Chapter 4 –
Analysing Financial Statements
How Firms Add
Value
Wow this chapter really gets straight into the depth of
the topic. I have to say I was a
terrified when I turned the first page and abbreviations jumped out at me all
over the page – aaahhh (FCF), (C), (FCF), (DCF) and so on. My first impression was am I going to be able
to do this assignment, self doubt started setting in. My
brain shut down just from seeing all of those abbreviations, as I knew they
would lead to equations, which will no doubt test me. I knew at that point, that I would be
challenged by this chapter.
Big breath, let’s just do this! The questions start….Key
Questions- What does ‘transfer’ of value regarding cash flow in a firm
mean? Regarding Capital markets, why would you trade in something that you know
may never happen? If equity investment involves predicting the future, what
tools does one need to do this? Discounted cash flow? Economic profit frameworks? I NEED A TUTOR!!!
I would have really liked to see a physical example in
this section with arrows pointing to show the flow, I found I had to read and
then re read to make some sense of the topics being discussed.
I forced myself to keep reading and just as my brain was beginning
to switch off, stumbled across something that finally made sense, yeah!
Key Concepts - I really
connected with the author when he said ‘To understand the value of the equity
of a firm we need to engage with the economic and business realities of a firm
that are actually driving the creation of value by the firm for its equity
investors” and then later compared the true cost of investing capital to our
own lives. All of these equations and
abbreviations suddenly had some relevance to me.
Key Concepts - I found
immense value in this comparison as I am currently planning the future model of
my working career, still however with some grey areas to iron out until I have
complete clarity. Weighing up the cost
of studying part time to complete my degree and further my working ability at
an older age was one I took very seriously.
I have to see this journey as an ‘investment’ in my mind to ensure I
stick with it. It could also be compared
to, if someone was suddenly diagnosed with a serious but fixable illness. I had a friend who was diagnosed with
diabetes and extremely high blood pressure and the doctors wanted him to
immediately take medication as he was a prime candidate for a heart attack or
stroke. When he weighed up the ‘cost’ to
his body of being on such high doses of medication and their known side effects,
he decided to make changes naturally.
Three months later with normal blood pressure and a healthy sugar level,
the doctors were amazed at the transformation.
When they asked what he did, he said I wrote a list of pros and cons to
reflect fixing myself with medication and I worked out I could fix this with
diet and exercise. The ‘cost’ therefore
was that he could no longer have his afternoon teas at the coffee shop
devouring pieces of chocolate cake smoothed in rich icing.
I can personally reflect on this concept as I spent quite
a lot of time weighing up the ‘cost’ of studying, to further my career. The added pressure to my already filled plate
was not something I took lightly and serious changes have had to be made. Five children, one being a baby (who is full
time at home with me) and a demanding job where you are only paid when you
perform (by commission) is not easy at the best of times. When I weighed up the ‘costs’, I realised I
could only physically study part time.
At this stage a slow part time.
The realisation I have to say was quite depressing as the thought of years
of studying to gain completion felt very daunting.
Originally I took on two modules. The thought of six
years of getting up at all hours of the day and night was not one I took
lightly and of course there is still an amount of unknown at the end ie will
this actually give me what I need for my job, what if I change direction on the
way, six years is a long time and there is a high possibility that change will
occur in that time.
I soon realised that I could only handle one module at a
time and then I had to reassess the ‘cost’ again to our lives of me
studying. By weighing this up, I
confirmed to myself that the future is always unpredictable and that I need to
make decisions based on the future as I see it currently. I guess this could be compared with how
capital markets work and why people trade in something that involves predicting
the future. Even though you take in as
many possible scenarios as you can think of, you still have to weigh it up on
the current realities, what has and hasn’t worked in the past and the direction
in which you are aiming for. I believe
this would be no different for a company.
A company would use the reality of the information in front of them, the
information relating to where they have been and the goals for the future, to
create the direction. They would use all
of these things to weigh up the ‘cost’ of going in the direction they were
currently planning.
I am a person who likes to challenge the ‘norm’ on a
daily basis and cannot stand people telling me, “You cannot have your cake and
eat it”. Why? Why can’t we have our cake and eat it. If you know clearly what is important to you,
what you are willing to sacrifice and not sacrifice, and then all you have to
do is find the right path that leads you to your goal.
When I had my youngest daughter Victoria, I weighed up
the pros and cons of continuing work and ‘costs’ to the household, little
Victoria and myself and I came up with three choices which I presented to my
boss, I can work from home, I can work
from the office with Victoria or I can leave. These were my only three choices,
as I had already weighed up the ‘cost’ of child care and the emotional separation
for myself and Victoria.
My bosses reply was, “I don’t care what you do as long as
you do your job to the same standard”.
So I tried to work in the office. I was not about to give up on being the best
Mum I could possibly be to our young daughter all because I had to earn a
living, so I breastfeed my baby at work.
I shut my office door and breastfeed my baby. It
was a struggle I have to admit. I was
exhausted from having a new baby at work, no sleep and trying to do all and be
all. I survived and you’ll be glad to
hear so did the baby! I then had to
weigh up again the ‘cost’ of doing things the way I was doing them and I
decided to work from home – I now do most of my work in my pj’s, my Mum comes
to help a couple of days. I take fifteen
minutes to get ready for an appointment now, where I used to be perfectly
groomed and take an hour. Most days the
heels are traded for flats as I often have to do a hand over with the baby
somewhere along the way. My Lancel
handbag now carry’s nappies and wipes and Victoria has been to numerous
appointments to list properties, sign contracts and talk to developers.
I decided to dump all clients who don’t like the new
style of working me and only deal with people who didn’t care that I was
wearing a baby attached to my back. I do
my job, when I cannot physically do my job which is not very often, I am honest
and say – Victoria is unwell can we meet on a different day or time etc, I
weighed up the’ cost’ of losing those clients compared to caring for my
daughter and, Victoria always wins. When
you know what you will and won’t compromise on it creates the foundation for direction. It also makes decision making fairly
simple. Weighing up family to money has
been something that regularly pops its head up in the work I do. I have lost countless number of ‘the big
deals’ which I have had to hand to someone else because I will not sacrifice
being a Mum. I have been wealthy and I
have also been very poor when my ex husband made me chose between money and my
children.
Weighing up ‘cost’ is a daily occurrence in everyone’s
lives. It is not something to be ashamed
of, in fact it should be embraced, as it makes us, whether personally or in
business, take responsibility and forces direction. I believe it is a good thing;
it makes us stop, reflect and dream for a better future and the path to get there. It also makes us dig deep into our own selves
and creates a strong willpower; it’s the willpower that gets us to our end goal. I believe a focused CEO of a company would
use these same concepts to create a successful direction for the company they
work for.
By reflecting on
what has worked in the past and what
hasn’t, comparing the negatives and benefits, by way of weighing up the pros
and cons of going in the direction being considered, shows the true ‘costs’ to a company and can help them make well thought out informed decisions for
the future.
In my situation, I had to weigh up the ‘cost’ and reality
of completing my degree part time. If it
takes me six/seven years to complete this degree how will this impact my work
schedule and household? Understanding
the realities that are involved in a situation are important as they these
realities provide the clarity and are what you will use when you actually go
through the process of weighing up the ‘cost’ of what you are considering.
In my case, the
realities are, I know at the half way mark I can approach companies to gain on
the job experience (you need to have completed half of your degree as even with
a degree, I will still need two years work experience to become a qualified
valuer). I gave thought to how this
would affect my energy levels which are already low from having to deal with a
few family problems and having a baby later in life which caused a magnesium
and iron deficiency. So to add something
further to my plate I had to start investing in my health by transforming my
diet and exercise regime, a direct ‘cost’ of making a decision to be able to add
a further workload to my days.
As stress is a major factor of our undoing and feeds the
negativity that tells us that we can’t do something I had to face these
realities also. To want to do more, I
had to then be more. More exercise, a
better diet, stress management and so forth, all of the ‘costs’ of making this
decision. As too much stress especially could
be my undoing, I had to find some time to investigate how to manage the
possibility of further stress.
The reality was that to do so I had to first understand
what triggered stress and how I could combat this quickly so my goal direction
could continue with minimal interruptions. I found short yoga bursts, walking and short
intervals of intensive exercise, distress and reboot my energy levels. Little bits of constant exercise fit into my
crazy days. Changing my mind set on how
I view my body was also essential. I now
take note of what I put in my mouth as in, is it refuelling my body or
harming. My nightly glass or two of red
wine my biggest hurt ‘cost’ as there is nothing like having a glass or two of
wine while watching the sunset over the ocean to end the evening with my
husband. However I soon noticed that we
enjoyed the time so much that we sporadically enjoyed more then we should and
the affect was, I woke feeling tired and irritable. I cannot afford to be tired at the start of a
day, so we banned wine during the week replacing it with camomile tea instead,
and the ‘cost’ actually made no difference as it was the habit of sitting and
chatting and watching the sunset that we actually enjoyed. Another example of having your cake and eat
it.
Just like a firm’s goal is to add value to its equity
investors, so is it the same for myself, investing in completing this degree is
furthering my employment opportunities. The
‘cost’ of completing this degree is definitely worth the outcome as it adds value
to my household and the growing costs of my family. There are other added benefits that are
invaluable compared to the costs of being time poor from studying. My children are still with me every day and they
also see what I am doing and why I am doing it and the long term investment I
am making for the future of us all as a family.
So when I say to the children , “No friends today I am
behind on an assignment but you can have them once I am finished”, they
understand the importance of co operating without argument, as long term they
see the expenses of their education etc and how by me getting more qualified
helps pay for a stronger future for them.
So in a way the children also weigh up the ‘costs’. They see that the goal is a good one which
‘value adds’, benefiting all.
Operating and
Financial Activities
Key Questions - I
struggled getting my head around why one would bother restating financial
statements in the first place. I found the only way I could digest this
chapter was to go back and highlight key points and then reflect on those
points. I did this to help find the
words the author was using that I could connect with directly and help create
understanding when my brain kept telling me, switch off/shut down, too
hard.
From this passage I gained the understanding of the
importance to separate operating and financial activities. By dissecting this chapter in which I
originally found difficult, this way, made it all seem less daunting. The author had made the key point’s very
straight forward and the nuts and bolts of his work were actually very easy to
interpret. I wish I had thought of doing
this to the previous chapters I read. I
guess that is the value of learning, you can always learn something new.
Key Questions - As I read the
reason why we need to identify all of the firm’s earnings, I wondered to myself
if all companies do this, separating financial and operating activities? If it isn’t mandatory by law to be included
in financial statements and I’m assuming most share holders have never thought
to do this before, do all companies do this?
I get the feeling it is not something they want everyone to know in case
the real figures are exposed and the ‘naked’ results of the company are on show.
Key Concepts - I enjoyed
the author’s comparisons to a Kinder Surprise chocolate when explaining the
difference between financial and operating activities; it was a great way to
simplify the two. It makes sense that it
is easier to add value to equity investors through operating activities instead
of financial. I never really thought before how difficult it must be as a
company to keep both wheels spinning.
Restate Two Key
Financial Statements
For someone who had never really thought too in depth
about individual financial statements before, I felt the author used
explanation language that created clear understanding.
As I read through this section I realised I would encounter
several problems when I must restate my company’s financial statements as some
of the wording in my company statements I found difficult to interrupt.
Profitability and
Efficiency
Key Concepts - I like the analogy
Martin used regarding his son and how he would take things a part and then go
through the process of putting them back together while being compared to how a company goes
about restated their financial statements.
Conclusion
I struggled with this chapter from the very beginning and
found the topics discussed hard to digest.
There was just so much information to take in. I
found in the other chapters I had read so far I could relate more to the readings. I guess all of the nuts and bolts of
financial statements had to be discussed eventually and the author did an
impressive job of fitting so much complex information into one chapter,
simplifying terms as much as possible. I
found the best way not to become overwhelmed with what I was reading was to go
back and highlight the key points and re read those.
The understanding I took from this chapter was, if you want
to see what is really happening in a company to determine a goal path, then you
need to not only separate the operating and financial activities, but you also
need to look at the past history, opportunities for the future and when you
have weighed all of those things up you can determine what ‘costs’ would be
involved in moving towards that goal with at all times making sure that value
is being added for equity investors.
My connection to this chapter came from one sentence that
the author said that “The true cost of everything we do in life is the
alternative things we could have been doing with our time energy and resources”. This sentence really resonated with me. It was my “Oh I get it moment”, the reason
for restating these financial statements.
Understanding the finance and operating activities of a firm in its
current state, allows one to compare it to its past activities, to create a
future. Before a future can be created,
the ‘cost’ of going forward must be thoroughly investigated.
