At this time of year, companies produce their annual reports to inform investors about their performance for the previous year and how that compared to the year before. Annual reports include the company’s financial statements. Shareholders can ask questions about the financial statements at the company’s annual general meeting.
There are three key elements of the financial statements:
- Statement of comprehensive income (also known as a profit and loss statement)
- Statement of financial position (also known as a balance sheet)
- Statement of cash flows
Below are examples and introductory explanations of these financial statements for a sample company making and selling clothing.
Revenue is the revenue generated by the company in its day-to-day operations (e.g. sales will be the value of clothing sold).
Cost of sales is the cost incurred by the company in producing the goods/services that it sells (e.g. raw materials (cloth) used to manufacture the clothing).
Gross Profit is the profit after deducting the cost of sales.
Administrative and Operating Expenses are all other costs incurred by the company in order to be able to operate (e.g. salaries, electricity, technology expenses).
Operating Profit is the profit after deducting operating expenses incurred by the company.
Finance costs is the cost of borrowing money from a financial institution. It is the interest charged on the amount borrowed.
Profit before tax is the operating profit after deducting finance costs. An increase in profit shows that the company is doing well because it can support its production, operational and financing liabilities.
Net Profit after tax is the profit (5,616,000 kina) that can be distributed to shareholders if the company declares a dividend. An increase in profits may mean that shareholders receive a higher dividend if the company declares a dividend. A reduction in profits may mean that shareholders receive a lower dividend, or the company may decide not to declare any dividend.
The statement of financial position shows the position of the company in terms of its assets and its liabilities. The assets of the company should always exceed its liabilities for the company to continue as a going concern. Current assets should exceed the current liabilities of the company otherwise the company may experience problems.
Current assets are assets which can be easily turned into cash. An inventory of clothing in the warehouse is a current asset as well as receivables (amounts due from customers for clothing sold to them on credit).
Non-current assets are the fixed immovable assets that the company uses in the production of its products (e.g. machinery used in making the clothing).
Share Capital is funds raised by issuing shares to investors.
Retained earnings – these are the profits from previous years accumulated by retaining a portion of profits after paying taxes and dividends.
Current liabilities – are debts that must be settled in less than a year. These liabilities include the value of goods attained from suppliers on credit. If not settled on time the company can experience problems with suppliers who may begin to insist on cash on delivery and this can affect the day-to-day operations of the company by reducing its ability to obtain goods on credit from suppliers.
Noncurrent liabilities – are debts that will be settled in more than one year. They can be loans used to finance the capital expenditure (expenditure on non-current assets) of the company or to finance expansion or acquisitions of other businesses.
The statement of cash flows shows how the cash of the company has been generated and used in the financial year.
Cash flow from operations shows the cash generated or used in the operations of the company. These include buying materials for production and payments made to suppliers. Interest paid and taxes paid are also shown here.
Cash flow from investing activities shows the cash generated by the company from its investment activities and disposal of assets or used to invest in property, plant, and equipment. Interest received from funds invested is also shown here.
Cash flow from financing activities shows how the company was financed. This can either be by issue of shares or by borrowings from financial institutions. This area also includes the payments of dividends to shareholders and the repayment of outstanding debt to lenders.
You will see that some numbers appear in the different statements (eg, 22,500 kina cash appears in the statement of financial position as a current asset and in the statement of cash flows as cash at the end of the year) indicating how the three statements are connected to produce a comprehensive picture of the financial health of the company.
The financial statements will also include more detailed notes to help you understand them.
The information in this article is general in nature and you should take care to inform yourself about the specific characteristics of a particular investment before deciding to invest in it. PNGX recommends discussing your investment objectives and needs with a stockbroker or qualified financial adviser. In PNG, you can either contact JMP Securities Limited or Kina Securities Limited.
By following these articles and reading more information available on the PNGX website (www.pngx.com.pg) you can build your wealth and invest in PNG.
