Critical Financial Review: Understanding Corporate Financial Information

By Kenny Tay

This book is about financial information that every one of us receives from time to time in the course of our work, business, or as investors in corporate securities, such as shares and bonds. Financial information about a company and its activities is necessary for us to make judgments and decisions regarding financing, investments, and take appropriate management actions. In particular, it is written to complement credit executives with limited accounting experiences or knowledge and who have credit and lending responsibilities.

I have written this book using my personal experiences as a financial skills training facilitator for over twenty years, and the comments of many of my course participants have given me the encouragement to organize my thoughts and views on financial information analysis and my approach in developing understanding of corporate financial numbers, particularly for people from non-financial backgrounds like engineers and lawyers. I hope this book can be of assistance to the people similar to those audiences I have been speaking to during my various training workshops on the subject.

• Language: English
• Publisher: Partridge Publishing Singapore
• Release date: Jun 24, 2017
• ISBN: 9781482882308

Kenny Tay

Kenny Tay began his merchant banking career with an affiliate of JP Morgan, the US -based investment banking group, followed by various executive appointments at the Dow Banking Group, Royal Trust Company of Canada, and UOB Australia Limited, a subsidiary of the United Overseas Bank Singapore. He is a Fellow of the Association of Chartered Certified Accountants, United Kingdom and holds a certificate in Company Law from Macquarie University, Sydney, Australia. He was also at one time a securities dealer licensed by the Victoria Securities Commission, State of Victoria. Currently he is the Chief Executive of the Australia New Zealand Institute, a work – based skills development organization providing learning and training using global electronic networks to develop human capital.

Book preview

Copyright © 2017 by Kenny Tay.

ISBN:                  Softcover                      978-1-4828-8229-2

                            eBook                            978-1-4828-8230-8

All rights reserved. No part of this book may be used or reproduced by any means, graphic, electronic, or mechanical, including photocopying, recording, taping or by any information storage retrieval system without the written permission of the author except in the case of brief quotations embodied in critical articles and reviews.

Because of the dynamic nature of the Internet, any web addresses or links contained in this book may have changed since publication and may no longer be valid. The views expressed in this work are solely those of the author and do not necessarily reflect the views of the publisher, and the publisher hereby disclaims any responsibility for them.

www.partridgepublishing.com/singapore

Contents

Preface

Chapter 1     Introduction To Corporate Financial Information

Chapter 2     Corporate Financial Statements

Chapter 3     Business Profitability

Chapter 4     Return On Investment

Chapter 5     Financial Risks

Chapter 6     Asset Quality

Chapter 7     Other Accounting Issues

Chapter 8     Beyond Financial Statements

Chapter 9     Basic Financial Analytical Tools

Chapter 10   Financial Forecasts And Plans

Chapter 11   Time Value Of Money And Investment Decisions

Examples of critical review of financial statements

Further Questions For Discussion

Answers To Chapters

Preface

This book is about financial information that every one of us receives from time to time in the course of our work or business, or as investors in corporate securities such as shares and bonds. Financial information about a company and its activities is necessary for us to make judgment and decisions regarding financing, investments and take appropriate management actions. In particular it is written to complement credit executives with limited accounting experiences or knowledge and who have credit and lending responsibilities.

Many books have been written already on this subject matter or that related to it. This book is an additional contribution to serve some readers who may want an alternative perspective, and it is particularly directed at the readers and users of financial statements who are non – accountants or those with limited financial knowledge and analytical experience. I believe the first time reader on the subject will be well served by this book before further advanced reading.

There is minimum academic treatment here in this publication because the subject of finance and financial information already has abundance of existing literature from academic institutions and research houses. At the same time the focus is on the application of the understanding of financial information and its relationships between the company and its environment including internal management practices. For the readers and users of financial statements who wish to seek further understanding and conceptual analysis, I am sure they can find some very good publications that are widely available now.

I have written this book using my personal experiences as a financial skills training facilitator for over 20 years and the comments of many of my course participants have given me the encouragement to organize my thoughts and views on financial information analysis and my approach in developing understanding of corporate financial numbers, particularly for people from non - financial backgrounds like engineers and lawyers. I hope this book can be of assistance to the people similar to those audiences I have been speaking to during my various training workshops on the subject.

The writing and completion of this book has been a great challenge during a time when I have many other commitments. This book would not have come about without the constant motivation and support of my colleagues, participants in my financial skills training workshops and the confidence of those organizations that have been inviting me to conduct those workshops for their executive staff repeatedly over the years. To them I wish to extend a very big thank you. In particular I acknowledge the support of the financial institutions and the financial services industry in the time when I was a training facilitator and to those who have been instrumental, I like to record a big thank you.

Lastly I wish to thank my wife, Esther, my children May and Calvin for putting up with my moods and temperament during the time. It would have been impossible to achieve this without their understanding and unspoken support.

Kenny Tay

CHAPTER 1

Introduction To Corporate Financial Information

1.    Corporate financial information

a. Financial information in general

i. All business entities produce financial information for their managers and owners to make decisions on every day business transactions or new investments. Without sufficient meaningful information the owner and its managers might not be able to optimize the use of the financial resources and select appropriate responses to its customers and suppliers. Poor decisions are often the result of inadequate financial information or delay in information availability.

ii. Corporate financial information is now more organized and available on a regular basis as companies have better accounting and financial systems and staff to organize, prepare and report the relevant financial information to the right set of decision makers. This has also been prompted by corporate regulations as well as securities exchange requirements which apply to companies that are publicly quoted on the securities exchange.

iii. The integrity and efficiency of this corporate financial information system has now been enhanced by the use of latest technology in computing and state of the art in accounting software. The outcome of this is a higher level of accuracy and frequency of financial information generated for decision making as well as a variety of reports from various analyses and data interpretation.

b. Relevance and importance to the users

i. The general public has much uses of the financial information in our modern lives. Organizations and people of all walks of life are now inter-wined economically resulting in their interdependence on financial resources for various commercial objectives.

ii. For one, most investors place their funds with public companies and financial institutions on the basis of what they understand from the financial information reported publicly. These shareholders and investors need regular and accurate updates of financial performance data to assist them in making investment decisions such as to dispose – off shares of those companies with poor profits and buying investments of higher returns and lower financial risks.

iii. Next, the banks and financial institutions have loan exposure to companies which are their borrowers. There is a regular process within these lending institutions to assess the financial health of these borrowing companies leading to the decisions to renew or terminate a particular lending relationship. Where new loans are requested, the lending bank would need financial information of each of the loan applicant in the form of financial statements or financial forecasts, for credit risk and loan repayment assessment.

iv. Customers sometimes also want financial details of their suppliers for them to assess whether the suppliers are able to fulfill their business obligations. For example a real estate company which is about to award a building contract to contractor would want the financial statements of the contractor for it to assess the financial resources or capability of that contractor to undertake the contract successfully. A construction company of poor financial condition might not be able to meet its performance requirements and contractual obligations.

v. Other stakeholders may include the employees’ unions and government tax offices. These public organizations use the financial statements for negotiating wage agreements and for tax assessment. Without financial statements, negotiation on union terms and tax payable may become complex and unsatisfactory.

c. Integrity of financial information and the audit

i. Financial information is used for important decisions before undertaking economic activities such as building a factory or selling off an investment, or coming into a business joint venture arrangement.

ii. Decisions such as these are influenced by the information made available. If the information is false or inaccurate, there would be economic costs and possibly legal consequences for both the users and the providers of the information. It is therefore important that the information to be relied upon must be honestly provided by the company’s management, and properly constructed to provide meaningful support for the decision makers such as the shareholders and bankers.

iii. The statutory audit process is an independent process to provide credibility of the financial information that is published or provided by a company to the various users for their purposes. The audit of the financial information and the supporting data would result in an independent audit report and opinion on the reliability and truthfulness of the financial statements. This would enhance the confidence of the users in relying on the information for making judgment and decisions.

iv. The users of the financial statements would be taking significant risks if full reliance is made of the unaudited financial statements. This risk is often not worth taking. Even if the financial information has been audited, full reliance is unwise as the audit process itself is not foolproof.

d. Conclusion

Financial information lights the way to the understanding of a company and its business successes. Business performances are measured and reported in financial terms. Without sufficient and clear financial information, stakeholders of the company would not be able to understand and evaluate its business success. This will weigh down on their investment and other financial decisions.

Where a company is unable to shed sufficient light on its revenue and financial conditions, the counter parties with whom it conducts business with, would become wary and very likely to reduce their confidence in the company.

Audited financial information provides some comfort to the users who make financial judgements and decisions. However, the information may not be enough and might not be fully reliable, but it is where we all begin.

LEARNING REVIEW 1

CHAPTER 2

Corporate Financial Statements

2.    Corporate financial statements of companies and business entities

a. Scope of the financial statements

i. The financial statements of a business organization are designed for informing the shareholders and other users on the financial achievements and conditions of the organization. Other non - financial information may also accompany them such as those required by law or by any regulations of the country that the business organization operates in.

ii. The financial information contained in the financial statements revolves around the profitability, cash flow and the asset – liability funding situation. The relevant information is summarized in monetary terms into three separate statements, namely the income statement, the statement of financial position and the statement of cash flow.

iii. As each of these statements is a summary, additional information to explain or support the individual figures therein may be necessary. This additional information is usually provided as Notes to the Accounts, placed after these financial statements. As these notes may contain important and useful information, the reader of the financial statements should always refer to them whenever appropriate.

iv. In general the details and disclosure of the information of a company and its business activities are specified by the business and corporate laws of the country where the company operates in.

b. Structure and content of the income statement

i. The income statement is also referred to as the Profit & Loss Statement. The purpose of this income statement is to show the revenue, costs and profit of the company which runs the business activities. A successful company would return a profit.

ii. The income of the company and its activities comprise –

a. Revenue from main business activities, and

b. Gains adjusted for losses from non – core business activities.

iii. Revenue from main business activities should always form a large component of the total revenue of the company as these activities probably consume significant management time, financial resources and take on business risks.

iv. Gains and losses from non – core business activities are shown in the audited incom4e statement as other income or losses after operating income. This means these income or loss items are not considered as normal items in the course of operating the main business. Rather they are additional items outside the normal operations. In general terms these items may be non-recurring or are not a significant part of the company’s business activities.

v. Where income or gains from non – core business activities do make up a significant portion of net profit as well as of a recurring nature, the company’s management and the auditors would consider them as separate operating segments instead of just as other operating income.

vi. Examples of income or gains from non-core business activities include gains or losses arising for foreign exchange translation, hedging of futures and options contracts, gains or losses from disposal of company assets and write back of provisions no longer required.

vii. The following income statement diagrams illustrate the other non – core business income and how to interpret their impact on the final profitability of a company. The situation represented by Company A is a normal one where there is little or no other non – core business income. Company B shows a situation where the profit of the company is 35. However this profit has taken into account other income of 20. The profit from its business is actually 15. The situation in Company C is really bad because true profit of 35 would not have been there had not been for other income of 40. If the other income is excluded, the company would plainly incur an operating loss of 5.

54291.png

c. Structure and content of the statement of financial position

i. The statement of financial position – the SFP, has been previously known as the balance sheet. The SFP is a financial statement that shows how the assets of a company are financed, and where the funds for them come from.

ii. Typically the financing of a company and its business operations come from a combination of capital from the owners, loans from banks and credit from trade creditors. The amount of capital and loans for the company is a matter of financing policy and decision of the company’s management. That can also be influenced by the money market conditions at the time of making those financing decisions.

iii. The assets of the company are acquired based on the needs of the business and its operations. Production assets are required where there are manufacturing activities such as factory buildings and land, plant and equipment, and computers and software. These are referred to as non - current assets in the SFP.

iv. Current assets are those assets use to support daily activities. These include stocks, raw material inventories and cash at bank held for payment of expenses. These current assets are fluctuating and volatile. Sometimes the amounts of these assets can be high and at other times they may be much less.

v. The amount of non-current and current assets of a company depends on the nature of the business and the volatility of the trading environment. The following provides a number of examples of statements of financial positions for common industries or businesses illustrating various financing positions for the assets.

54352.png

vi. The SFP of Company A above shows a situation where there is much more capital and reserves in the company than its liabilities. The funds from capital, reserves and current liabilities are used to fund the non – current and current assets. The large amount of capital and reserves has been sufficient to finance non – current assets and leave a significant amount for financing some of the current assets. The amount of current and non – current assets for a company is influenced by the nature of business as well as deliberate management policies.

In the case of Company C, there is much more liabilities compared to capital and reserves. It can be alternatively described as an ‘under-capitalized’ condition which has led to a high level of liabilities or non – equity financing. It is even