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MODULE 2:FINANCIAL STATEMENTS
Financial Statements include:Balance Sheet*Income Statement*Statement of Cash FlowStatement of Stockholders’ Equity
*Module 2 focus
Financial Statements 1
BALANCE SHEET OVERVIEW
Purpose: indicate the financial position, including what the company owns and owes.
Time: relates to a single point in time, rather than a period of time.
Two Parts:
Assets – are owned and have probable future benefits
Equities – indicate how assets were acquired, two types:
Debtors’ equity, known as liabilities Stockholders’ equity
Financial Statements 2
The balance sheet is also called the “Statement of Financial Position.”
In fact, that is the preferred term used by international standards.
Use of the Balance Sheet
Based on formula:
Everything we have came from somewhere.
Assets = Liabilities + Owners’ Equity
The balance sheet is used to evaluate:
Liquidity – time needed to change an asset into cash or to cancel a liability
Solvency – ability to pay long-term debts as they mature
Financial Statements 3
Both sides of the equation should be the same!
BALANCE SHEET FORMAT
Balance SheetXXX CorporationAt Dec. 31, 20XX
Assets Liabilities
Current Assets 17,000 Current Liabilities 8,000Investments 1,000 Deferred Taxes 2,000Fixed Assets 80,000 Long-Term Liabilities 30,000Intangible Assets 1,500 Total Liabilities 40,000Other Assets 500
Owners’ EquityCapital Stock 40,000Retained Earnings 20,000Total Equity 60,000
Total Assets 100,000 Total Liabilities and Equity 100,000
Financial Statements 4
BALANCE SHEET CLASSIFICATION
Asset – Probable future economic benefit obtained or controlled by the entity
Assets are recorded if:
Rights are acquired
Possesses future economic benefits
Five Major Categories
Current Assets - Expected to be realized in cash, sold, or used up within one year.
Investments - Securities or property held longer than one year for the purpose of enhancing income.
Fixed Assets - Property, plant and equipment used in business.
Intangibles - Lack physical existence.
Other assets – do not fit in above categories
Financial Statements 5
You own it!
It has value!
Balance Sheet ClassificationCurrent Assets
Current Assets – Expected to be realized in cash, sold, or used up within one year.
Examples:
Cash – coin, currency, and funds on deposit in the bank; most liquid asset
Accounts Receivable – claims against customers and others for money, goods, or services (amounts owed to us)
Prepaid Expenses – cash paid to others before receipt of goods or performance of services
Inventories – raw materials, work in process, or finished goods held for further manufacturing or sale
Short-Term Investments – securities held for less than a year, usually for cash management purposes
Balance Sheet ClassificationLong-Term Investments
Securities or property held longer than one year for the purpose of enhancing income (rather than cash management).
Financial Statements 6
Balance Sheet ClassificationFixed Assets
Fixed Assets - Property, plant and equipment used in business (does not include property held for investment).
Examples: Land Buildings Furniture Equipment Construction in Progress
Balance Sheet ClassificationIntangible Assets
Intangibles – Non-financial assets with no physical substance
Trademarks – word, symbol, or phrase that identifies a particular company or product
Patents – government granted right to use, manufacture, and sell a product or process (20 years in US)
Copyrights – government granted right to utilize the creation of an author, artist, or musician
Franchise Rights – right to sell certain products or services
Goodwill – excess cost over the fair market value of identifiable assets; occurs only when buying another company.
Financial Statements 7
BALANCE SHEET CLASSIFICATIONAccounting for Liabilities
Liability – probable future sacrifice of an economic benefit
Qualities of a Liability
An asset or service must be transferred in the future
The entity cannot avoid the transfer
The event causing the obligation has already occurred
Current Liabilities – Due within year and paid by current assets. Example: amounts owed to suppliers (called accounts payable).
Long-Term Debt – Financial payments to be made after one year. Example: mortgage on a building.
Other Long-Term Liabilities – Obligations not considered current liabilities or long term debt Example: deferred income taxes and retirement obligations
Financial Statements 8
For analysis purposes, APIC is treated the same as Common Stock.
BALANCE SHEET CLASSIFICATION
Shareholders’ Equity
Residual interests after obligations to creditors are met.
Equity Accounts:
Common Stock – represents voting ownership in corporation
Additional Paid In Capital – common stock that exceeds “par”
Preferred Stock – optional form of ownership, usually with dividends and without voting rights
Retained Earnings – cumulative net income that has not been paid in dividends
Treasury Stock – stock repurchased by the company (contra-equity)
Financial Statements 9
CONSOLIDATED BALANCE SHEETSThe Home Depot, Inc. and Subsidiaries
AMOUNTS IN MILLIONS, EXCEPT SHARE DATA
January 29, January 28,2012 2007
ASSETSCurrent Assets:Cash and Cash Equivalents $1,987 $600Receivables, net 1,245 3,223Merchandise Inventories 10,325 12,822Other Current Assets 963 1,341Total Current Assets 14,520 18,000
Property and Equipment, at cost:Land 8,480 8,355Buildings 17737 15,215Furniture, Fixtures and Equipment 10,040 7,799Leasehold Improvements 1,372 1,391Construction in Progress 758 1,123Capital Leases 588 475
38,975 34,358Less Accumulated Depreciation and Amortization 14,527 7,753
Net Property and Equipment 24,448 26,605
Notes Receivable 135 343Goodwill 1,120 6,314Other Assets 295 1,001
Total Assets $40,518 $52,263
Footnote Disclosures:2012 2007
US Stores 1,974 1,872Canadian 180 155Other Countries 98 73HD Supply Stores (Business Customers) 893 Total Stores 2,252 2,993
Financial Statements 10
CONSOLIDATED BALANCE SHEETSThe Home Depot, Inc. and Subsidiaries
AMOUNTS IN MILLIONS, EXCEPT SHARE DATA
January 29, January 28,2012 2007
LIABILITIES AND STOCKHOLDERS' EQUITYCurrent Liabilities:Short-Term Debt $0 $ —Accounts Payable 4,856 7,356Accrued Salaries and Related Expenses 1,372 1,307Sales Taxes Payable 391 475Deferred Revenue 1,147 1,634Income Taxes Payable 23 217Current Installments of Long-Term Debt 30 18Other Accrued Expenses 1,557 1,924Total Current Liabilities 9,376 12,931
Long-Term Debt, excluding current installments 10,758 11,643
Other Long-Term Liabilities 2,146 1,243Deferred Income Taxes 340 1,416Total Liabilities 22,620 27,233
STOCKHOLDERS' EQUITYCommon Stock 87 121Paid-In Capital 6,966 7,930Retained Earnings 17,246 33,052Accumulated Other Comprehensive Income 293 310Treasury Stock** -6694 -16,383Total Stockholders' Equity 17,898 25,030
Total Liabilities and Stockholders' Equity $40,518 $52,263
Financial Statements 11
INCOME STATEMENT
Compare to the balance sheet:
Balance sheet: a specific point in time (on Dec 31)Income statement: over a period of time (from Jan 1 to
Dec 31)
INCOME STATEMENT COMPONENTS
Revenue – enhancement of assets or settlement of liabilities due to delivering goods or rendering services
Expenses – use of assets or incurrence of liabilities related to delivering goods or providing services
Income – difference between revenue and expenses
Financial Statements 12
INCOME STATEMENT FORMATS
Single Step Format - All types of revenues and gains listed first, followed by all expenses and losses.
Multi-Step Format - Separates operating and non-operating activities; classifies expenses by function
Reality Check – 16.7% of Fortune 100 uses a single step format.
Financial Statements 13
INCOME STATEMENT FORMATS
Single Step FormatAll types of revenues and gains listed first, followed by all expenses and losses.
X CORPORATIONINCOME STATEMENT
For the period ending December 31, 20XX
RevenuesSales $150,000
Rent Revenue 10,000Investment Gains 5,000 Total Revenue 165,000
ExpensesCost of Goods Sold 70,000
Selling, General, and Administrative Expense 10,000
Financial Statements 14
All revenues are shown together
All expenses are shown together
Interest Expense 5,000Tax Expense 25,000 Total Expenses 110,000
Net Income $55,000
Earnings per Share $1.25
Advantages of Single Step: Format is simple and does not imply greater importance to certain types of accounts.
Financial Statements 15
INCOME STATEMENT FORMATSMultiple Step Format
A multi-step income statement: Separates operating and non-operating activities Classifies expenses by function
X CORPORATIONINCOME STATEMENT
For the period ending December 31, 20XXSales $150,000
Cost of Goods Sold -70,000 Gross Profit 80,000Selling, General, and Administrative Expenses -10,000Income from Operations 70,000Rent Income 10,000
Investment Gains 5,000Interest Expense -5,000 Income before Tax 80,000Tax Expense -25,000 Net Income $55,000
Financial Statements 16
Operating revenues and expenses
Non-Operating revenues and expenses
Earnings per Share (44,000 shares outstanding) $1.25
Operating – within corporate missionNon-Operating – rent, interest, equipment sales
Note: Multistep income statements usually include Gross Profit (Sales – Cost of Goods Sold).
CONSOLIDATED STATEMENT OF EARNINGSThe Home Depot, Inc. and Subsidiaries
AMOUNTS IN MILLIONS, EXCEPT SHARE DATA
January 29,January
28,Amounts in millions 2012 2007
NET SALES $70,395 100.0% $90,837 100.0%Cost of Sales 46,133 65.5% 61,054 67.2%GROSS PROFIT 24,262 34.5% 29,783 32.8%Operating Expenses:Selling, General and Administrative 16,028 22.8% 18,348 20.2%Depreciation and Amortization 1,573 2.2% 1,762 1.9%Total Operating Expenses 17,601 25.0% 20,110 22.1%
OPERATING INCOME 6,661 9.5% 9,673 10.6%Interest and Other (Income) Expense:Interest and Investment Income 13 27Interest Expense -606 -0.9% -392 -0.4%Other 0 0Interest and Other, net -593 -365
EARNINGS BEFORE TAXES 6,068 8.6% 9,308 10.2%
Provision for Income Taxes 2,185 3.1% 3,547 3.9%
Financial Statements 17
EARNINGS FROM CONTINUING OPERATIONS 3,883 5.5% 5,761 6.3%
Why did Home Depot’s income decline? ANS: Sold a business (an independent unit for commercial).
Financial Statements 18
Discontinued Operations
Discontinued Operations – component that (1) will be eliminated from ongoing operations, and (2) has no management involvement after disposal.
Rules: a component must be a product group or division, but not a
brand Discontinued operations are always reported net of taxes No longer part of regular operations, separated off for both
balance sheet and income statement.
Reported in two parts: Part 1 - Gain or loss from operations of discontinued
operations Part 2 - Gain or loss from the disposal (FMV – BV)
Financial Statements 19
IRREGULAR ITEMS
In the US, two items:
Discontinued Operations Extraordinary Items
receive special treatment.
Treatment: Show
near the bottom of the income statement (prior to net income)
net of taxes
Note:
DE items receive this treatment whether single or multi-step.
Income before DE items is referred to as “Income from Continuing Operations”
IFRS standards do not recognize extraordinary items.
Financial Statements 20
PROFITABILITY RATIOS1. Profit Margin on Sales
Indicates: The relation of profits to sales.
ProfitMargin = Net Income
Sales
Interpretation:
Higher - less sales are needed to generate a desired level of profit. How is the ratio improved? Hint: The denominator is the top of the IS and the numerator is the bottom of the IS. What is in between?
2. Return on Assets
Indicates: How assets are utilized to achieve a profit.
Returnon Assets = Current Year Net Income
Average Total Assets
Options: Some add interest expense to the numerator to put leveraged and unleveraged entities on equal basis.
Interpretation: Higher - greater ability to produce profits.
Financial Statements 21
3. Return on Stockholders' Equity
Indicates: The degree of profitability attributable to stockholders. Differs from ROA to extent that the entity is leveraged (has debt).
Returnon Equity = Current Year Net Income
Average Stockholders’ Equity
Options: Some subtract PS dividends from numerator to evaluate only amounts available to CS.
Interpretation:
Higher - a greater degree of profits available to stockholders.
Financial Statements 22