UnderstandingFinancial Statements
• Goal: Understand the financial consequences of decisions
• What are the three basic financial (or accounting) statements?– Income Statement– Balance Sheet– Cash Flow Statement
The Goal: Making Good Financial Decisions
3 types of financial statements
Income Statement
Sales Revenue
Cost of Goods Sold
Operating Expenses
Gross Profit
Operating Income
Interest Expense
Operating Income
Earnings Bef Taxes
Income Taxes
Net Income
Op
erat
ing
Act
ivit
ies
Fin
anci
ng
Act
ivit
ies
minus
minus
minus
minus
equals
equals
equals
equals
What is the format of an income statement?
.
Income StatementAn Example
The Income Statement for Trimble & Associates:
Sales $850
Cost of Goods Sold 550
Gross Profit on Sales $300
Operating Expenses:
Marketing Expenses 90
General & Admin Expenses 80
Depreciation 30
Total Operating. Expenses $200
Operating Income 100
Interest Expense 20
Earnings Before Tax 80
Income Tax (25%) 20
Net Income 60
Income from operating the business
Income after \paying interest
Cost of borrowing
Income Statement Can You Put It Together?
Cost of Goods Sold $250
Depreciation $ 8
Sales $290
Income Taxes(25%) $ 2
Admin. &Sales Exp. $ 18
Interest Expense $ 6
Organize this Income statement Put the pieces where they go!!4. Good judgment
Gross Profit on Sales $
Operating Expenses:
Total Op. Exp. $
Operating Income $
Earnings Before Taxes $
Net Income $
Gross Profit on Sales $
Operating Expenses:
Total Op. Exp. $
Operating Income $
Earnings Before Taxes $
Net Income $
Here You Go!
Cost of Goods Sold $250
Depreciation $ 8
Sales $290
Income Taxes(25%) $ 2
Admin. &Sales Exp. $ 18
Interest Expense $ 6
Depreciation $ 8
Sales $290
Income Taxes(25%) $ 2
Admin. &Sales Exp. $ 18
Interest Expense $ 6
Cost of Goods Sold $25040
26
14
8
6
Balance Sheet
What is the basic format of a balance sheet?
• In its simplest form, the Balance Sheet is:
Total assets always equal debt plus equity.
Total Assets
Owner’s Equity
Outstanding Debt
Debt & Equity
= +
Balance Sheet
Describe the 3 main parts of a balance sheet.
• Assets– What the company owns
• Liabilities (Debt)– What the company owes
• Owner’s Equity (Net Worth)– Amount invested by the owners
Basic pieces of the balance sheet
Continue
What does the balance sheet tell us?
• A Snapshot of a company’s financial position at a specific point in time
How is it different from an income statement?
• The Income Statement covers a period in time (Jan 1 – Dec 31, 2007)
• The Balance Sheet represents a specific moment (December 31, 2007)
Balance Sheet Income Statement and Balance Sheet
The Income Statement and Balance Sheet complement each other
Jan
uar
y 1
Dec
emb
er 3
1
Balance Sheet on December 31, 2006
Balance Sheet on December 31, 2007
YEAR 2007
Income Statement for 2007
Balance Sheet
What are the 3 types of assets?• Current assets, consisting of?
• What is the nature of current assets?
They are cash or moving toward cash.
Balance Sheet
• Fixed assets include:– Machinery and Equipment– Buildings and Land
• The cost of a depreciating fixed asset is recorded in the balance sheet as an asset (not an expense) and depreciated over its useful life.
• Other assets include such things as:– Patents– Copyrights– Goodwill
OK, enough about assets.
Now let’s look at how they are financed
Balance Sheet Debt or Liabilities
What is debt?• Financing provided by a creditor
• Debt is divided in two parts:– Current debt or short-term
liabilities– Long-term debt
Where does debt
come from?
Balance Sheet Owners’ Equity
What is owners’ equity?• Money invested by the owners, as the
esidual owners.
• Equity consists of what?– Amount invested when purchasing
ownership in the business– Retained Earnings: All the profits
retained in the company (profits not paid out in dividends to the owners)
Owners have 2 ways to invest in a business:•Buy stock•Reinvest all or part of the firm’s profits
Balance Sheet Owners’ Equity
Let’s say it again! Retained Earnings is the accumulated profits (gains-losses) of the business, less the dividends paid to stockholders since the firm was created
Owners’ Equity
Cumulative Profits
Owners’ Investment
Cumulative Dividends
Retained Earnings
Owners’ Equity
Owners’ Investment
Retained earnings: A concept that many students fail to understand. Do you?
Balance Sheet () An Example
ASSETS DEBT AND EQUITY Current Assets Current Liabilities:
Cash $50 Accounts payable $20
Accounts receiv 80 Short-term notes 80
Inventories 220 Total current debt $100
Total current assets $350 Long-term debt 200
Fixed assets: Total debt: $300
Gross fixed assets $960 Common stock $300
Accum depreciation -390 Retained earnings 320
Net fixed assets $570 Total common equity $620
TOTAL ASSETS $920 TOTAL DEBT AND EQUITY $920
The Balance Sheet for Trimble & Associates:
Balance Sheet Can you put itd together?
Given the information below, can you arrange the balance sheet?Remember: ASSETS = LIABILITIES + EQUITY
Cash $ 70
Accounts Receivable $ 220
Inventories $ 310
Total Current Assets $ 600
Gross Fixed Assets $2,500
Accumulated Depreciation $(300)
Net Fixed Assets $2,200
Assets:Current Assets
Fixed Assets
TOTAL ASSETS $ 2,800
FIRST: ASSETS
Cash $ 70
Accounts Receivable $ 220
Inventories $ 310
Total Current Assets $ 600
Gross Fixed Assets $2,500
Accumulated Depreciation $(300)
Net Fixed Assets $2,200
Balance Sheet Putting it together
Common Stock $ 900
Long-term debt $ 800
Total Owners’ Equity $1,750
Total Debt $1,050
Total Current Liabilities $ 250
Short-term Notes $ 20
Accounts Payable $ 230
Liabilities:Current Liabilities:
Owners’ Equity:
TOTAL DEBT&EQUITY $ 2,800
NEXT: DEBT & EQUITY
Retained Earnings $ 850
Common Stock $ 900
Long-term debt $ 800
Total Owners’ Equity $1,750
Total Debt $1,050
Total Current Liabilities $ 250
Short-term Notes $ 20
Accounts Payable $ 230
Retained Earnings $ 850
Balance Sheet All Together
The complete balance sheet is as followsAssets:Current Assets
Fixed Assets
TOTAL ASSETS $ 2,800
Liabilities:Current Liabilities:
Owners’ Equity:
TOTAL DEBT&EQUITY $ 2,800
Cash $ 70
Accounts Receivable $ 220
Inventories $ 310
Total Current Assets $ 600
Gross Fixed Assets $2,500
Accumulated Depreciation $ 300
Net Fixed Assets $2,200
Common Stock $ 900
Long-term debt $ 800
Total Owners’ Equity $1,750
Total Debt $1,050
Total Current Liabilities $ 250
Short-term Notes $ 20
Accounts Payable $ 230
Retained Earnings $ 850
Cash Flow Statement
“Cash is King!!Cash flow problems is a major reason for small firms failing—even at times when
the business is profitable.
Run out of cash
and your business will fail!
CASH IS KING is not some cliché, but a principle you cannot afford to violate!
Cash Flow Statement Accrual versus Cash Accounting
• What is the difference between accrual-basis accounting and cash-basis accounting?
• So what?
Cash Flow Statement
“What question does the cash flow statement answer?
“Where did the cash come from and where did the
cash go?”
Cash Flow Statement
Where does the information come from to prepare a cash flow statement?•Income statement•All the changes in the balance sheets from the beginning of the year to the end of the year
– Except changes in accumulated depreciation and retained earnings
Cash Flow Statement
• Cash inflows and outflows result from three activities:– Operating Activities:
Cash flow from normal operations– Investment Activities:
Cash flow related to the investment in or sale of assets
– Financing activities:
Cash flow related to financing the firm
Three activities cause cash to increase or decrease
Cash Flow Statement Operating Activities
• Cash flow from operations consists of the net flow of cash from day-to-day business activities
• Start with Operating income• Add back Depreciation expense
(a non-cash expense)
• Subtract income taxes(to work on an after-tax basis)
• Subtract increase in net working capitalWhich consists of:
– Increase in A/R (a use of cash)– Increase in inventories (a use of cash)– Decrease in A/P (a source of cash)
What is cash flow from opera- tions?
Cash Flow Statement Investment Activities
• Investment activities consist of – The purchase or sale of fixed assets
(change in gross fixed assets)– The purchase or sale of other long-term
assets (changes in goodwill, patents, etc.)
What is cash flow from investment activities?
Cash Flow Statement Financing Activities
Financing activities include:– Paying dividends and interest expense– Increasing or decreasing short-term and
long-term debt• Increase: borrowing more money• Decrease: paying off debt
– Owners invest more or less in business • Buy more stock• Company buys owner’s stock back
What is cash flow from financing activities?
Cash Flow Statement Cash Flow Statement for Trimble AssociatesOperating Activities
Operating income $ 100Plus depreciation 30Less income taxes (20) $ 110Change in net working capital:Less increases in A/R $ (5)Less increases in inventories (40)Plus increases in A/P 5 (40)Cash flows from operations $ 100
Investment ActivitiesLess increase in gross fixed assets $ (100)
Financing ActivitiesLess interest expenses $ (20)Less dividends paid (15)Plus incr in short-term notes 20Plus incr in long-term notes 50Total Financing Activities $ 35
Increase (Decrease) in cash $ 5
Cha
nge
in n
et
wor
king
cap
ital
Cash Flow Statement Can You Arrange this Cash Flow Statement?
Operating activities:
PlusLessLessLessPlusCash flows from operations:
Investment activitiesLess
Financing activitiesLessLessPlusPlusTotal financing activities
Increase (Decrease) in cash
Operating Income $120
Depreciation $ 40
Taxes $(30)
Increases in accts receivable $(20)
Increases in inventories $(10)
Increases in accounts payable $ 5
Increase in gross fixed assets $(90)
Interest expenses $(30)
Increases in short-term notes $ 15
Increases in long-term notes $ 30
Dividends paid $(10)
$100
$ 5
$ 100
$ (90)
$ 5
$ 15