15.2. Three Financial Statements#

Financial statements are written records that illustrates the business activities and the financial performance of a company. In most cases they are audited to ensure accuracy for tax, financing, or investing purposes.

Uses. Management uses them for decision-making, budgeting and performance evaluation. Investors use them to asses profitability, financial health, future performance, and creditworthiness (especially lenders).

  • Income statement: company performance (profit and loss) over a period. Broadly speaking:

    \[\text{net earnings} = ( \text{revenues} - \text{total expenses} ) \times ( 1 - \text{tax rate} ) , \]

    with total expenses = operative (labor + non-labor + DA) + Interest (due to debt holders), and “partial earnings” EBITDA, EBIT, EBT with trivial definition (Earnings Before: I:interest, DA: depreciation and amortization, T: tax)

  • Balance sheet: financial position at a specific point in time, in terms of:

    • assets: cash and equivalent + acc.receiv. + inventory + PPE (Plant property and equipment, subject to CapEx and depreciation, \(PPE(n) = PPE(n-1) + \text{CapEx}(n) + \text{DA}(n)\)

    • liabilities: debt + acc.pay.

    • equity:

      \[\begin{split}\begin{aligned} \text{retained earnings}(n) & = \text{retained earnings}(n-1) + \text{net earnings}(n) - \text{dividends}(n) \\ \text{shareholder equity}(n) & = \text{equity capital}(n) + \text{retained earnings}(n) \ , \end{aligned}\end{split}\]

      being \(\text{retained earnings}(n)\) the cumulative retained earnings not distributed to shareholders.

      The 2 contributions \(\text{shareholder equity}\), \(\text{total liabilities}\) shows how the compnay’s asset are financed: either through capital raised or retained earnings (equity), or through debt (liabilities). The identity

      \[\text{total liabilities} + \text{shareholders equity} = \text{total asset}\]

      must hold in a proper filled balance.

  • Cash flow statement tracks the flows of cash in and out of the business over a period. Cashflows over a period modifies cash,

    \[\begin{split}\begin{aligned} \text{closing cash}(n) & = \text{opening cash}(n) + \text{total cashflow}(n) \\ \text{opening cash}(n) & = \text{closing cash}(n-1) \end{aligned}\end{split}\]

    Cashflows are usually classified as:

    • operating CF (DA is added back to net income, since it’s not a cashflow going anywhere; it lowers income, but it’s not a cashflow)

    • investing CF

    • financing CF

      \[\begin{split}\begin{aligned} \text{ Op.CF}(n) & = \text{net earnings}(n) + \text{DA}(n) - \Delta \text{WC}(n) \\ \text{Inv.CF}(n) & = \text{investment in PPE}(n) \\ \text{Fin.CF}(n) & = \text{issuance of debt}(n) + \text{issuance of equity}(n) - \text{dividends}(n) \\ \end{aligned}\end{split}\]

      being \(\text{WC}(n) = \text{acc.rec}(n) + \text{inventory}(n) - \text{acc.pay}(n)\) the working capital.