Decoding Company Financial Reports: Key Elements Explained
Understanding Financial Statements
Business Structures
Sole Trader: A business run by one person. While not regarded as a separate economic entity, the sole trader is the owner who takes on all risks. If the company faces financial difficulties, the owner is personally liable and may need to use personal resources to cover debts.
Partnership: As a sole trader expands, more owners may join, forming a partnership. In the event of financial risk, each partner is liable and may need to use personal resources. A legal partnership agreement sets out the partners’ rights, duties, and the percentage of profits each will share.
Limited Liability Company (LLC): Established to avoid the main risks that might arise in other business structures. LLCs require a written memorandum and articles of association. There are two main types: private (family-owned businesses) and public (listed companies that sell shares to the public on a stock exchange market).
Key Financial Statements
Statement of Changes in Equity: A voluntary statement for SMEs but compulsory for listed/large companies. It informs about changes in equity during a specific period. It includes:
- Statement of Recognized Gains and Losses: Details net income, expenses, or revenues charged directly to net equity, and transfers to the income statement.
- Statement of Total Changes in Equity: Covers stockholders’ capital/dividends, other changes in equity, accounting policies, and corrections of mistakes.
Statement of Cash Flow: Voluntary for SMEs, but compulsory for listed/large companies. Companies preparing abbreviated formats may not be obligated to disclose this statement. It informs about changes in cash during a period, including cash inflows (collections) and cash outflows (payments). The statement also includes variations in cash and equivalents (bank accounts, temporary financial investments, etc.).
The cash flow statement is divided into three parts:
- Cash flows from operating activities
- Cash flows from investing activities
- Cash flows from financing activities
Initial cash +/- cash-flows (CF) = Final cash
Explanatory Notes: Compulsory for the financial statements of every company. These notes explain all data included in the financial statements, describing particular aspects of the company. In Spain, the proposal for profit distribution is always in note 3. There are 13 notes in abbreviated formats and 27 notes in normal formats.
Audit Report
A written opinion from an external auditor on the validity and reliability of a company’s financial statements, required for large/listed companies. The goal is to document reasonable assurance that a company’s financial statements are free from error and accurately show the “true and fair view” of the economic and financial situation.
Types of Audit Opinions:
- Clean or Unqualified: Indicates that all revised documents show the company’s financial activities and records are correct and acceptable.
- Qualified: Generally positive, but indicates that the auditor has found something that means the audited company has not adhered to accounting standards. Includes an extra section addressing why it could not be considered an unqualified opinion.
- Adverse: Indicates the company has not adhered to standards and the auditor has discovered discrepancies in the company’s financial statements.
- Disclaimer: Indicates the auditor was not able to complete the audit due to a particular reason.
Other Important Reports
Management Report: Compulsory for listed/large companies. It specifies a minimum content, including a fair presentation of business evolution, the situation, important events after the balance sheet date, foreseeable evolution of the company, research/development activities, and acquisition of own shares.
Social Responsibility Report: A compulsory document for listed and large companies to assess and take responsibility for the company’s effects on environmental and social wellbeing. Companies typically showcase efforts that go beyond regulatory requirements to their stakeholders.
Corporate Governance Report: A compulsory document for listed companies to evaluate the system of rules, practices, and processes by which a company is directed and controlled. Good corporate governance creates a transparent set of rules in which shareholders, directors, and officers have aligned incentives.
Key Financial Elements
Current Assets (CA): Cash, ST deposits, accounts receivable, inventory, marketable securities, office supplies, notes receivable, income taxes receivable, interest receivable, prepaid revenue shares, prepaid expenses, prepaid insurance, net receivables, income earned but not received, short term investments, ST loans and advances, stock, debtors, salaries advance, tax advance, advance to suppliers.
Non-Current Assets (NCA): Investments, property, plant, equipment, advances, long term receivables, prepaid revenue shares, non-marketable investments, deferred income statements, intangible assets, financial assets, materials and supplies, accumulated depreciation, check to invoices, to receipts, vehicles, goodwill.
Current Liabilities (CL): ST debt, accounts payable, wages payable, notes payable, loans payable, accrued income taxes, income taxes payable, bank overdraft, creditors, bills payable, advances and deposits received, trade payables, issue premium.