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Key Statements
Three key financial statements summarize the firm’s activities for a specific period
• Balance sheet (what you’re worth)• Income statement (your budget)• Statement of cash flows (your checkbook)
The Accounting Equation
Assets - Liabilities = Owners’ equity
Assets—the resources that a business owns (i.e.- cash, inventory, equipment, real estate)
Liabilities—the firm’s debts (loans, a/p)
Owners’ equity—difference between assets & liabilities
- what would be left for the owners, if the firm’s assets were sold and the money
used to pay off its liabilities
The Balance Sheet
• The dollar amounts of a firm’s assets, liabilities, and owners’ equity accounts at the end of a specific accounting period
– also called statement of financial position
– assets listed in order of liquidity
ease with which an asset can be converted into cash
Assets-Listed in order of liquidity
– Current assets—can quickly be converted to cash
• Cash, marketable securities, a/r, inventory
– Fixed assets—will be held or used for a period longer than one year
• Land, buildings, and equipment
– Intangible assets—do not exist physically -value is based on the rights they give the firm
• Patents, copyrights, trademarks, franchise rights, and goodwill
Liabilities
– Current liabilities—debts to be repaid in one year or less
• Accounts payable—short-term debts from credit purchases
• Notes payable—debts secured with promissory notes (IOU’s)
– Long-term liabilities—debts that need not be repaid for at least one year
• Mortgages, bonds, and long-term loans
Owners Equity
– For sole proprietorships—owners’ equity
– For partnerships—each partner’s share of ownership is reported separately in each owner’s name
– For corporations—stockholder’s equity
The Income Statement
• A firm’s revenues minus its expenses– Profit (cash surplus)– Loss (cash deficit)
• Revenues– Money earned from selling goods or providing services
• Gross sales—the total dollar amount of all goods and services sold during the accounting period
• Net sales—dollar amounts received, adjusted for returns, allowances, discounts
COGS
Cost of goods sold
Beginning inventory
Net purchases
Ending inventory
= + –
• Gross profit– A firm’s net sales less the cost of goods
sold
The Income Statement
• Operating expenses– All business costs other than the cost of goods
sold• Selling expenses—costs related to marketing activities• General expenses—costs of managing the business
• Net income– Net sales less COGS & operating expenses,
when the difference is positive
• Net loss– Net sales less COGS & expenses, when the
difference is negative
The Statement of Cash Flows
• How the company made & spent its money
– Cash flows from operating activities (providing goods and services)
– Cash flows from investing activities (asset
based) (purchase & sale of land, equipment, buildings)
– Cash flows from financing activities (liability based)
(pay off loans, sell stock, get a loan)
Financial Ratios
• Used to show relationship between two elements of a firm’s financial statements
• Can be compared with– The firm’s own past ratios– Ratios of competitors– Industry averages
Who Uses Accounting Information
– Managers, to plan business strategy
– Lenders, to reduce their risk when lending
– Stockholders, to know whether to invest or how well their investment is doing
– Government agencies to enforce the law
How do they know the information on the statements is accurate?
What is an audit?
– An examination of a company’s financial statements and accounting practices by someone not employed by the firm
– Generally accepted accounting principles (GAAP)
-an accepted set of guidelines and practices for companies reporting financial information
– An audit does not guarantee that a company has not “cooked” the books
The Sarbanes-Oxley Act of 2002
– Top executives are required to certify periodic financial reports and are subject to criminal penalties for violations
– Auditors must maintain financial documents and audit work papers for 5 years
– Auditors and accountants can be imprisoned for up to 20 years for destroying documents and violating securities laws
– Public Corps must change auditing firms every 5 years
– There is protection for whistle-blowers who report violations of the Sarbanes-Oxley Act