WHAT IS MANAGEMENT



V. FInancial Statements

Learning objective 4

EXPLAIN HOW THE MAJOR FINANCIAL STATEMENTS DIFFER. (TEXT PAGES 394-406)

A. A FINANCIAL STATEMENT is the summary of all transactions that have occurred over a particular period.

1. These indicate a firm’s financial health and stability.

2. The key financial statements are:

a. The balance sheet, which reports the firm’s financial condition on a specific date;

b. The income statement (or profit and loss statement, or “P&L” for short, reports revenues, expenses, and profits (or losses) for a specific period of time;

c. The statement of cash flows, which provides a summary of money coming into and going out of the firm.

3. The differences among the financial statements:

a. The balance sheet details what the company owns and owes on a certain day.

b. The income statement shows what a firm sells its products for and what its selling costs are over a specific period.

c. The statement of cash flows shows the difference between cash coming in and cash going out of a business.

B. The Accounting Equation

1. If you owe no money (liability) the sum of your assets is your equity.

2. If you incur a liability, your assets are equal to what you owe plus what you own.

3. In accounting terms:

assets = liabilities + owners’ equity

4. Owner’s equity is a way of stating the difference between what is owned versus what is owed.

5. The fundamental accounting equation—owner’s equity and liabilities will always be the same number as assets—is the basis for the balance sheet.

C. The Balance Sheet

1. A BALANCE SHEET is the financial statement that reports a firm’s financial condition at a specific time.

a. The term balance sheet implies a balance between two figures–assets on one side and liabilities and owners equity on the other.

b. To create your personal balance sheet, you add up everything you own, and then subtract the money you owe others.

c. A balance sheet can help managers make business decisions.

d. Understanding the balance sheet gives managers a picture of the company’s financial health.

2. ASSETS are economic resources (things of value) owned by the company.

a. Assets include productive, tangible items that generate income, as well as intangibles of value.

b. Intangibles(such as brand names, trademarks, and copyrights(can be among the firm’s most valuable assets.

c. Assets are characterized based on LIQUIDITY, how fast an asset can be converted into cash.

i. For example, an accounts receivable is the amount of money owed to the firm that it expects to be paid within one year.

ii. Current assets are items that can or will be converted to cash within one year.

iii. Fixed assets are long-term assets that are relatively permanent, also referred to as property, plant, and equipment.

iv. Intangible assets are long-term assets (e.g., patents, trademarks, copyrights) that have no real physical form but do have value.

3. LIABILITIES are what the business owes to others (debts).

a. Current liabilities are debts due in one year or less.

b. Long-term liabilities are debts not due for one year or longer.

c. Common liability accounts:

i. Accounts payable are current liabilities involving money owed for merchandise and services purchased on credit but not paid for yet.

ii. Notes payable are short-term or long-term liabilities that a business promises to repay by a certain date.

iii. Bonds payable are long-term liabilities that represent money lent to the firm that must be paid back.

d. Equity

i. The value of things you own (assets) minus the amount of money you owe others (liabilities) is called equity.

ii. The value of what stockholders own in a firm (minus liabilities) is called stockholders’ equity (or shareholders’ equity).

iii. OWNERS’ EQUITY is the amount of the business that belongs to the owners minus any liabilities owned by the business.

iv. The formula for owners’ equity:

owners’ equity =

assets - liabilities.

e. The balance sheet shows all the assets the company has and also what it owes.

D. The Income Statement

1. The INCOME STATEMENT (also called the profit and loss statement) summarizes:

a. all the resources (called revenue) that have come into the firm from operating activities;

b. the money resources that were used up;

c. the expenses incurred in doing business;

d. what resources were left after all costs and expenses, including taxes, were paid out.

2. Net income or net loss is revenue left over after all costs and expenses, including taxes, are paid.

a. The income statement reports the results of operations over a particular period of time.

b. The income statement is arranged according to the following formula:

revenue

– cost of goods sold

= gross profit (gross margin)

– operating expenses

= net income before taxes

– taxes

= net income (or loss)

c. The income statement includes valuable financial information for stockholders, lenders, investors, and employees.

3. REVENUE is the value of what is received for goods sold, services rendered, and other financial sources.

a. There is a difference between revenue and sales.

b. Most revenue comes from sales, but other sources of revenue include rents earned, interest earned, and so forth.

c. GROSS SALES are the total of all sales the firm completed.

d. Net sales are gross sales minus returns, discounts, and allowances.

4. COST OF GOODS SOLD (COST OF GOODS MANUFACTURED) is a measure of the cost of merchandise sold, or the cost of raw materials and supplies used for producing items for resale.

a. The cost of goods sold includes the purchase price plus any costs associated with obtaining and storing the goods.

b. Most retailers don’t have to consider the cost of raw materials, so their main concern is purchase price and storage cost.

c. GROSS PROFIT (GROSS MARGIN) is how much a firm earned by buying (or making) and selling merchandise, without expenses.

d. The gross margin doesn’t tell you everything—you must subtract expenses to determine net profit or loss.

5. Operating expenses and net profit or loss

a. OPERATING EXPENSES are costs involved in operating a business, such as rent, utilities, and salaries.

b. Operating expenses can be classified into two categories:

i. Selling expenses are expenses related to the marketing and distribution of the firm’s goods or services.

ii. General expenses are administrative expenses of the firm.

iii. There are also non-operating expenses, such as interest.

c. After all expenses are deducted, the firm’s net income before taxes is determined.

i. After allocating for taxes, you get to the bottom line, the net income (or perhaps net loss).

ii. This figure is what the firm incurred from revenue minus sales returns, costs, expenses, and taxes.

iii. Net income can also be referred to as net earnings or net profit.

d. Businesses need to keep track of how much money they earn, spend, how much cash they have on hand, and so on.

6. Users of financial information are very interested in the flow of cash into and out of a business.

E. The Statement of Cash Flows

1. The STATEMENT OF CASH FLOWS reports cash receipts and disbursement related to the firm’s three major activities.

a. Operations: cash transactions associated with running the business;

b. Investments: cash used in or provided by the firm’s investment activities;

c. Financing: cash raised from the issuance of new debt.

2. Accountants analyze all of the cash changes that have occurred from operating, investing, and financing to determine the firm’s net cash position.

3. The statement of cash flows is different from the income statement.

a. The statement of cash flows shows the cash position, how much money is on hand at any given time.

b. Companies don’t want to have too much money on hand, but do need to have enough to pay their expenses.

4. A business can increase sales and increase profit and still have cash flow problems.

F. A Word About Depreciation

1. DEPRECIATION is the systemic write-off of the cost of a tangible asset over its estimated useful life.

2. Assets such as equipment and machinery are considered depreciable subject to accounting rules.

3. Companies are permitted to recapture the cost of assets using depreciation as a business operation expense.

4. There are several ways to calculate depreciation.

SELF Check Questions (Text page 406)

1. What does an income statement show? What about a statement of cash flow?

2. How are these statements useful for small businesses?

3. What is the accounting equation?

4. What is depreciation? |

PowerPoint 12-9

Financial Statements

(Refers to text pages 394-396)

TEXT REFERENCE

Study Skills: Make Good Study Habits a Life Skill

(Box in text on page 395)

An additional exercise and discussion is available page 12.31 of this manual.

PowerPoint 12-10

The Balance Sheet

(Refers to text pages 396-398)

TEXT FIGURE 12.2

Classification of Assets (Box in text on page 397)

TEXT FIGURE 12.3

Sample Very Vegetarian Balance Sheet (Box in text on page 399)

critical thinking

exercise 12-2

Preparing a Balance Sheet

This exercise directs students to use a given list of accounts to create a balance sheet. (See complete exercise on page 12.44 of this manual.)

PowerPoint 12-11

The Income Statement

(Refers to text pages 398-403)

TEXT FIGURE 12.4

Sample Very Vegetarian Income Statement (Box in text on page 400)

lecture link 12-4

It’s the Earnings That Count

When one entrepreneur approached venture capitalists for expansion capital, he learned that revenue was not as important as the bottom line, net profit. (See complete lecture link on page 12.35 of this manual.)

TEXT FIGURE 12.5

Example of Cost of Goods Sold for a Retail Store (Box in text on page 402)

critical thinking

exercise 12-3

The Pizza Stand

A student organization plans to operate a pizza stand during the homecoming weekend. This exercise asks students to prepare a budget and calculate expected profit. (See complete exercise on page 12.46 of this manual.)

PowerPoint 12-12

The Statement of Cash Flows (Refers to text pages 403-406)

lecture link 12-5

Using the Statement of Cash Flows

Companies do not go out of business because they report net losses—they fail because they run out of cash. (See complete lecture link on page 12.36 of this manual.)

Bonus Case 12-4

The Best Laid Plans Often Go Awry

This case discusses how offering credit to customers affected the finances of a pottery import firm. (See complete case, discussion questions, and suggested answers on page 12.60 of this manual.)

TEXT FIGURE 12.6

Sample Very Vegetarian Statement of Cash Flows (Box in text on page 404)

Bonus Case 12-5

Managing by the Numbers

This case discusses how financially knowledgeable workers helped improve one company’s finances. (See complete case, discussion questions, and suggested answers on page 12.62 of this manual.)

TEXT REFERENCE

Career Development: Create a Career Plan

(Box in text on page 405)

An additional exercise and discussion is available on page 12.29 of this manual.

TEXT REFERENCE

Ethical Challenge:

The Accounting Hot Seat

(Box in text on page 406)

The owner of a small cabinet builder has asked the accountant to shift revenues from one fiscal year back to the previous one. What is the legal and/or ethical thing to do? | |

-----------------------

►

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download