3. Understanding Financial Statements and KPIs

• Common-sizing reduces all figures on a financial statement to percentages for reference purposes.
• Assets are investments of a firm.
• Liabilities are methods of financing that a firm has used.
• There are only four sensible reasons to hold cash:

  1. Transaction motive, to pay for goods and services used by a firm.
  2. Compensatory balances, to take advantage of free services offered when there is a certain level of cash in an account.
  3. Precautionary reserves, to protect against market downturns or see a firm through difficult economic periods.
  4. Speculation/investment motives, such a cash reserve is sometimes known as a “war chest” which allows a firm to take advantage of any opportunities that present themselves.
• In order to extend its market reach in business, a firm must be willing to carry out some of its transactions on credit, thus creating accounts receivable. A firm doing so extends credit to buyers who might otherwise go elsewhere to seek such terms.
• Accounts receivable represent credit that the firm has extended to customers, displayed in current assets.
• Marketable securities are short-term invested assets, displayed in current assets.
• Fixed assets are the long-term investments that a firm has made.
• Current liabilities are obligations of a firm that must be satisfied within the next 12 months.
• Long-term debt This refers to the obligations of a firm that extend anywhere from 10 to 30 years.
• Equity capital refers to funds outstanding that have been contributed by the owners of a firm.
• The income statement is a dynamic moving picture of what fund flows look like over a period of time.
• Many larger corporations, rather than operating in accordance with the typical calendar year beginning January 1 and ending December 31, will instead use the fiscal year. This can be any 12- month period a firm chooses, and it's used to accommodate a firm’s maximum income generating period and allow for maximum deductions.
• There are also monthly income statements that allow management to remain constantly informed of the company’s progress throughout the earnings cycle, and quarterly income statements that must be made available to investors.
• Gross profit occurs when the cost of goods is subtracted from sales.
• The net income is divided by the number of shares and provides the financial manager with the earnings per share (EPS).
• The cash flow statement is an assessment of cash activity over the course of a given business period.
• Source of cash identifies areas where cash amounts were increased, whereas use of cash identifies areas where cash amounts were decreased.
• KPIs are measures that illustrate a firm’s effectiveness in meeting its goals.
• Net profit, also known as net income, is revenue adjusted for the cost of doing business.
• Profit margin is the amount by which revenue from sales exceeds costs in a business and is denoted as a percentage figure.
• The current ratio measures the relationship between current assets and current liabilities.