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GSBS6506 Financial Statement Analysis

tag 0 Download 0 Pages / 0 Words tag 21-06-2022


Analysis of the financial statement as a whole is a big challenges that I came across many times in practical life. Before reading this chapter I already learned the basics related to accounting and how it affects the companies in day to day business and how the cash outflows and inflows have impact on the business. However, I did not have much knowledge regarding the preparation of financial statement and treatment of various items included in the financial statement. Reading this chapter provided me with the great opportunity for understanding various crucial aspects of financial statements. The below mentioned topics are the rundown of the things I have realized while going through the chapter.

Reading chapter 4.1 regarding adding values to the firms I found out the answer to the question that how the firms add values to the equity investors. Generally the equity investors get return in form of dividends but it does not add any value to the firm. Therefore, we have to focus on the free cash flow (FCF) rather than the dividends included in the financial statement. The FCF is driven by 2 items that is cash flow from operations and net cash invested in the operating assets of the firm. More amounts invested in the operating assets, the firm will have less amounts towards FCF. However, the cash is not a measure to analyse the performance of affirm for a given year. Measuring the economic profit of the company is the direct way to measure the value addition of the year. The earnings of the business can be measured through the RONA (return on the net operating assets). it is the operating income after tax divided by NOA (net operating asset). RNOA is considered as the amount invested in the business or return on the capital employed. Further, we can state the economic profit as –

Economic profit = (RNOA – Cost of capital) x NOA

Where, RNOA = OI / NOA

OI = earned operating income and NOA = net operating assets.

Through chapter 4.2 I got clear idea regarding the operating as well as the financial activities. Now, it is quite tricky as I got confused regarding what are the activities that will come under operating and what will come under finance. Initially I thought I will stuck in this and will never be able to differentiate the activities. However, though the topic differentiated the activities through the example of chocolate egg and free gift provided with that, no clear definitions for the activities are provided by the author in the chapter. Therefore, the novice like me will still face problem differentiating the activities. The more confusing statement of the topic that increased my confusion is that the financial and operating activities interact with each other.  

To be very honest, I went through 4 to 5 times through the pages 4-6 and 4-7 to understand the calculation part and get clear idea regarding the explanation of figure 4-1 that shows the financial activities and operating activities. Though still I don’t have very clear idea, whatever I understood is that the operating activities are used for the production part and financing activities are used to meet the financial obligation. The calculation part helped me little bit more to understand that –

As FCF = C – I,

Where, C = OI and I = changes in NOA

Therefore, FCF = operating income – changes in the net operating asset

The balance sheet and the income statement are inter-connected. Again the question came into my mind was why all the incomes were not shown in the income statement under the revenues? Is there any particular reason behind that or it is just the way of presenting the information in the financial statement? Another confusing part of the financial statement was the statement of changes in equity. The chapter stated it through the example of Ryman Healthcare. Looking at the annual report of the company the 1st thing came into my mind is that why restatement of changes in equity statement is required? I got to know that it is required identify the earnings of a firm clearly and to make it sure that the equity of the firm includes the genuine equity only.

As I keep on reading, I found that chapter 4.3 speaks about restatement of the financial statements. Restatement is actually a group work and is not supposed to do alone. The balance sheet which includes the assets, liabilities and equities is restated to separate the liabilities, financial and operating assets and identify the NFA (net financial assets), NOA (net operating assets) and NFO (net financial obligations) clearly. While I m still in the learning stage, I found it very helpful to differentiate the financial assets through marking it as ‘F’ and operating assets through marking it ‘O’. Again I got confused when I came across about the restatement of cash as matching the cash inflows and outflows is a tough job. Generally the cash requirements are met through bank overdrafts. But the biggest question here is how much cash is exactly required to carry on the business operations? It became tougher for me when I came to know that the financial statement does not state clearly regarding this. The doubt here came into my mind whether the firm cannot estimate the actual cash requirement or the firm simply wants to hide the information from the outsiders? The questions remained unanswered. However, I came to know that the main purpose for restating the income statement is to differentiate financial and operating expenses and revenues.

Chapter 4.4 speaks about the efficiency and profitability. Profit is a very common term and I come across the term frequently in daily life. However, the new thing I learned that it is more like maths rather accounts and the profit margin is measured as –

PM = OI / Sales

Where, OI = comprehensive operating income after tax.

Efficiency on the other hand is the management of NOA (net operating asset) to generate the turnover or sales. It is measured through the relationship among turnover and assets and is known as asset turnover. It is measured as –

ATO = Sales / NOA

Overall, though the chapter was very helpful to get a clear idea regarding financial statement, I actually had to spend much time in understanding some aspects of the chapter. Through I am now familiar with the term operating and financial activities; I still do not have clear idea regarding differentiation of the activities. However, I am quite sure that this is not a job of just one day and I require more and more practice to get more clear idea.

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