Investors, financial institutions, and government agencies need financial statements to communicate performance, and profit or loss, between them. Companies also produce financial reports for internal use.
The subject that has these internal reports at its core is called “managerial accounting.” These types of reports are not public and are in the hands of the managerial team of the company to decide what will include and how they will be structured.
Financial accounting, a sub-course of accounting, has at its core the reports that been created for external use. The financial statements that are available for public use and communicate information between the above-mentioned company participants. This lingo is important for your own research.
Publicly traded companies need to publicize reports on both a quarterly and annual basis. The exact date that the earning will be publicly available is shown in the various finance websites under “earnings.”
Earnings date of Apple in Finviz.com
A note to be taken seriously for every investor is that the marking and/or the public relations department writes much of the information in those reports. They often hide any negative information in the “notes” section. Companies in the US also file the 10-K annual report and 10-Q quarterly report. The 8-K periodic report is been created for major events (such as acquisition, bankruptcy resignation of a director, etc). They need to send all these above to the United States Securities and Exchange Commission (SEC) for controlling. This version of a quarterly and annual report is a less glossy version of the above and you can find them here.
The process that the accounting sector of a company follows to create these financial statements is called “double-entry.”
The Double Entry Bookkeeping
This system uses both sides of a transaction to record the process. For example, if we want to buy a new PC for our office we would need to spend another asset such as cash. Another example will be the furniture account in our financial statement will be increased by the cost of the chair we are planning to buy and the cash account will be decreased by the same amount.
This bookkeeping process is standardized from country to country. For example, the USA uses the US GAAP principles, Germany uses the BilMoG guidelines, and Switzerland the Swiss GAAP FER.
Since 2001, more than a hundred countries follow also the International Financial Reporting Standards (IFRS) standard which makes the financial reporting communication easier from country to country.
The most important document a company produces about its financial health. The annual report, in many cases, includes the full 10-K report that a US company has filed with the SEC, as well as highlights, letter from the CEO, auditor’s report, management discussion and analysis, the financial statements, notes to the financial statements, and other information.
The financial statements are the only pieces of information that must follow a set of rules by law. The rest are presented in a subjective manner, and they are left to the company’s creativity.
The auditor’s report is a statement drafted by the team that audited the company’s books by the government. The notes section contains additional information about the data in the financial statements. The management discussion and analysis section include the management’s perspective on the company’s results.
The table of contents of Berkshire Hathaway of 2019.
Berkshire Hathaway is a great example of a good annual statement. They include a chairman’s letter that Warren Buffet personally writes and not some kind of marketing team. Then they include the 10-K form which they declared with the SEC according to their rules and regulations.
The ending of chairman of the board Warren Buffet on his letter to shareholders.
Inside the notes section, we can find the accounting methods used and any changes to them, key financial commitments, lease obligations, pension benefits, etc.
Also known as “statement of financial position,” this financial report gives a snapshot of the company’s financial condition at that particular time. The name “balance sheet” comes from the balance between assets, on one side, and liabilities and equities, on the other. This equilibrium is called the accounting equation.
Assets = Liabilities + Equities
Current assets, such as cash and savings, and long-term assets, such as buildings and machines, are located on the left side. On the right side, we can find the current liabilities, long term liabilities, owner’s equity (when we talk about sole proprietorship or partnership) or shareholders’ equity (when we talk about an LLC, in the US, or a corporation. A GmbH or an AG in Germany and Switzerland).
In Germany under the “HGB §266” and in Switzerland under the “Art. 959a OR” one can find the structure of the balance sheet as defined by the law.
Example of a balance sheet presented in “account format”.
The asset side of a balance sheet contains the current asset and long-term asset categories. The current assets category includes assets that can be used in the next 12 months. The long-term assets, on the other hand, are assets that a company will be used up in after 12 months.
Cash and Cash Equivalents — Cash is king! Maybe the most important account in the balance sheet. So important that there is another financial statement dedicated to tracking the changes that happen to it. It’s called the cash flow statement and it’s analyzed below.
Accounts Receivable — When a customer buys something without paying in cash, the amount received in this account.
Inventories — This account sums up the cost (cost of producing or acquiring them) of goods that a company has available for purchase.
Supplies — This account sums up the cost of supplies business owners at this point in time.
Other Current Assets — This account contains all other current assets that are too insignificant to be in a separate account.
The property, Plant, and Equipment — Here land, buildings, leasehold improvements, equipment, furniture, fixtures, delivery trucks, automobiles, etc, are included.
Goodwill and Intangible Assets — Customer loyalty and customer base are listed as goodwill on the balance sheet. When a company buys another company, the difference between the money paid and the value of the company’s tangible assets is listed as goodwill on the balance sheet. A patent, copyrights, etc, are forms of intangible assets.
As the current asset account, the opposite of the current liabilities accounts, these debts are referred to debts that will be paid in less than a year. The long-term liabilities account referred to liabilities for longer than one year. This debt will not cause a company to file bankruptcy, but the company might not be able to pay this long term build up debt.
Accounts Payable — This account is the opposite of the account we saw in assets as accounts receivable. It includes the sum of the cost of products purchased by the company, without cash.
Salaries Payable — Salaries that need to be paid in employees.
Interest Payable — This account sums up the amount of interest the company owes as of the date the balance sheet created.
Bank Loans — Loans and mortgages incurred for more than a year.
Bonds Payable — Corporate bonds issued by the company for longer than a year.
Pensions — This account contains the sum that the company owes as of the date of the balance sheet for the company’s pension plan.
The difference between assets and liabilities. We can think of this account as the amount of money that we will still have if we pay all our debts by using our assets.
Common Stock — This account contains the amount of money that the company has received when issued its common stocks.
Retained Earnings — Dividends that have not been paid to the shareholder, but kept inside the company.
Treasury Stocks — The value of the stocks that have been repurchased.