Financial Statement Analysis – Introduction

Statement of Comprehensive Income

Statement of comprehensive income deals with the two of the five elements of financial information namely income and expense. Studying these two variables together let you peek into entity’s financial performance in the past period that can either be monthly, quarterly, semi-annually or annually depending on how often entity publishes financial statements.

As per IAS 1 entity’s financial performance can be presented in a single Statement of Comprehensive Income or in two separate statements namely Income statement and Statement of Other Comprehensive Income. Entity is free to choose whether to report in a single statement or two as IAS 1 prescribes no conditions in this regard.

To assess financial performance the idea is simple. Current stakeholders and prospective investors are interested in knowing if entity is making excess revenue (income) above expenses. Mathematically it can be shown as follows:

Profit = [Revenue – Cost of Sales] + Other income – Expenses

For financial analysis purposes concentration is mainly on Income Statement as it reports entity’s profit in a particular period. Entity will end up in a loss if the total of cost of sales and expenses overweigh the total Revenue and Other incomes.

Income statement reports on how well entity utilizes its resources in generating cash flows and in that process how good it was able to balance the expenses and obligations. Assets are consumed to generate benefits. The benefits needs to exceed the cost of rendering such benefits. It is not always possible that entity has each and every resource required and thus has to ask for help from others in terms of credit purchases, loans, shares etc that form up capital of the business and entity has to pay the cost for such capital as well in terms of interest, dividends etc.

Therefore entity needs not only to cover the cost of consuming the asset but also the cost of capital made available to it by the investors, lenders and creditors.

Statement of Cash flows

Though Statement of Comprehensive income let analysts and users understand how company performed but it does not give any hint about actual cash flows i.e. how much income of income/revenue has actually resulted in cash inflow and what expenses/costs actually caused cash outflow. Determining real cash flow understand entity’s ability to stay operational in long term by making cash available for long term growth and also to meet obligations in short term.

Having profit in the income statement is not enough if entity cannot actually payout this profit to shareholders for which it needs cash. To keep track of entity’s solvency and liquidity we have Statement of Cash flows as it gives a detailed account of cash flows by dividing entity’s activities in three categories namely operating activities, investing activities and financing activities.

1. Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. These are day to day transactions that are actual business of the entity i.e. sale and purchase etc. These are are a prime source for generating cash flows.
2. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. For example sale and purchase of items of property, plant and equipment.
3. Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. These are related to getting loans, issuing shares, redeeming debentures, paying back loans etc.