Business 1220 Introducing Financial Statements Professor Sergio Janczak, Ph.D. 2008-9 KC 1
Introducing Financial Statements Types of Financial Statements 1. Balance Sheet 2. The Statement of Earnings or Income Statement (SE/IS) 3. Statement of Retained Earnings 2008-9 KC 2
Financial Statement Objectives Understand the components of the B/S, S/E and SRE Develop the ability to construct the statements Lay a foundation for the Finance section of the course 2008-9 KC 3
The Statement of Earnings (same as) / Income Statement Reports financial performance for one accounting period. An accounting period generally is one year in length. 2008-9 KC 4
Revenue Categories Gross Sales Net Sales (Gross Sales - Discounts & Returns) Other Revenue 2008-9 KC 5
Expense Categories Cost of Goods Sold (COGS) Operating Expenses Other Expenses 2008-9 KC 6
Profit Categories Gross Profit: Revenue less COGS Operating Profit: Gross Profit less Operating Expenses Net Profit: Operating Profit less Other Expenses, plus Other Income. 2008-9 KC 7
Income Statement: General Form Gross Sales less Returns & Discounts = Net Sales less Cost of Goods Sold = Gross profit less Operating Expenses = Operating Profit +/- Other Revenue/Expenses = Net Profit Before Tax -Tax = Net Profit 2008-9 KC 8
Cost of Goods Sold For a Merchandising Firm: The purchase price of the goods, plus transportation costs to your place of business For a Manufacturer: The cost to acquire raw materials, plus the costs to convert them to finished goods (labour, energy, building & equipment). 2008-9 KC 9
Cost of Goods Sold Section Beginning Inventory + Purchases = Cost of Goods Available for Sale - Ending Inventory Cost of Goods Sold 2008-9 KC 10
How to Figure Out Purchases Cost of Goods Sold + Ending Inventory = Cost of Goods Available for Sale - Beginning Inventory Purchases 2008-9 KC 11
Operating Expenses Other than COGS, the costs that are regularly incurred in the normal course of operating your business EXAMPLES: Selling expenses, rent, advertising, office salaries & equipment, etc. 2008-9 KC 12
Depreciation The using up or expiration of a fixed asset s usefulness The process of allocation the cost of a fixed asset over the time of its worth All fixed assets must be depreciated except for Land In this course we will only use the Straight- Line Method 2008-9 KC 13
How to Figure out Depreciation Example: You buy a machine that costs $10,000 that will last for 10 years on January 1, 2000 Depreciation Per Year: Cost of Asset Life Span Therefore, $10,000/10 years = $1,000/year 2008-9 KC 14
How to Figure out Depreciation Cont Cont d Therefore the annual EXPENSE is $1,000 which will be found on the I/S You will also ACCUMULATE this on the B/S Year Ending: 2000 2001 2002 Machine, Cost Less: A/D Machine, Net 10,000 1,000 9,000 10,000 2,000 8,000 10,000 3,000 7,000 2008-9 KC 15
Other Expenses Those costs that are not normally part of the firm s operations. EXAMPLES: Extraordinary losses on equipment or inventory, settlement of a law suit, financing costs (like interest), etc. 2008-9 KC 16
Do an Income Statement of yourself. (FOR WHAT PERIOD?) 2008-9 KC 17
THE BALANCE SHEET The balance sheet shows the financial condition of a firm at a particular point in time, or a snapshot, in terms of what it owes and what it owns. 2008-9 KC 18
Three Parts Assets - What the firm owns Liabilities - What the firm owes Shareholder s Equity or Net Worth - The difference between assets and liabilities, owners claim in the company 2008-9 KC 19
Assets = Liabilities + Equity ALWAYS 2008-9 KC 20
ASSETS Things of value owned by the company. 2008-9 KC 21
Current Assets (CA) In the normal course of operations, assets expected to be converted into cash or used up within one year from the Balance Sheet date. Examples: Cash Marketable Securities Accounts Receivable Inventory These are ALWAYS listed in order of liquidity How easy it is to transfer into actual $$$ 2008-9 KC 22
Fixed Assets (FA) Physical items which are expected to last more than one year. Examples: Land Buildings Equipment Automobile These are listed in order of permanence 2008-9 KC 23
Intangible Assets (IA) Non-physical items, such as rights or privileges, etc. owned by a company. Seldom converted into cash in normal operations. Examples: Organizational expenses Goodwill Patents 2008-9 KC 24
Other Assets (OA) Not directly related to the day-to-day operations of the business. Examples Investment in Subsidiary Own controlling interest (50% + 1 vote) Not intended for resale Other Investments Do NOT own control interest (less than 50%) Not intended for resale 2008-9 KC 25
LIABILITIES Debt or obligations the firm is expected to pay. 2008-9 KC 26
Current Liabilities (CL) Debts that normally are expected to be paid within one year of the date of the balance sheet. Examples : Accounts Payable Notes Payable Accrued Expenses Taxes Payable Working Capital Loan 2008-9 KC 27
Long Term Liabilities (LTL) Debts due in more than one year from the date of the Balance Sheet. Examples: Mortgage Long Term Loan 2008-9 KC 28
SHAREHOLDERS EQUITY (SE) The difference between total assets and total liabilities. Shareholders Equity (Net Worth) can include three types of accounts: 2008-9 KC 29
1. Capital or Capital Stock (Share Capital etc.) 2. Capital Surplus or Deficit 3. Retained Earnings 2008-9 KC 30
Capital or Capital Stock The investment of the owner(s) in the business. Three alternate forms: 1. A single account for a Sole proprietorship usually seen as Sergio Janczak, Capital 2. A set of named accounts - one for each partner in a Partnership 3. The Share accounts (Common and Preferred) for a Corporation 2008-9 KC 31
Capital Surplus or Deficit The difference between the par value and the actual selling prices of both common or preferred shares. 2008-9 KC 32
Main Types of Stock Common Stock Voting rights: Dividends: Liquidation during bankruptcy: Preferred Stock Voting rights: Dividends: Liquidation during bankruptcy: 2008-9 KC 33
Retained Earnings The accumulated after tax profits or losses that are not paid out in dividends. In the final statement will see how this account changes year to year and actually LINKS the I/S with the B/S. 2008-9 KC 34
Do a Balance Sheet for yourself as of today. 2008-9 KC 35
Statement of Retained Earnings At the end of each period, updates the record of the cumulative net profits that were not paid out as dividends. 2008-9 KC 36
Retained Earning, Beginning of Year (essentially the ending of last year) Plus Net Profit After Tax (or Less any Loss) Less Dividends declared (if any) Equals Retained Earnings, End of Year 2008-9 KC 37
Retained Earnings is NOT cash. It simply is a record of the past profits that were kept in the business. Where is the cash it represents? 2008-9 KC 38
Financial Statement Links Three Direct Links Between the Balance Sheet and the Income Statement: Inventory Retained Earnings Depreciation 2008-9 KC 39
1. Inventory The beginning and ending inventory in the COGS section of the Income Statement must be identical to the inventory on the beginning and ending Balance Sheets. 2008-9 KC 40
Sample COGS Section for 2000 Beginning Inventory, Jan 1/00 20 Plus: Purchases 880 Cost of Goods Available 900 Less: Ending Inventory, Dec 31/00 140 Cost of Goods Sold 760 Therefore, Ending Inventory for Dec. 31/01 is the Beginning Inventory for Jan 1/01 2008-9 KC 41
2. Retained Earnings R/E on the Beginning Balance Sheet Plus Net Profit from the Income Statement Equals Ending Balance Sheet R/E (Assuming no dividends) 2008-9 KC 42
3. Depreciation Accumulated Depreciation on the Beginning Balance Sheet, Plus Depreciation Expense from the Income Statement Equals Accumulated Depreciation on the Ending Balance Sheet 2008-9 KC 43
Depreciation Expense The portion of an asset s original cost that is charged against the revenue for one accounting period. Shown on the Income Statement. Often called just depreciation 2008-9 KC 44
Accumulated Depreciation A cumulative record of all depreciation expense charges to-date. The Balance Sheet records fixed assets at their original cost, less accumulated depreciation. 2008-9 KC 45
Sample Fixed Asset Presentation on B/S: Equipment, Cost 250,000 Accumulated Dep., Equip (150,000) Equipment, Net 100,000 2008-9 KC 46
Depreciation Methods: Straight Line Units of Output Declining Balance Sum-of-the-Years Digits We will use straight-line only! 2008-9 KC 47
Straight-Line Depreciation Rates Can vary based on asset s expected useful life. A fixed amount of the original cost is charged each year until the asset is fully depreciated Lacking specific case data, reasonable assumptions: Buildings Equipment Office Furnishings Computers & Automobiles 20-40 years 10-20 years 5-10 years 5 years 2008-9 KC 48