the form of profit and loss projections

4. Transform such data into cash-flow projections

5. Evaluate the resultant balance sheets

6. Execute ratio analysis and compare projections against one another as well as against those of comparable companies

7. Examine proposed decisions regarding marketing, production, research and development and make an assessment about their impact on profit as well as on the liquidity of the company

Through simulation of competing plans, useful gains are obtained with regard to the evaluation of financial effects of each alternative plan. With different sets of assumptions providing different scenarios regarding sales, production costs, effectiveness and practicality, projected financial statements for each such scenario holds enough information to indicate the future prospects, inclusive of sales and earnings forecasts, cash flows, balance sheets, projected capitalization, and income statements.

Company management also uses the these financial statements to choose from different budget alternatives. The planner will provide sales revenue, production expenses, balance sheet and cash flow statements for different contending plans and will explain the essential assumptions of each. Having analyzed this data, the management will then select the annual budget. Having chosen the action plan, all that remains to be done is to explore and find deviations in the plan and rectify them.

Financial Reports Used to Prepare Audited Financial Statements

Audited financial statements, which have been prepared by a CPA for a business or charity, are used to provide accountability and accuracy to a company’s shareholders and those with a vested interest in the company. So I can prepare an audited financial statement I need certain financial reports from the company. The company needs to provide their income statement, balance sheet, and statement of cash flows along with source documents to support these reports.

A company’s income statement can also be called the P&L (Profit and Loss) and Statement of Operations. The income statement demonstrates how revenue earned (the top line) from the sales of products and services before expenses are taken out, is transformed into the net income (bottom line), the end result after revenue and expenses are accounted for. The income statement documents whether the company made a profit or not during a reported period of time.

The balance sheet, also called statement of financial position, is a summary of a company’s balances as of a specific date, usually the last day of the fiscal year. The balance sheet is composed of three parts: assets, liabilities, and ownership equity or net worth, with assets in one section and liabilities and net worth in the other, with the two sections balancing. The difference between assets and liabilities is a company’s net worth or equity. A company’s assets also equal their liabilities plus owner’s equity, which will show how the assets were financed, either by borrowing money (liability) or using the owner’s money (owner equity).

The statement of cash flows shows how changes in the balance sheet and income statement affect cash and cash equivalents. It also demonstrates operating, investing, and financing activities. The statement of cash flows helps investors and management determine the short-term viability of a company, specifically their ability to cover expenses.

As a CPA I examine these three financial statements and their supporting documentation provided by the company and assesses the overall accounting principles used. From this information I then create an audited financial statement which will include an opinion, either qualified or unqualified, about the nature of the financial documents.

An unqualified opinion in an audited financial statement indicates that the CPA is in agreement with the methods used by the company to prepare their financial documents. The audit is found to be accurate, complete and fairly presented to meet the requirements of the US GAAP (Generally Accepted Accounting Principles). The audit provides the CPA a reasonable basis for their opinion that the financial statements are free of material misstatements or false/missing information.

A qualified opinion indicates that the CPA is not in agreement with aspects of the financial statements and/or methods used to prepare their financial documents. A qualified opinion indicates that the CPA is not confident that the financial statements are correct or accurate.

Occasionally an opinion will not be given within an audited financial statement. This could be due to the fact that there were insignificant documents available to properly prepare the audit, or there were issues that need to be addressed before evaluating the accuracy of the financial documents. A lack of opinion usually indicates that a company needs to improve their accounting practices so they can meet the requirements of the US GAAP (Generally Accepted Accounting Principles).