Financial Statements Part I

Who Needs Financial Statements?

Information is provided by a small business accountant in Phoenix, AZ.

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Properly interpreting the information found in a company’s financial statements is vital for everyone who is affected by the actions of the company. In other words, potential investors and current stakeholders, including stockholders, employees, vendors, and lenders, must be able to gauge their business decisions based on information derived from financial statements. This paper will identify the purpose of financial statements by answering the following questions in regards to hypothetical company, Bake-O Donuts, Inc. 2003 Annual Report: What does the income statement tell you about the company? What does the balance sheet tell you about the company? What does the statement of cash flows tell you about the company? What information is provided in the statements that will assist you in making these business decisions?

The Income Statement Tells A Story

What does the income statement tell you about the company?

A company’s income statement is a vital document for determining profitability. Often referred to as the P&L (profit and loss) statement, this document typically shows a company’s revenue, gross margin (revenue minus cost of goods sold), operating expenses, total expenses, and net income. Savvy shareholders will continuously inspect the income statements for the companies in which they have a vested interest to ensure that their investment remains a strong and profitable company.

Bake-O Donuts, Inc. 2003 Income Statement shows a horizontal analysis beginning in 1999, with a total of $439 million in revenue that consistently rises each year to a total of $1.1 billion in 2003. This statement is important for potential investors and lenders. Seeing a steady increase in revenue and net income over a five year time period, is an appealing aspect due to the fact that Bake-O Donuts shows that it is not only profitable, but that it is sustaining steady growth. Based on Bake-O Donuts’ ability to earn money for their shareholders, investing in this restaurant chain would likely be a sound business decision, evident by inspecting earnings per share over the past five years, which has risen from $0.58 per share to $1.66 per share in 2003.

The Balance Sheet May Shed Light

What does the balance sheet tell you about the company?

The balance sheet is a quick guide to a company’s assets, liabilities, and stockholder’s equity. Bake-O Donuts’ balance sheet data highlights working capital (current assets minus current liabilities), which is a deficit of $38,977. Generally speaking, a negative working capital is a poor sign of stability for a company; however, in Bake-O Donuts’ case this figure is a result of current liabilities out weighing current assets due to the purchase of property and equipment. A closer analysis of Bake-O Donuts’ balance sheet shows that funding for property and equipment is in part from capital earned by issuing long-term senior notes and from additional paid in capital. This information is important to investors seeking to purchase senior notes from Bake-O Donuts. Knowing that Bake-O Donuts is spending as much as $966 million in property and equipment is a sign that the company is continuing to grow, with little sign of slowing down. This would be an indication that a Landry’s long-term note is a secure investment opportunity.

Take A Quick Glance at the Money

What does the statement of cash flows tell you about the company?

A statement of cash flows is designed to allow financial statement users a quick reference to operating activities, including total cash received, total cash used, investment activities, and financing activities. Then, after taking cash at the beginning of the reporting period into consideration, cash at the end of the reporting period is stated.

When looking at Bake-O Donuts’ current cash flow statement, potential investors can see that net cash provided by operating activities is reported to be $122 million, $46 million of which came from net income. Net cash used in investing activities is reported to be just under $190 million, $163 million was spent on property and equipment additions, and $27 million on business acquisitions, net of cash acquired. Bake-O Donuts’ net cash provided by financing activities is $90 million. This figure is the total of just over $8 million in purchases of common stock for treasury, $49 million in payments under credit line, and $148 million in borrowings on senior notes. The bottom line of Bake-O Donuts' cash and cash equivalents at end of year is just over $35 million. This is impressive numbers for would-be investors.

Lenders would also be interested in seeing that a company is capable of earning $148 million in capital through the issuance of senior notes alone, while investing $190 million on expansion projects. This shows lenders Bake-O Donut’s ability to gain capital and to grow quickly.

What information is provided in financial statements that will assist you in making business decisions?

In addition to the figures expressed by Bake-O Donut’s operating, investment, and financing activities, additional information is provided in the auditor’s report, report of independent public accountants, and management’s discussions.

In the report of independent public accountants, Arthur Anderson LLP states, “in our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bake-O Donuts, Inc., and subsidiaries as of December 31, 2001 and the results of their operations and their cash flows for each of three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States”.

Fully understanding and interpreting the financial statement data and notes is one method for measuring the performance of a company. Another method is to conduct nonfinancial performance measures. Nonfinancial performance measures can give investors, and other stakeholders, insight into the company’s abilities based on employee initiatives, facility capabilities, and a company’s ability to provide an exceptional service.

In Bake-O Donut’s case, nonfinancial performance can be measured by reading consumer reports and even visiting locations to see if whether waiters and waitresses are friendly, outgoing, and if they have the ability to earn more money for the company by up-selling menu items to their customers. Seeing if Bake-O Donut’s locations are capable of being used for multiple purposes, such as catering, business functions, private parties, or for some other diversified activity.

In Closing...

An income statement is a vital tool used by many for making informed business decisions. Bake-O Donuts’ income statement shows a horizontal trend of increased revenue beginning in 1999 through to 2003. While looking to see how well a company operates, a potential investor may check the company’s balance sheet for a quick comparison of current assets less current liabilities, also referred to as working capital. In Bake-O Donuts’ case, working capital was expressed as a negative number; however, this figure was not an accurate portrayal of Bake-O Donuts’ financial position. In order to accurately assess Bake-O Donuts’ financial position, an inspection of cash flows is needed to see that the company earned capital through the sale of senior notes.

Additional measures of a company’s performance can be derived through inspecting nonfinancial performance measures. Measures such as these can be used to determine areas of strength not necessarily expressed in a company’s financial statements.

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Comments 1 comment

Maggie 21 months ago

You're a real deep thriken. Thanks for sharing.

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