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  Business Education
Understanding Annual Reports

How to Read a Financial Report.

The purpose of this guide is to give the reader the most important elements in reading a corporate financial statements. This guide is particularily useful for non-financial managers that need a clear understanding of what is included inside financial statements and the ability to communicate this information to other colleagues. After all, accounting is the language of business.

Corporate financial statements have three basic types: Income Statement (or Profit and Loss statement), Balance Sheet, and Cash Flow Statement. The income statement tells you how a company performed over a period of time which is usually one year. The balance sheet statement tells you what the company owns (assets) and owes ( liabilities ) at a specific point in time. The cash flow statement explains to the reader the actual inflows and outflows of cash from the business firm.

Balance Sheet

The balance sheet represents the financial position of the company at a particular day. This is normally at the end of a 12 month period. Some companies financial periods will end on December 31st of each year which is called the end of the calendar year. A company's financial period that ends on another month is referred to as a fiscal year period. The balance sheet is divided into two parts: assets and liabilities and stockholders equity. Both sides must always be in balance. The assets column lists all goods and property that the business firm owns. Liabilities lists all debts by the company.

The following sections gives you a comprehensive explanation of each element found in a balance sheet.

  Current Assets
  Current assets includes cash and other assets which will normally be turned into cash at some point during the year. Cash will sometimes include marketable securities in a balance sheet. Marketable secutrities are generally highly liquid and safe short-term investments that a company holds to park its idle cash not earmarked for any business expenses.

The Net Working Capital figure simply deducts the current assets from the current liabilities on the balance sheet. USBR calculates the Net Working capital as follows:

1 Cash $ 30,000


  Marketable Securities

Marketable securities represent temporary investments of excess or idle cash. This cash is usually invested in money market securities such as commercial paper or treasury bills. These are normally highly liquid and safe investments since many are backed by the federal government and very large companies with high credit standing. Marketable securities have very little if any price fluncuation and are normally shown on the balance sheet at cost.

2 Marketable Securities - cost $40,000 ( Market Value $42,000 )

  Accounts Receivable

Accounts receivable represents amounts of sales not collected from customers. Goods are normally shipped to customers prior to payment which creates receivables. Most businesses require customers to pay within 30, 60, or 90 days. Some customers may fail to pay their bills due to a wide variety of circumstances Thus, accounts receivable must represent a realistic projection of customers who will not pay. The accounts receivable are figured after a provision for bad debts This is a bookeeping entry which estimates the amount of receivables that will not be collected.

3 Accounts Receivable - ( Less allowance for doubtful accounts $2,875 ) $225,000



The inventory of a manufacturer is composed of three groups: raw materials, work-in-process, and finished goods . The raw materials is goods to be used in the finished product. Work in process is partially completed products, and finished goods inventory is completed and ready for sale. Inventory is usually measured at cost according to Generally Accepted Accounting Principles (GAAP)


  Prepaid Expenses

Prepaid expenses are deferred charges for such items as the introduction of a new product to market, plant relocation expenses. However, deferred charges are not included in current assets because the benefit from the expenditure will be reaped over several years into the future. Therefore the expenditure incurred will be gradually written off over several years rather than fully charged off in the year the payment is made.

Prepaid Expenses $76,600



  Total Current Assets

Current assets are the working assets as mentioned above because they are in a constant cycle of being converted into cash. Inventories are sold and become accounts receivable. Accounts receivable when collected become cash. Cash is then used to pay business debts and on-going operating expenses.


  Fixed Assets

Fixed assets are often referred to as property, plant , and equipment. Fixed assets represents assets not intended for sale that are used over and over again by the business firm to process and manufacture the product, warehouse, or transport the product to different locations. This category includes land, buildings machinery equipment, furniture, automobiles, and trucks. These assets are generally valued at cost less the accumulated depreciation on the balance sheet.

The fixed assets amount reported on the balance sheet is not intended to reflect market value at present or replacement cost in the future. It is recognized that the cost to replace an asset at some future date may be higher, that cost is also quite variable.


Depreciation is defined as the decline in usefulvalue of a fixed asset due to wear and tear from use and passage of time. Fixed assets may also suffer a decline in useful value from obsolescence because of new products or technology that makes the present equipment out of date.

The cost incurred to acquire the property, plant., or equipment must be spread over the expected useful life by taking into account the factors discussed above.

  Accumulated Depreciation
 Depletion is a term used primarily by mining and oil companies or any other type of extractive industries. To deplete means to exhaust or use up a resource. As the oil or other natural resource is usedup, a depletion reserve is set up to compensate for the natural wealth the company no longer actually owns.
  Net Fixed Assets
 Net fixed assets is the valuation for balance sheet purposes of the investment in the property, plant, or equipment This figure is arrived at by deducting the depreciation from the original cost of the asset which is the accumulated depreciation since the time of the asset's purchase.
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