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Understanding the Balance Sheet

Published November 25, 2013 by Mayrbear's Lair

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Making investments in a company’s stock is a significant event in an individual’s life because an uninformed decision can become quite costly. To make the most informed decisions, individuals should conduct extensive research to help them make choices they feel secure about. To achieve this, many people can look to a company’s annual report for more insight into their financial condition. Roth (2008) explains that a company’s financial statements contained within their annual report are a significant asset to help individuals who are looking to make a sound investment in a company’s stock. They help people make better assessments by learning about a company’s strategies, financial health, and even information about their behavioral and moral values (Roth, 2008).  For this blog post, we will address our fictitious friend Liz who is confused about the true state of the Target Corporation’s financial condition (See Exhibit A below). This is a brand she is considering investing in because of her emotional attachment to it. However, the figures her buddy Tom disclosed upon reviewing their balance sheet suggested that investing in Target was not a sound idea because of the substantial percentage amount (74%) they invested of their total assets as risky obligations. Tom’s percentage rate caused Liz confusion because her calculations arrived at a different figure which was lower and amounted to 65%.

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To help Liz with her confusion, we must explain how Tom arrived at his position. First, let’s analyze how Liz calculated her figures. For example, at the end of their fiscal year in February, 2008, the Target Corporation had liabilities (including current and long-term) that rounded off to about $29 million, while their asset totals came to about $45 million. To help Liz better understand these debt structure figures, she looked to a common-size balance sheet formula to translate these numbers into percentages. By taking the $29 million liabilities figure and dividing it by the $45 million asset figures, Liz came up with 65% as amount of debt Target has accrued. Tom, however, arrived at a figure that was nearly 10% higher which confused Liz because her math equations incontrovertibly added up.

Calculating-Percentages

What Liz did not take into consideration in her calculations, however, were the company’s commitments and contingencies contained within the notes of the report.  Fraser and Ormiston (2010) suggest that even though the balance sheet may not reflect a dollar amount in this category, this disclosure is intended to draw attention to the information that is located in the notes of the financial statements. These notes are significant because they list the commitments of a company’s contractual obligations that may still have an adverse effect on their financial outlook. Because companies engage in complicated financial reporting procedures that include such things as product financing, sales of receivables with recourse, limited partnerships and joint-ventures, that are not required to be included on the balance sheets, they are however, provided in the notes (Fraser & Ormiston, 2010). These are complicated components that are difficult to comprehend but play an important role in painting a full picture of the company’s operations. In other words, there are other factors that are not reported on a company’s balance sheet with unpredictable outcomes that can have an effect on Target’s future liabilities. In other words, Liz also needed to include in her calculations the figures provided in the commitments and contingency notes as well. These notes revealed for instance, that Target also had further contractual obligations and operating leases that extended beyond the year 2008 which included lease payments of $1,721 million with options that could extend the terms of the lease. Their contractual obligation payments also consisted of interest rates and a $98 million commitment in legally binding lease payments for the planned openings of future facilities that were scheduled to occur in 2008 or later. Tom arrived at his additional 10% figure because he factored in the information of these provisions to his equations and Liz did not.

Exhibit A

Target Example

References:

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Roth, R. (2008). The writers guide to annual reports. Atlanta, GA: Booksurge.com.

The Annual Report

Published November 13, 2013 by Mayrbear's Lair

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Today begins our six week adventure navigating through topics that will help us understand how business owners can make the most effective the financial decisions that help them run their companies more efficiently with higher profits. Dr. Felix Lao (2013) explains that:

“The measurement of accounting information is critical to the owners of the business to make judgments about the value of assets or liabilities owed by the business. It accurately measures profit or loss made by the business in a particular period. Shareholders can make decisions and evaluate about the future of an organization by looking at past and current financial data. It helps management actually manage the operation by looking at functional units as well as overall performance and effectiveness to plan. The information provides critical tools that reveal an accurate and true view of the financial position of the company to ensure that risks are adequately and appropriately taken and the resources are invested well.”

To give us a better understanding of the financial condition of a company, my research work will take a closer examination of the extensive financial information that is contained within a firm’s financial tome known as their Annual Report. Take for example a company like Target that does a fabulous job selling products to customers.  A good number of consumers are so pleased with this corporation’s performance in fact, that many consider buying shares in the company’s stock.

To find out more about their financial situation investors will look to their annual reports to help them determine how well the company is performing.  Unfortunately, more questions arise regarding the content of these reports because most individuals are not trained in deducing the information they contain to help them comprehend the true nature of the company’s financial health.  Technical questions about the firm’s financial condition and performance cannot easily be addressed unless the key elements in the annual report are understood. Investors must acknowledge that in order to figure out how well a company is doing they must look to the company’s financial statements because those are the documents that can provide details that address the following information: (a) where a company’s money came from, (b) how it was spent, and (c) where it currently stands.

2011-annual-report-finances

Typically, there are four kinds of financial statements in a company’s annual report: (a) the balance sheets that disclose what a company owns and owe, (b) the income statements that reveal incoming revenue and outgoing expenditures, (c) the cash flow statements which show the exchange of currency transactions, and (d) the statements of shareholders’ equity which reveal the changes in shareholder interests (Beginners guide to financial statements, 2007). Individuals who can comprehend the information these statements contain are in a better position to understand the company’s financial condition.

The financial statements in a company’s annual report are useful for many reasons. For example, Fraser and Ormiston (2010) explain that they not only reveal how well the firm is performing, they also show whether or not it is providing opportunities for growth and future advancements  (Fraser & Ormiston, 2010). The enormous volume of information in these reports can  be intimating to the untrained eye. To help with an overview of the most important aspects, each report contains a 10-K form which serves as a summary that highlight the report’s key components.

Smart investors will look to the contents of the firm’s annual report to help paint a clear picture of what a company is doing, what it claimed it was going to do, what it actually did, and most significantly, what it intends to do next. Roth (2008) also points out that annual reports are significantly more important in today’s economy because they have become a platform for which organizations use to expand their investments, launch new products, create more effective marketing strategies, address behavioral or morale issues, and can even alter a company’s strategic direction (Roth, 2008).  In other words, the information provided in them are beneficial to investors and creditors whose interpretation of the contents contained within these reports can help them assess the firm’s viability.

References:

Beginners guide to financial statements. (2007, February 5). Retrieved October 28, 2013, from U.S. Securities and Exchange Commission: http://www.sec.gov/investor/pubs/begfinstmtguide.htm

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Lao, F. (2013). Ashford University. Clinton, IA.

Roth, R. (2008). The writers guide to annual reports. Atlanta, GA: Booksurge.com.