Understanding Financial Statements: Urban Outfitters Case Study

Introduction to Financial Statements

Financial statements are the official records of a company's financial performance and business activities over a given period (Kramer & Johnson, 2009). They serve stakeholders in several distinct ways. Investors use them to assess a company's profitability and decide whether or not to invest in it (Kramer & Johnson, 2009). Lenders may use them to assess whether the business is a going concern and, consequently, whether to extend credit facilities (Kramer & Johnson, 2009). Labor unions may also use the information presented in financial statements as a basis for negotiations with management (Kramer & Johnson, 2009). Finally, a company's owners and management use financial statements to assess financial performance, determine profitability, evaluate whether the business is a going concern, and as a basis for planning — such as determining how much to pay in employee bonuses (Kramer & Johnson, 2009). All the information needed to make these decisions can be found in items within the financial statements and in the accompanying notes to the accounts (Kramer & Johnson, 2009).

The Four Basic Financial Statements

There are four fundamental financial statements: the income statement, the balance sheet, the cash flow statement, and the statement of changes in equity (Kramer & Johnson, 2009). The balance sheet is a statement showing a company's assets and liabilities as at a given date (Kramer & Johnson, 2009). The income statement is a list of a company's total revenues and expenses, and the resultant surplus or deficit (Kramer & Johnson, 2009). The cash flow statement lists cash outflows from investing and operating activities as well as cash inflows over a given period (Kramer & Johnson, 2009). Finally, the statement of equity shows the changes in shareholder equity throughout a given period (Kramer & Johnson, 2009). This paper focuses on the income statement and the balance sheet, as these are the most relevant statements for understanding Urban Outfitters' financial position.

Urban Outfitters: Nature of Business

It is important to briefly understand the nature of Urban Outfitters' business in order to better interpret its financial statements. Urban Outfitters' core business involves wholesale selling and general consumer retail through mobile applications, catalogs, websites, and physical stores. As of January 2016 and 2017, the company operated 572 and 606 stores globally, including 484 and 515 stores in the United States respectively (SEC, 2018). The company prepares consolidated financial statements, which bring together the business operations of all branches and subsidiaries, with a fiscal year ending January 31st each year.

The Balance Sheet and Its Constituent Items

The balance sheet summarizes a company's liabilities, assets, and shareholders' equity (Welc, 2020), thereby showing the company's financial position at a given point in time.

Assets are the business's economic resources, which may be either tangible or intangible, and either current or non-current. Current assets are those liquidated, used, traded, or sold within one year — typically through normal business operations — and can be readily converted into cash (Welc, 2020). Non-current, or fixed, assets are long-term assets used for more than one year (Welc, 2020).

The company's current assets include:

i) Cash and cash equivalents — the total value of cash on hand, in the bank, and in highly liquid investments with maturities of less than three months.

ii) Marketable securities — the value of securities with maturities of one year or less, recorded at amortized cost, which reflects fair value.

iii) Inventory — the value of closing stock recorded at net realizable value or cost, whichever is lower. Net realizable value is estimated by analyzing trends, expected changes in demand, and anticipated discounts (SEC, 2018). Cost is estimated using the first-in-first-out (FIFO) system and takes into account agent commissions, import taxes, freight charges, and storage costs (SEC, 2018).

iv) Accounts receivable — the total value due from credit card receivables and the company's wholesale customers (SEC, 2018).

v) Prepaid expenses and other current assets.

i) Property, plant, and equipment — the total value of equipment, buildings, and furniture and fixtures, recorded at cost less accumulated depreciation. Depreciation is calculated using the straight-line method (SEC, 2018). Depreciation is the process of expensing an asset over its useful life (Alvarez & Fridson, 2011). The straight-line method involves expensing an asset in equal annual installments until it reaches its salvage value — the amount the company expects to recover from disposing of the asset at the end of its useful life (Alvarez & Fridson, 2011). The company depreciates operating equipment over a useful life of 3 to 10 years, buildings over 39 years, and fixtures over 5 years (SEC, 2018).

ii) Intangible assets, goodwill, and long-lived asset impairment — impaired assets are those whose market value has fallen below their book value (SEC, 2018). These are written down on the balance sheet, and the impairment loss is recorded in the income statement (SEC, 2018).

Liabilities are the company's credit obligations (Welc, 2020). Equity is the claim of the company's owners over its assets, represented by the value of preference and common shares held (SEC, 2018). Common shareholders are the company's owners and hold voting rights, while preference shareholders are creditors without voting rights (Welc, 2020).

The basic balance sheet equation is:

Assets (what the company owns) = Liabilities + Equity (the sources that provide the assets) (Kramer & Johnson, 2009).

Common liabilities include:

i) Accounts payable — amounts owed to creditors with a repayment period of less than one year.

ii) Accrued expenses — expenses that have been incurred but for which cash has not yet been paid.

iii) Deferred rent and other liabilities — the company expenses rent in equal annual installments over the lease period (SEC, 2018). Deferred rent is the difference between the cash paid and the annual rent expense recognized (SEC, 2018).

iv) Long-term debt — debts with a repayment period of over one year.