Detailed in-depth notes for the first year 'Financial Management' paper on week 1 content for financial reporting (overview of accounting, income statements, balance sheets, cash flow statements). Mainly based on lectures, with summaries of readings (where applicable), learnings from pre-work probl...
Notes from: MT1 lecture + class, accounting book C1-4
FM Lecture 1
Accounting is the process of identifying, measuring and communicating economic information to permit
informed judgements and decisions by users of the information
Identifying which economic information should be included
Measurement may include subjective judgments and modeling
Users of information: investors, lenders, employees, suppliers, governments/ regulators,
customers, competitors, unions, public/ press, managers, tax authorities
Financial reporting to ensure transparency given separation of management and ownership
IFRS conceptual framework:
Fundamental qualitative characteristics: what makes financial information useful? (essential) RF
o Relevance: predictive/ confirmatory value
o Faithful representation: neutral, free from error (no arithmetical error, though numbers
can be subjective), complete
Enhancing qualitative characteristics: what improves the usefulness of relevant and faithfully
represented financial information (desirable but not essential) VCUT
o Comparability: consistency helps
o Verifiability: direct (eg. Sales revenue from invoices)/ indirect (estimated numbers from
asking for the model and underlying assumptions for the estimate)
o Timeliness
o Understandability: classification, characterization, presentation
Profit
o Profit = revenue – (expenses directly related to revenue generation)
Expense includes depreciation of fixed assets bought, but not its whole price
Initial retained earnings + net income – dividends = final retained earnings
o Hence, dividends affect retained earnings in BS, but not profit on IS
When there are dividends, there is an additional line item 'dividends' under capital in BS
FM Chapters 1-2
, Cash flow statement: measure change in cash, a subset of wealth
Income statement (aka statement of financial performance): measure change in total wealth
Balance sheet (aka statement of financial position): measures total wealth. All transactions and
events affect the balance sheet, but not all necessarily affect the cash flow and income
statements
Cash flow statement
Operating cash flow
- From trading activities (from customers, to suppliers/ employees), including tax
- Positive value is good as it shows that cash received from running the business exceeds cash
paid out to run it
Investing cash flow
- Purchase and sale of land, building, equipment + marketable securities
- Negative value implies growth in operating capacity
- Positive value implies divesting of assets and shrinkage in business, could be good if asset is
disposed at an attractive price
Financing cash flow
- From share issuance, paying bank loan
- Positive value means finance has been raised, negative means repayment of finance
Change in cash/ net cash flow
Opening cash balance
Closing cash balance
All related: for example, to expand operating capacity (negative investing cash flow), you can
use excess from operating cash flow, use financing cash flow, or balance from previous period
Used to assess (1) the ability to generate future net cash inflows (2) liquidity/ solvency
Operating cash flow involves changes to wealth, investing and financing cash flows can be
viewed as wealth-neutral
Subjectivity in line items (what is considered 'consumables' vs 'leisure' etc.)
*Assets vs expenses
o Expenses: if it is to be used within one year
o Assets:
should bring economic benefit for more than one year
even if used within one year, it can be an asset if it is inventory (eg. Sugar used
for producing candy of a candy company)
Current assets: held for one year but can be easily converted to cash
o Eg. A chair can be an office expense or fixed asset
o Threshold is one year regardless of reporting frequency
Questions to consider when commenting:
Is the company generating positive operating cash flow?
Are investing cash flows negative, meaning that the company is growing? If so, how is this
growth being funded?
Is the company borrowing, and if so, is this to cover negative operating cash flow, to enable
investment, or simply to increase the company’s bank balance?
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