While Statement of Cash Flows explains Cash and Cash Equivalent figure from Statement of Financial Position, this statement gives more details and explains the figures given in the equity section of Statement of Financial Position. Rows titles given in the equity section of Statement of Financial Position are the titles for each column in the Statement of Changes in Equity i.e. Share capital, Share Premium, Retained Earnings and reserves
This statement looks very complicated and congested with numbers which may puzzle or confuse you. However, there are only a couple of figures which are relevant for the financial analysis.
In my another article, https://www.rmr-accountants.co.uk/equity I have explained that Retained Earnings figure in the Equity section is an important figure from financial performance and analysis viewpoint as it represents accumulation of undistributed profits in the past. A higher figure means better past performance. However, it should be noted that this figure can also be negative (in brackets) for those companies who have made losses in the past. This is usually the case for start ups and struggling companies. If this figure is in brackets, it should be taken as negative.
For Ratio Analysis, the most important figure given in this statement is the figure for “Dividend”. Dividend is the distribution of profits to shareholders. There are many ratios which look into this figure as Dividend policy is an important topic from financial analysis perspective. Dividend figure may also be given in Statement of Cash Flows which represent how much dividend has been paid which could be for this year or/and the previous year. however, Statement of Changes in Equity contains the figure which is declared for the year. If this figure is different in both statements, you should take the figure from the Statement of Changes in Equity. The figure for dividend can be seen in the Retained Earnings column as profit for the year from Statement of Profit or Loss is added to the Retained Earnings and loss for the year and dividend is deducted from the Retained Earnings figure.
The rest of the figures given in this statement are not directly relevant for the sake of financial analysis so we will discuss these below briefly.
The first column is for share capital which represents the nominal value of the shares issued by the company. In figure 8.1, this figure for Burberry is £0.2million which is calculated by multiplying the number of shares with the nominal value of one share (418,275,123 shares x 0.05p). The movement in this column is for issue of more share which will increase the value of this column and/or purchase of own shares which will reduce the value of this column. Companies issue more shares to increase money mostly for growth. However, in difficult times, the reasons could be to pay for operating expenses. For example, during Covid-19 pandemic, Rolls-Royse PLC issued more shares to pay for running expenses to survive the reduction in revenues. A buyback of shares usually indicates the company has surplus cash for which they have no other use at the moment.
Share premium is a reserve which has a direct link with Share Capital. In https://www.rmr-accountants.co.uk/equity , I have discussed the nominal value of a share. This is a value which is recorded in financial statements when a share is issued at its nominal value by the company to the shareholders. However, it is often the case, especially for well-established and profitable companies, that the shares are sold more expensive than the nominal value of the share. For Example, a share with a nominal value of £1 can be sold at £10 or even £100. Anything above the face value will be recorded in share premium account.
Most of the reserves given in equity section are simply the different names for Retained Earnings as these reserves are created out from Retained Earnings figures. As the name suggests, these reserves represent the monies put aside (reserved) for different reasons. For example, Capital Reserves indicate business ability and intention to invest in long term assets in future.
However, there are reserves which have no direct connection with retained earnings. Revaluation Reserves are reserves which are created when assets are revalued. For example, if a building was bought for £1million and 5 years later its value has increased to £2 million, the gain of £1million will be recorded as revaluation reserve. The accounting rules do not allow to record it as a profit until that asset is sold.
Hedging Reserves and Foreign Currency Reserves also do not have a direct connection with the financial performance. There are only very few ratios where these individual numbers are relevant so my advice is not to spend too much time in this area.
This article is written by Raja Mizan who is a senior lecturer in accounting & finance in a UK university. He is an ACCA member and also runs his own accountancy practice RMR Accountants & Business Advisors.