Question

1.) Describe the financial statements that are contained in an annual report or Form 10-K.

2.) Explain the importance of the notes to the financial statements.

Answer 1

An annual report or Form 10-K includes a company’s income statement (sometimes called as earnings statement), balance sheets, cash flow statement and statement of stockholders’ equity.

i) Income statement
ii) Balance sheet statement
iii) Cash flow statement
iv) Statement of changes in equity

Income statement:
Income statement summarizes the expenses and revenues that are generated by a company over a reporting period. It is also known as earnings statement or statement of profit and loss.
Income statement is based on the basic equation Revenues – Expenses = Net Income
Revenues earned are used to pay expenses, interest on debt and taxes.
Following are the components in an income statement:
Total Revenue
Cost of Goods Sold
Gross Profit (= Total Revenue - Cost of Goods Sold)
Operating Expenses (Salaries, rent, utilities, depreciation etc will come under operating expenses we add all the operating expenses to get total operating expenses)
Total Operating Expenses
Operating Profit (EBIT) (= Gross Profit - Total Operating Expenses)
Interest Expense
Earnings before tax (EBT) (=EBIT-Interest expense)
Taxes
Net Income   (=EBT-Tax)
Number of Shares Outstanding
Earnings Per Share (EPS) =( Net Income/Number of Shares Outstanding)

Balance sheet statement:
It reports assets, liabilities and shareholders' equity of a company at a specific point in time. It provides a snapshot of what a company owns and owes.
A balance sheet statement adheres to the following equation:

Assets = Liabilities + Shareholders' Equity

A company pays all the things it owns (assets) by either borrowing money (liabilities) or taking it from investors (issuing shareholders' equity).

Following are the components in a balance sheet statement:
Assets
Under assets accounts are listed in an order of liquidity (from higher to lower), that is the ease with which they can be converted into cash. These accounts are divided into two parts (current and non current assets). Current assets are those which can be converted to cash in one year or less and non current assets are the long term assets which cannot be converted to cash in one year.
Under current assets the general order of accounts is given by:
Cash and cash equivalent: These are the most liquid assets
Marketable securities: This will contain equity and debt securities for which there is a liquid market.
Accounts receivable: This is amount of money which customers owe to the company.
Inventory: Goods available for sale will come under this account.
Prepaid expenses: It represents the value that has already been paid for by the company. Example: Insurance, advertising contracts or rent payments.
Long-term assets or non-current assets include the following:
Long-term investments: Securities that cannot be liquidated in the next year.
Fixed assets: These include land, equipment, buildings, machinaries etc.
Intangible assets: This account includes non-physical valuable assets like intellectual property and goodwill.

Liabilities
Money that a company owes to outside parties are called liabilities. Example includes bill payments to suppliers, interest on bonds, rent, salaries etc. Like assets, liabilities are also classified as current and non current or long term liabilities.

Current liabilities accounts might include current portion of long-term debt, bank indebtedness, interest payable, rent, tax, utilities, wages payable, customer prepayments, dividends payable and others.
Long-term liabilities can include:
Long-term debt: Interest and principal payments on the bonds issued by a company.
Deferred tax liability: Taxes that have been accrued but will not be paid for another year.

Shareholders' Equity
It is the money attributable to shareholders of a company.
Shareholders' equity includes the following components:
Preferred stock: It offers the holders a higher claim on a company's earnings and assets compared to those who own the company's common stock.
Common stock: This is a type of stock, or ownership stake in a company, that gives voting rights on corporate decisions to the holders.
Treasury stock: Treasury stock is stock that the issuing company repurchases.
Additional paid-up capital: This is the excess amount that investors pay over the par value of a company's stock.
Retained earnings: Total earnings of a company that have not yet been distributed to shareholders.
Unrealized gains and losses: An unrealized gain/loss occurs when an investment gains/loses in value but that amount has not been cashed in.

Cash flow statement:
It provides aggregate data regarding all cash inflows and outflows of a company.
A cash flow statement is prepared from the information available in a company’s balance sheet and income statement.
The cash flow statement is prepared by taking cash flows from three different business activities: cash flow from operations, cash flow from investing and cash flow from financing.

Cash flows from operations:
It analyzes a company’s cash flow from net income or losses.
Here we reconcile the net income with the actual cash the company received from or used in its operating activities. We adjust net income for any non-cash items like depreciation expenses and also for any cash used or provided by other operating assets/liabilities of a company.

Cash flow from investing activities:
It includes sales or purchase of long-term assets like plants, properties, and investment securities, etc.
Example: If a company buys a piece of machinery, it is paying out cash and hence it is a cash outflow. So, it would reflect as a cash outflow from investing activities.
Similarly if a company is selling its long term investment and getting money it will be recorded as cash inflow.
Cash flow from investing provides future benefits to a company.

Cash flow from financing activities:
This cash flow results from issuance or retirement of a firm’s debt and equity securities and also include dividends paid to stockholders.

Statement of changes in equity:
The statement of changes in equity reports the amounts and sources of changes in equity investors’ investment in the firm over a period of time. It is similar to share holders equity we have explained under shareholder's equity section in balance sheet. Separate statement of changes in equity gives more explanation about the shareholder's equity.

Part2:

Notes to financial statements provide details on the financial statement components such as investments, fixed assets, debt etc.
It highlights the financial matters that are not includes in numbers. Example includes contingencies, uncertainities, estimates, business acquisitions or disposals, legal actions, employee benefit plans etc.
It provides information about accounting methods, assumptions, and estimates used by management.
It also provides the basis of presentation (of the financial statements) such as the fiscal period covered by the statements and the inclusion of consolidated entities.
Analysts use notes for better financial analysis of a company.