Meaning of Financial Statement

A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity. In British Englishincluding United Kingdom company lawa financial statement is often referred to as an account, although the term financial statement is also used, particularly by accountants. For a business enterprise, all the relevant financial information, presented in a structured manner and in a form easy to understand, are called the financial statements. They typically include four basic financial statements, accompanied by a management discussion and analysis: 1. Balance sheet: also referred to as statement of financial position or condition, reports on a company's assets, liabilities, and Ownership at a given point in time. 2. Income statement: also referred to as Profit and Loss statement (or a "P&L"), reports on a company's income, expenses, and profits over a period of time. Profit & Loss account provide information on the operation of the enterprise. These include sale and the various expenses incurred during the processing state. 3. Statement of retained earnings: explains the changes in a company's retained earnings over the reporting period. 4. Statement of cash flows: reports on a company's cash flow activities, particularly its operating, investing and financing activities. For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.

Financial Statements Analysis

Introduction: Analysis means establishing a meaningful relationship between various items of the two financial statements with each other in such a way that a conclusion is drawn. By financial statements we mean two statements: (i) Profit and loss Account or Income Statement (ii) Balance Sheet or Position Statement These are prepared at the end of a given period of time. They are the indicators of profitability and financial soundness of the business concern.

The term financial analysis is also known as analysis and interpretation of financial statements. It refers to the establishing meaningful relationship between various items of the two financial statements i.e. Income statement and position statement. It determines financial strength and weaknesses of the firm. Analysis of financial statements is an attempt to assess the efficiency and performance of an enterprise. Thus, the analysis and interpretation of financial statements is very essential to measure the efficiency, profitability, financial soundness and future prospects of the business units.

Financial analysis serves the following purposes:

1. Measuring the profitability
The main objective of a business is to earn a satisfactory return on the funds invested in it. Financial analysis helps in ascertaining whether adequate profits are being earned on the capital invested in the business or not. It also helps in knowing the capacity to pay the interest and dividend.

2. Indicating the trend of Achievements

Financial statements of the previous years can be compared and the trend regarding various expenses, purchases, sales, gross profits and net profit etc. can be ascertained. Value of assets and liabilities can be compared and the future prospects of the business can be envisaged.

3. Assessing the growth potential of the business

The trend and other analysis of the business provide sufficient information indicating the growth potential of the business.

4. Comparative position in relation to other firms

The purpose of financial statements analysis is to help the management to make a comparative study of the profitability of various firms engaged in similar businesses. Such comparison also helps the management to study the position of their firm in respect of sales, expenses, profitability and utilising capital, etc.

5. Assess overall financial strength

The purpose of financial analysis is to assess the financial strength of the business. Analysis also helps in taking decisions, whether funds required for the purchase of new machines and equipments are provided from internal sources of the business or not if yes, how much? And also to assess how much funds have been received from external sources.

Definition and Explanation of Financial Statement Analysis:

Financial statement analysis is defined as the process of identifying financial strengths and weaknesses of the firm by properly establishing relationship between the items of the balance sheet and the profit and loss account. There are various methods or techniques that are used in analyzing financial statements, such as comparative statements, schedule of changes in working capital, common size percentages, funds analysis, trend analysis, and ratios analysis. Financial statements are prepared to meet external reporting obligations and also for decision making purposes. They play a dominant role in setting the framework of managerial decisions. But the information provided in the financial statements is not an end in itself as no meaningful conclusions can be drawn from these statements alone. However, the information provided in the financial statements is of immense use in making decisions through analysis and interpretation of financial statements

Methods or Types of Financial Statement Analysis:

Following are the most important tools and techniques of financial statement analysis: 1. Horizontal Analysis 2. Vertical Analysis

1. Horizontal Analysis
Comparison of two or more year's financial data is known as horizontal analysis, or trend analysis. Horizontal analysis is facilitated by showing changes between years in both dollar and percentage form.

2. Vertical Analysis
Vertical analysis is the procedure of preparing and presenting common size statements. Common size statement is one that shows the items appearing on it in percentage form as well as in dollar form. Each item is stated as a percentage of some total of which that item is a part. Key financial changes and trends can be highlighted by the use of common size statements.

Techniques or Tools of Financial Statement Analysis

There are so many techniques are used by the analyst for analyzing the financial statement but most important techniques or tools ,which are normally used, are as follows: 1. 2. 3. 4. 5. 6. Comparative Analysis Method Common Size Financial Statement Trend Analysis Ratio Analysis Fund Flow Analysis Cash Flow Analysis

1. Comparative Analysis Method

Comparative Financial Statement analysis provides information to assess the direction of change in the business. Financial statements are presented as on a particular date for a particular period. The financial statement Balance Sheet indicates the financial position as at the end of an accounting period and the financial statement Income Statement shows the operating and non-operating results for a period. But financial managers and top management are also interested in knowing whether the business is moving in a favorable or an unfavorable direction. For this purpose, figures of current year have to be compared with those of the previous years. In analyzing this way, comparative financial statements are prepared. Comparative Financial Statement Analysis is also called as Horizontal analysis. The Comparative Financial Statement provides information about two or more years' figures as well as any increase or decrease from the previous year's figure and it's percentage of increase or decrease. This kind of analysis helps in identifying the major improvements and weaknesses. Comparative financial statements, like all other financial statements have the following types of financial statements:

a) Comparative Balance Sheet b) Comparative Income Statement a) Comparative Balance Sheet

The comparative balance sheet shows the different assets and liabilities of the firm on different dates to make comparison of balances from one date to another. The comparative balance sheet has two columns for the data of original balance sheets. A third column is used to show change (increase/decrease) in figures. The fourth column may be added for giving percentages of increase or decrease. While interpreting comparative Balance sheet the interpreter is expected to study the following aspects:

(i) Current financial position and Liquidity position (ii) Long-term financial position (iii) Profitability of the concern

Comparative Balance Sheet of Mc Donald as on 31st Dec 2008 & 31st Dec 2009
31st 2008 Current Assets: Cash $500 Accounts Receivables $2,000 Inventory $1,500 Total Current Assets $4,000 Fixed Assets: Buildings $3,000 Furnitures & office $1,000 equipments Total Fixed Assets $4,000 Total Assets $8,000 Liabilities: Current Liabilities: Accounts Payable $1,000 Notes Payable $500 Interest Payable $100 Total Current $1,600 Liabilities Shareholder's Equity: Common Stock $5,000 Retained earnings $1,400 Total Stockholder's $6,400 equity Total Liabilities & $8,000 Stockholder's equity Dec 31st 2009 $600 $3,000 $2,500 $6,100 $4,000 $1,500 $5,500 $11,600 Dec Increase / % of increase / (Decrease) (decrease) $100 $1,000 $1,000 $2,100 $1,000 $500 $1,500 $3,600 20.00% 50.00% 66.67% 52.50% 33.33% 50.00% 37.50% 45.00%

$1,200 $500 $120 $1,820

$200 $0 $20 $220

20.00% 0.00% 20.00% 13.75%

$7,500 $2,280 $9,780 $11,600

$2,500 $880 $3,380 $3,600

50.00% 62.86% 52.81% 45.00%

b) Comparative Income statement

The income statement provides the results of the operations of a business. This statement traditionally is known as trading and profit and loss A/c. important components of income statement are net sales, cost of goods sold, selling expenses, office expenses etc. The figures of the above components are matched with their corresponding figures of previous years individually and changes are noted. The comparative income statement gives an idea of the progress of a business over a period of time. The changes in money value and percentage can be determined to analyze the profitability of the business. Like comparative balance sheet, income statement also has four columns. The first two columns are shown figures of various items for two years. Third and fourth columns are used to show increase or decrease in figures in absolute amount and percentages respectively. The analysis and interpretation of income statement will involve the following: The increase or decrease in sales should be compared with the increase or decrease in cost of goods sold. To study the operating profits The increase or decrease in net profit is calculated that will give an idea about the overall profitability of the concern

Comparative Income Statement of Mc Donald for the years ended 31st Dec 2008 & 31st Dec 2009
Dec 31st Dec Increase/ 2009 (Decrease ) Sales $7,000 $9,000 $2,000 Less: Cost of goods $5,000 $6,400 $1,400 sold Gross profit $2,000 $2,600 $600 Less: Operating expenses General & $200 $300 $100 administrative expenses Selling & $400 $500 $100 distribution expenses Other operating $100 $150 $50 expenses 31st 2008 % of increase / (decrease) 28.57% 28.00% 30.00%

50.00%

25.00% 50.00%

Operating profit $1,300 Less: Interest $300 expenses Net income before $1,000 taxes Less: Taxes at 30% $300 Net Income after $700 taxes

$1,650 $400 $1,250 $375 $875

$350 $100 $250 $75 $175

26.92% 33.33% 25.00% 25.00% 25.00%

2. Common Size Financial Statement

Financial statements reveal the financial credibility of a company. A financial statement, which expresses the different values in form of percentage, is called a Common size financial statement. A common size financial statement helps in comparing two companies, which differ in size. Two components of the common size financial statement are: A) Balance sheet B)Incomestatement. When both these components are clubbed together, a common size financial statement is obtained.

Advantages of the common size financial statement:

One advantage of having the various amounts expressed in percentage is, the percentage assets of any company can be compared to another company or to other companies in the industry. The size of the companies being compared, is not important. The companies being compared may be small or big. Hence, it is termed as common size. Since size of the company does not matter, it removes any kind of bias, while comparing companies. Analyzing the operational activities of comparing companies can also be obtained. Changes in different values pertaining to company's performance can also be ascertained during a particular period. For example, if one wishes to know how the cost of goods sold over a span of time has changed, the common size financial statement can be helpful. A common size financial statement is used for predicting future trends and analyzing prevailing trends in the industry.

A) Common Size Balance Sheets Just as with income statements, common size balance sheets can be presented either
vertically or horizontally. A horizontal common size balance sheet expresses each years balance sheet items as a percentage of a given base year, while a vertical common size balance sheet expresses them as a percentage of a reference item. Typically vertical common size balance sheets are presented in reference to total assets. This format allows the investor to compare the capital structure over time and across companies. In fact, creating such a presentation allows an investor to compare two companies even if they use different currencies, as both size and currency exchange issues are negated with the conversion to common size. For forecasting purposes, it may also be useful to prepare a vertical common size balance sheet referencing each line item to sales. This is because many current assets and liabilities (accounts receivable, inventory, accounts payable, etc.) are influenced by the companys sales level.

B) Vertical Common Size Income Statements

Vertical common size financial statements remove the impact of size by expressing each line item as a percentage of a reference item, usually sales or assets. In a spreadsheet this can be done simply by dividing each line item by that years net revenues figure. Common-SizeComparativeincomestatement For the year ended December 31, 2002, and 2001 (dollars in thousands) Common-Size Percentage 2002 2001 2002 2001 Sales $52,000 $48,000 100.0% 100.0% Cost of goods sold 36,000 31,500 69.2% 65.6% ------------ ------------ ------------ -----------Gross margin 16,000 16,500 30.8% 34.4% ------------ ------------ ------------ -----------Operating expenses: Selling expenses 7,000 6,500 13.5% 13.5% Administrative expense 5,860 6,100 11.3% 12.7% ------------ ------------ ------------ -----------Total operating expenses 12,860 12,600 24.7% 26.2% ------------ ------------ ------------ -----------Net operating income 3,140 3,900 6% 8.1% Interest expense 640 700 1.2% 1.5%

Net income before taxes Income tax (30%) Net income

-----------2,500 750 -----------$ 1,750 ======

-----------3,200 960 -----------$2,240 ======

-----------4.8% 1.4% -----------3.4% ======

-----------6.7% 2.0% -----------4.7% ======

3. Trend Analysis
Trend analysis depicts behavior of the ratios over a period of time and the trends in the operation of the enterprise. The trend figures are index figures giving a birds eye view of the comparative data by presenting it over a period of time. This is horizontal analysis of financial statement, often called as Pyramid Method of Ratio Analysis a guide to yearly changes. Under this form of analysis, generally financial ratios are studied for a specified number of years. It is a dynamic analysis depicting the changes over a stated period. The working of trend analysis involves the following three steps: Selection of the base year. Assignment of an index number of 100 to each item of the base year. Calculation of percentage relationship that each item bears to the same item in the base year.

4. Ratio Analysis
The ratios analysis is the most powerful tool of financial statement analysis. Ratios simply mean one number expressed in terms of another. A ratio is a statistical yardstick by means of which relationship between two or various figures can be compared or measured. Ratios can be found out by dividing one number by another number. Ratios show how one number is related to another.

Advantages of Ratios Analysis:

Ratio analysis is an important and age-old technique of financial analysis. The following are some of the advantages / Benefits of ratio analysis: 1. Simplifies financial statements: It simplifies the comprehension of financial statements. Ratios tell the whole story of changes in the financial condition of the business

2. Facilitates inter-firm comparison: It provides data for inter-firm comparison. Ratios highlight the factors associated with successful and unsuccessful firm. They also reveal strong firms and weak firms, overvalued and undervalued firms. 3. Helps in planning: It helps in planning and forecasting. Ratios can assist management, in its basic functions of forecasting. Planning, co-ordination, control and communications. 4. Makes inter-firm comparison possible: Ratios analysis also makes possible comparison of the performance of different divisions of the firm. The ratios are helpful in deciding about their efficiency or otherwise in the past and likely performance in the future.

Limitations of Ratios Analysis:

1. Limitations of financial statements: Ratios are based only on the information which has been recorded in the financial statements. Financial statements themselves are subject to several limitations. Thus ratios derived, there from, are also subject to those limitations. 2. Comparative study required: Ratios are useful in judging the efficiency of the business only when they are compared with past results of the business. However, such a comparison only provide glimpse of the past performance and forecasts for future may not prove correct since several other factors like market conditions, management policies, etc. may affect the future operations. 3. Limited use of single ratios: A single ratio, usually, does not convey much of a sense. To make a better interpretation, a number of ratios have to be calculated which is likely to confuse the analyst than help him in making any good decision. 4. Personal bias: Ratios are only means of financial analysis and not an end in itself. Ratios have to interpret and different people may interpret the same ratio in different way.

Classification of Accounting Ratios:

Classification of Accounting Ratios / Financial Ratios (B) (A) (C) Functional Classification or Traditional Classification or Significance Ratios or Ratios Classification According to Statement Ratios According to Importance Tests Profit and loss Profitability ratios Primary ratios account ratios or Liquidity ratios Secondary ratios revenue/income Activity ratios statement ratios Leverage ratios or Balance sheet ratios long term solvency or position statement ratios ratios Composite/mixed ratios or inter

statement ratios

Profitability Ratios:
Profitability ratios measure the results of business operations or overall performance and effectiveness of the firm. Some of the most popular profitability ratios are as under:

Gross profit ratio Net profit ratio Operating ratio Expense ratio Return on shareholders investment or net worth Return on equity capital Return on capital employed (ROCE) Ratio Dividend yield ratio Dividend payout ratio Earnings Per Share (EPS) Ratio Price earning ratio

Liquidity Ratios:
Liquidity ratios measure the short term solvency of financial position of a firm. These ratios are calculated to comment upon the short term paying capacity of a concern or the firm's ability to meet its current obligations. Following are the most important liquidity ratios.

Current ratio Liquid / Acid test / Quick ratio

Activity Ratios:
Activity ratios are calculated to measure the efficiency with which the resources of a firm have been employed. These ratios are also called turnover ratios because they indicate the speed with which assets are being turned over into sales. Following are the most important activity ratios:

Inventory / Stock turnover ratio Debtors / Receivables turnover ratio Average collection period Creditors / Payable turnover ratio Working capital turnover ratio Fixed assets turnover ratio Over and under trading

Long Term Solvency or Leverage Ratios:

Long term solvency or leverage ratios convey a firm's ability to meet the interest costs and payment schedules of its long term obligations. Following are some of the most important long term solvency or leverage ratios.

Debt-to-equity ratio Proprietary or Equity ratio Ratio of fixed assets to shareholders funds Ratio of current assets to shareholders funds Interest coverage ratio Capital gearing ratio Over and under capitalization

Cash Flow Statement

Cash flow statement may provide considerable information about what is really happening in a business beyond that contained in either the income statement or the balance sheet. Analyzing this statement should not present an intimidating task; instead it will quickly become obvious that the benefits of understanding the sources and uses of a companys cash far outweigh the costs of undertaking some very straightforward analyses.

Who cares about a Cash Flow Statement?

Executives want to know if the cash generated by the company will be sufficient to fund their expansion strategy Stockholders want to know if the firm is generating enough cash to pay dividends Suppliers want to know if their customers will be able to pay if offered credit Investors want to evaluate future growth potential Employees are interested in the overall viability of their employer as indicated by its ability to fund its operations

Format of the Cash Flow Statement

Statement of Cash Flows Cash Flow from Operating Activities Net Income XXX,XXX Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization XX,XXX Changes in other accounts affecting operations:

(Increase)/decrease in accounts receivable (Increase)/decrease in inventories (Increase)/decrease in prepaid expenses Increase/(decrease) in accounts payable Increase/(decrease) in taxes payable Net cash provided by operating activities Cash Flow from Investing Activities Capital expenditures Proceeds from sales of equipment Proceeds from sales of investments Investments in subsidiary Net cash provided by investing activities Cash Flow from Financing Activities Payments of long-term debt Proceeds from issuance of long-term debt Proceeds from issuance of common stock Dividends paid Purchase of treasury stock Net cash provided by financing activities Increase (Decrease) in Cash

X,XXX X,XXX X,XXX X,XXX X,XXX XXX,XXX (XXX,XXX) XX,XXX XX,XXX (XXX,XXX) (XXX,XXX) (XX,XXX) XX,XXX XXX,XXX (XX,XXX) (XX,XXX) (XX,XXX) XX,XXX

Fund Flow Statement

The fund flow statement reports the flow of funds through the firm during the year. In order to prepare fund flow statement proper understanding of working capital and sources and applications is necessary. The fund flow statement is a record, a post-mortem of where the funds came from and how these were utilized during the year. The fund flow statement attempts to explain the change in financial position from one balance sheet to the subsequent balance sheet in terms of change in the funds or the working capital position of the firm.

Definition
According to R.N. Anthony, Fund flow is a statement prepared to indicate increase in cash resources and the utilization of such resources of a business during the accounting period. According to Smith Brown, Fund flow is prepared in summary form to indicate changes occurring in terms of financial conditions between two different balance sheet dates.

Objectives of Fund Flow Statement

1. To help to understand the changes in assets. 2. To point out the financial strength and weaknesses of the business. 3. To inform as to how the funds of the business have been used. 4. It evaluates the firms financing capacity. 5. Fund flow statement helps in estimating the amount of finance required for completing its various projects. 6. This statement gives an insight into the evolution of the present financial position. Funds flow statement also referred to as the statement of changes in financial position or the statement of sources and uses of funds. The term fund refers to net working capital.

Process of Preparing a Fund Flow Statement

Funds Flow Statements is prepared in two parts The first one is sources of Funds and the other is Uses of Funds or Application of funds. The difference of these two parts is change in working capital. When sources of funds exceed the application of funds, it is increase in working capital and when application of funds exceeds the sources, it is decrease in working capital. Funds Flow Statement presents those items only which affect the working capital. If any transaction does not affect the working capital at all i.e., if it results in increase or decrease in both current assets and current liabilities (such as payment to creditors) or it affects only fixed assets and fixed liabilities (such as conversion of debentures into shares, or shares into stocks or vice versa, issue of bonus shares, purchase of fixed assets like building or machinery by issue of shares or debentures etc.), it is not to be shown in funds Flow Statement.

Limitations Of Fund Flow Statement

1. The fund flow statement is prepared with the help of balance sheet and profit and loss account of the current period and these statements are based on historical cost. So a realistic comparison of profitability and the funds position is not possible as the current cost is not considered for the purpose of preparation of fund flow statement. 2. The cash position of the firm is not revealed by fund flow statement. To know the cash position a cash flow statement has to be prepared. 3. The various activities are not classified as operating activities, investing activities and financing activities while preparing fund flow statement.

Uses of Fund Flow Statement

1. The users of fund flow statement, such as investors, creditors, bankers, government, etc., can understand the managerial decisions regarding dividend distribution, utilization of funds and earning capacity with the help of fund flow statement. 2. The quantum of working capital is revealed by the schedule of working capital

changes, which is a part of fund flow statement. 3. The fund flow statement is the best and first source for judging the repaying capacity of an enterprise. 4. The management will be able to detect surplus/shortage of fund balance. 5. The fund from operation is not mentioned in the profit and loss account and balance sheet but it is separately calculated for the purpose of fund flow statement.

Annual Financials for McDonald's Corp

All amounts in millions except per share amounts.

12/2010
(TTM)

12/2009
(TTM)

12/2008
(TTM)

12/2007
(TTM)

Operating Activities

Net Income (Loss) Depreciation Amortization Amortization of Intangibles Deferred Income Taxes Operating (Gains) Losses Extraordinary (Gains) Losses (Increase) Decrease in Receivables (Increase) Decrease in Inventories (Increase) Decrease in Prepaid Expenses (Increase) Decrease in Other Current Assets (Increase) Decrease in Payables (Increase) Decrease in Other Curr Liabs. (Increase) Decrease in Other Working Capital Other Non-Cash Items Net Cash from Continuing Operations Net Cash from Discontinued Operations Net Cash from Operating Activities Investing Activities Sale of Property, Plant, Equipment Sale of Long Term Investments Sale of Short Term Investments Purchase of Property, Plant, Equipment Acquisitions Purchase of Long Term Investments Purchase of Short Term Investments Other Investing Changes Net Cash from Disc. Investing Activities

4,946.30 4,551.00 4,313.20 2,395.10 1,276.20 1,216.20 1,207.80 1,214.10 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 -75.70 203.00 101.50 -39.10 0.00 -94.90 -160.10 -85.30 0.00 0.00 0.00 0.00 -50.10 -42.00 16.10 -100.20 -50.80 1.00 -11.00 -29.60 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 -39.80 -2.20 -40.10 -36.70 11.70 214.20 280.80 130.30 0.00 0.00 0.00 0.00 323.80 -295.30 209.00 1,496.30 6,341.60 5,751.00 5,917.20 4,944.90 0.00 0.00 0.00 -68.60 6,341.60 5,751.00 5,917.20 4,876.30

0.00 0.00 0.00 364.70 0.00 144.90 229.40 0.00 0.00 0.00 0.00 0.00 -2,135.50 -1,952.10 -2,135.70 -1,946.60 194.50 260.30 331.80 -228.80 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 -115.00 -108.40 -50.20 466.50 0.00 0.00 0.00 194.10

Net Cash from Investing Activities Financing Activities Issuance of Debt Issuance of Capital Stock Repayment of Debt Repurchase of Capital Stock Payment of Cash Dividends Other Financing Charges, Net Cash from Disc. Financing Activities Net Cash from Financing Activities Effect of Exchange Rate Changes Net Change in Cash & Cash Equivalents Cash at Beginning of Period Cash at End of Period

-2,056.00 -1,655.30 -1,624.70 -1,150.10

1,931.80 1,169.30 3,744.20 2,218.10 463.10 332.10 548.20 1,137.60 -1,147.50 -664.60 -2,698.50 -1,645.50 -2,698.50 -2,797.40 -3,919.30 -3,943.00 -2,408.10 -2,235.50 -1,823.40 -1,765.60 130.50 -224.90 34.30 2.10 0.00 0.00 0.00 0.00 -3,728.70 -4,421.00 -4,114.50 -3,996.30 34.10 591.00 57.90 -267.40 -95.90 82.10 123.30 -146.80

1,796.00 2,063.40 1,981.30 2,128.10 2,387.00 1,796.00 2,063.40 1,981.30