The earnings statement

MINING EXPLAINED

— The following is an excerpt from Mining Explained, published by The Northern Miner.

Sometimes called the income statement or profit-and-loss statement, the earnings statement shows how much money a company made or lost during the year from the sale of products or services, and the expenses the company incurred for wages, operating costs, etc. The difference between how much was taken in and how much was spent is the net earnings, or profit, of the company. This money is used to reinvest in the company and to pay dividends to shareholders.

The earnings statement is divided into four main sections: the operating section, the non-operating section, the creditors’ section, and the owners’ section.

The operating section lists income from the sale of the company’s goods or services, minus the cost of sales (labour, energy, etc.) This provides the gross operating profit.

In the non-operating section, non-operating income, such as interest and dividends from company investments, is added to the net operating profit. To this is added “extraordinary items,” which are any unusual and significant additions to income or losses (the one-time sale of a large asset, for example). The sum of these represents the company’s remaining income from all sources.

Payments to creditors are listed in the creditors’ section. These usually take the form of fixed interest charges on bank loans and interest charges to other debt-holders who have lent money to the company. These payments are deducted from the income of the company.

Finally, we have the owners’ section, which shows the company’s net earnings or deficit. The net earnings are shifted to the retained earnings statement, which shows the total annual earnings retained after payment of all expenses and dividends.

The retained earnings statement

This portion of the annual report shows the amount of earnings which have been kept in the business, either as cash or reinvested in new assets. Stated another way, this portion of the annual report reveals the excess of net earnings that have been accumulated by a company year-by-year, over and above dividends paid out to shareholders.

Changes in financial position

This section of the report explains changes in working capital (current assets minus current liabilities) between two consecutive years. It goes by many names (including “source and application of funds statement” and “source and use of funds statement”), but basically acts as a bridge between a company’s balance sheet for those two years. It also summarizes how a company raised financings for the year and how those financings were used.

Auditor’s report

Companies are legally required to appoint an outside, independent accountant to represent shareholders and report to them each year on the company’s business. Essentially, the accountant’s job is to verify the accuracy of the company’s financial statements. The auditor’s report is usually quite brief, and is meant to give the shareholder assurance that the annual report is a reliable indication of the company’s financial health. Unfortunately, in recent years, the brief report came with an equally cursory examination of the company’s finances — and the resulting financial scandals led some investors to question the competence and professionalism of the major auditing firms. The accounting profession, fortunately, is taking steps to repair the damage done by poor auditing practices, and with financial accounting practices gradually being standardized around the world, we can hope that the auditor’s letter can again be seen as a measure of certainty in financial reporting.

Notes to the financial statement

Finally, interesting information is often found in the notes to the financial statements in annual reports. Study these carefully, as they will sometimes disclose details of lawsuits filed against the company, or other information useful to investors.