MBA403 Week 1: Measuring Financial Performance
Purpose and Process of Financial Statement Analysis
Core Philosophy: Knowing numerical data assists in transforming business relationships and provides a significant competitive advantage.
Information Logic Flow:
Inputs: Financial statements, sustainability reports, external sources of information, non-financial data, and the economic/business environment.
Processing: Analysis, interpretation, insights, and communication.
Outputs: Business strategy, decision-making, and stakeholder engagement.
Stakeholder Analysis
Stakeholder Categories:
Internal Stakeholders: Board members, Shareholders, Management, and Staff.
External Stakeholders: Customers, Suppliers, Competitors, Government authorities, Regulators, Unions, Community members, Interest groups, Media, Potential Investors, Lenders, and Analysts.
Stakeholder Priorities: Different philosophies exist regarding stakeholder importance; for instance, Alibaba's Jack Ma prioritizes customers first, employees second, and shareholders third.
The Balance Sheet (Statement of Financial Position)
General Definition: A snapshot of a company's financial position at a specific point in time recorded on an accrual basis.
Fundamental Accounting Identity:
Components of the Balance Sheet:
Assets: Resources owned by the business to generate sales. Examples include cash, inventory, buildings, plant and equipment, investments, debtors (accounts receivable), prepaid insurance, and goodwill.
Liabilities: Financial obligations of the business. Examples include loans and borrowings, creditors (suppliers), income tax payable, and employee entitlements (such as annual leave provisions).
Equity (Net Assets or Capital): Includes initial shareholder capital (contributed equity), reserves, and retained earnings/profits. Net assets serve as the balancing item in the identity.
Features and Classifications:
Current vs. Long-term: Assets and liabilities are distinguished by timeframes, with current items being less than 12 months (<12\,m) and long-term items exceeding 12 months (>12\,m).
Accrual Basis: Transactions are recorded when they occur, not necessarily when cash changes hands.
Limitations of the Balance Sheet:
Assets are often recorded at historical valuations, which is particularly relevant for inventories.
Certain intangible assets may be omitted if a valuation cannot be easily attached.
The Balance Sheet provides an estimate of Net Assets (Book Value), which frequently differs from Market Value.
The Income Statement (Profit and Loss Statement)
General Definition: Presents the results of a company's operations and its profitability over a specific period of time on an accrual basis.
Core Components:
Revenues (Sales): The value of goods or services sold, inclusive of cash and credit sales.
Expenses: Costs incurred to generate revenues.
Cost of Goods Sold (COGS): Direct costs attributed to the provision of goods or services, often separated from other expenses.
Net Profit (Net Income/Earnings): The final profit or loss for the period calculated as Revenues minus Expenses.
Gross Profit: Calculated as .
Reporting Metrics: Public companies typically report Earnings Per Share (EPS), which is a key measure for valuing shares.
The Cash Flow Statement
General Definition: Reports all cash inflows (positive) and outflows (negative) over a period, recorded on a cash basis rather than an accrual basis.
Classification of Cash Flows:
Operating: Cash flows related to items in the Income Statement, such as cash sales, wages, and interest paid on borrowings. Positive net operating inflows generally indicate a profitable business.
Investing: Cash flows related to the purchase or sale of investment items like property, equipment, and financial assets. It also includes loans made or repayments received.
Financing: Transactions related to financing through liabilities or equity, including borrowing (inflow), principal repayments (outflow), dividends paid, and shares issued.
Reconciliation: The statement reconciles with the opening and closing cash balance found in the Balance Sheet.
Developing Business Insights from Financial Statements
Insight Scenario 1: High debt levels and negative retained earnings paired with a transition to profitable trading after a startup phase suggests that debt levels are likely to reduce going forward.
Insight Scenario 2: Ample cash/working capital (current assets minus current liabilities) indicates a business has the financial resources to survive a downturn, even if sales decline due to recession.
Insight Scenario 3: High debt levels, rising interest rates, and erosion of profitability due to competition identify a business as a candidate for failure.
Cash Flow Insight Matrices:
Successful/Established Company: Positive Operating flow, Negative Investing (investing in growth), Negative Financing (paying dividends/debt).
Acquisition Strategy: Positive Operating flow with Positive Investing/Financing (raising funds through divestment or debt for potential acquisition).
Over-leveraged Company: Positive Operating flow and Positive Investing (selling assets) to cover Negative Financing (paying down high debt).
Expansion Phase: Positive Operating flow combined with Positive Financing (borrowing/capital raising) to fund Negative Investing (expansion).
Troubled/Startup Company: Negative Operating flow covered by Positive Financing (raising cash for deficit). If Negative Operating flow occurs alongside Positive Investing (selling assets) and Negative Financing (paying loans), recovery is urgent to avoid failure.
Market Value versus Book Value
Book Value: The accounting view of the company's value, representing the Net Assets or Equity shareholders would receive if the company were liquidated.
Market Value: The value of a company as determined by the stock exchange. It can be higher than book value if investors are optimistic, or lower if they are pessimistic.
Market Capitalisation Formula:
Takeover Implications: If Market Value falls significantly below an accurate Book Value, the company may be considered cheap and attract takeover bids.
ASX Reporting Season
Timeline: Most Australian public companies operate on a June Financial Year (30th June).
The Season: The major reporting period occurs in August, allowing time for accounts to be compiled and published.
Significance: Earnings reports provide key performance information and create opportunities for investors to navigate market fluctuations and build knowledge.
Questions & Discussion
Q1: Identify a company's external and internal stakeholders?
Response: Internal stakeholders include the Board, shareholders, management, and staff. External stakeholders include customers, suppliers, competitors, government bodies, regulators, unions, the community, interest groups, the media, potential investors, lenders, and analysts.
Q2: Why are these groups interested in our financial statements?
Response: Stakeholders use these statements to assess financial position, performance over a specific period (profitability), and the adequacy of cash flow generation to ensure business survival and strategic viability.
Q3: Is there anything unexpected on the Balance Sheet for a retailer like Harvey Norman?
Response: (Exercise context) Observations often include significant property holdings or finance-related assets that differ from pure retail operations.
Q4: Are you able to determine from the Balance Sheet whether Harvey Norman has been profitable in previous years?
Response: Yes, by viewing the Retained Profits/Earnings section within Equity, which reflects the accumulation of past profits that have not been paid out as dividends.