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Basics of Financial Statements

elwyn avatar
elwyn
0 diapositives · 163 Views · Jul 06, 2014

The fundamentals of financial statements, focusing on the balance sheet equation. It covers the various types of assets that companies own, including cash, receivables, inventories, real estate, equipment, securities, and intangibles. Understanding these assets is crucial, as they must possess future value to the company. The module aims to provide a solid foundation for analyzing financial statements and understanding the overall financial health of an organization.

#financial statements #balance sheet #assets #company value #financial health
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Basics of Financial Statements
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  1. Module 1: Basics of Financial Statements

  2. Balance Sheet Equation Assets: companies own cash, receivables, inventories, real estate, equipment, securities, and intangibles—must have future value to the company Liabilities: Companies’ obligations to employees, suppliers, governments, bankers, lenders, bondholders Equity: The owners’ remaining investment in the company
  3. Balance Sheet Equation Balance Sheet: Everything a company owns was purchased with money from creditors or owners. Who owns what? Company owns the assets Investors (owners) purchase shares of stock in the company, including a share of earnings Creditors own promises of future payment from companies
  4. Financial Statements FINANCIAL STATEMENTS INCLUDE: Balance Sheet: List of assets, obligations, and owners’ equity on a date. Income Statement: Change in owners’ equity due to operating the business. Revenues, expenses, profits, and losses=net income Cash Flows: Change in cash balance due to (1) operating the business, (2) buying or selling long-term assets, and (3) financing the company (cash flows to/from lenders and owners). Stockholders’ Equity: Change in owners’ accounts from beginning of the period to end of the period.
  5. Financial Accounting Information DEMAND: Who needs to know about the finances of companies? Almost everyone! Managers, employees, investment analysts, shareholders and directors, customers, regulators and tax agencies, voters and their representatives… However, readers must be knowledgeable before they can understand financial reports because they are written in the language of business. Accounting provides the language.
  6. Supply of Accounting Information SEC filing requirements: Form 10-K: annual report Form 10-Q: quarterly Form 8-K: additional Benefits of disclosure. Lower costs of funds because reliable information supports trust in the company Increases stock prices overall, reduces risk Costs of disclosure. Preparation and dissemination, competitive disadvantages, litigation potential, and political costs
  7. Berkshire Hathaway’s Balance Sheet
  8. Berkshire Hathaway’s Income Statement
  9. Berkshire Hathaway’s Statement of Stockholders’ Equity
  10. The statement of cash flows reports on cash flows for operating, investing, and financing activities over a period of time. Statement of Cash Flows
  11. Information Related to Financial Statements Management Discussion and Analysis Independent Auditor’s Report Financial Statement Footnotes Report on Internal Controls
  12. Profitability Analysis
  13. Oversight of Financial Accounting SEC oversees all publicly traded companies Financial Accounting Standards Board (FASB)and has delegated authority from SEC Congress and federal courts can overrule the SEC or the FASB

  14. Module 2: Introducing Financial Statements and Transaction Analysis

  15. Balance Sheet Reflects the Accounting Equation Assets = Liabilities + Equity Uses of funds = Sources of funds Assets are listed in order of liquidity Liabilities are listed in order of maturity Equity consists of Contributed Capital and Retained Earnings
  16. Assets To be reported on a balance sheet, an asset must Be owned (or controlled) by the company Must possess expected future economic benefits
  17. Examples of Current Assets Cash—currency, bank deposits, and investments with an original maturity of 90 days or less (called cash equivalents); Marketable securities—short-term investments that can be quickly sold to raise cash; Accounts receivable, net—amounts due to the company from customers arising from the sale of products and services on credit (“net” refers to uncollectible accounts explained in Module 6); Inventory—goods purchased or produced for sale to customers; Prepaid expenses—costs paid in advance for rent, insurance, advertising or other services.
  18. Examples of Long-term Assets Property, plant and equipment (PPE), net—land, factory buildings, warehouses, office buildings, machinery, motor vehicles, office equipment and other items used in operating activities (“net” refers to subtraction of accumulated depreciation, the portion of the assets’ cost that has been transferred from the balance sheet to the income statement, which is explained in Module 6); Long-term investments—investments that the company does not intend to sell in the near future; Intangible and other assets—assets without physical substance, including patents, trademarks, franchise rights, goodwill and other costs the company incurred that provide future benefits.
  19. Examples of Current Liabilities Accounts payable—amounts owed to suppliers for goods and services purchased on credit. Accrued liabilities—obligations for expenses that have been incurred but not yet paid; examples are accrued wages payable (wages earned by employees but not yet paid), accrued interest payable (interest that is owing but has not been paid), and accrued income taxes (taxes due). Unearned revenues—obligations created when the company accepts payment in advance for goods or services it will deliver in the future; also called advances from customers, customer deposits, or deferred revenues. Short-term notes payable—short-term debt payable to banks or other creditors. Current maturities of long-term debt—principal portion of long-term debt that is due to be paid within one year.
  20. Net Working Capital
  21. Examples of Noncurrent Liabilities Long-term debt—amounts borrowed from creditors that are scheduled to be repaid more than one year in the future; any portion of long-term debt that is due within one year is reclassified as a current liability called current maturities of long-term debt. Long-term debt includes bonds, mortgages, and other long-term loans. Other long-term liabilities—various obligations, such as pension liabilities and long-term tax liabilities, that will be settled a year or more into the future. We discuss these items in later modules.
  22. Equity Equity consists of: Contributed Capital (cash raised from the issuance of shares) Earned Capital (retained earnings). Retained Earnings is updated each period as follows:
  23. Examples of Equity Accounts Common stock—par value received from the original sale of common stock to investors. Preferred stock—value received from the original sale of preferred stock to investors; preferred stock has fewer ownership rights compared to common stock. Additional paid-in capital—amounts received from the original sale of stock to investors in addition to the par value of common stock. Treasury stock—amount the company paid to reacquire its common stock from shareholders. Retained earnings—accumulated net income (profit) that has not been distributed to stockholders as dividends. Accumulated other comprehensive income or loss—accumulated changes in equity that are not reported in the income statement (explained in Module 9).
  24. Income Statement
  25. When are Revenues and Expenses Recognized? Accrual Accounting: Revenue Recognition Principle—recognize revenues when earned Matching Principle—recognize expenses when incurred
  26. Operating vs. Nonoperating Operating expenses are the usual and customary costs that a company incurs to support its main business activities Nonoperating expenses relate to the company’s financing and investing activities
  27. Statement of Cash Flows Statement of cash flows (SCF) reports cash inflows and outflows Cash flows are reported based on the three business activities of a company: Cash flows from operating activities - Cash flows from the company’s transactions and events that relate to its operations. Cash flows from investing activities - Cash flows from acquisitions and divestitures of investments and long-term assets. Cash flows from financing activities - Cash flows from issuances of and payments toward borrowings and equity.
  28. Cash Flow from Operations
  29. Articulation of Financial Statements Financial statements are linked within and across time – they articulate. Balance sheet and income statement are linked via retained earnings.
  30. Recording transactions Understand basic recording of transactions. Pay $100 wages in cash: Cash assets are reduced by $100, and wage expense of $100 is reflected in the income statement, which reduces income and retained earnings by that amount. Wages Expense $100 Cash $100 All transactions incurred by the company during the accounting period are recorded similarly.
  31. Adjusting Accounts
  32. Global Accounting Balance Sheet The most visible difference is that the typical IFRS-based balance sheet is presented in reverse order of liquidity. Income Statement The most visible difference is that GAAP requires three years’ data on the income statement whereas IFRS requires only two.

  33. Module 3: Accounting Adjustments and Constructing Financial Statements

  34. The Accounting Cycle

  35. T-Accounts and Journal Entries
  36. Capital Investment
  37. Asset (Inventory) Transaction
  38. Cash Dividends All transactions between the company and its shareholders are considered financing transactions. This includes payment of dividends, the issuance of stock, and any subsequent stock repurchase. Financing transactions affect only the balance sheet; they do not affect the income statement.
  39. Adjusting Accounts
  40. Types of Adjustments Cash received or paid before recognition of revenue or expense: Prepaid expenses Unearned revenues Cash received or paid after recognition of revenue or expense Accrued expenses Accrued revenues
  41. Prepaid Expenses (Assets) Assume that Apple pays $200 to purchase time on MTV for future iads. Apple’s cash account decreases by $200, and an asset called prepaid advertising increases by the same amount. When the ad is aired, the prepaid asset is “used up” and is removed from the balance sheet and recognizing the cost as an expense.
  42. Unearned Revenues (Liabilities) Assume that Apple receives $400 cash from a customer as advance payment on a multi-unit iPod sale to be delivered next month.
  43. Recognition of Unearned Revenue as Earned Revenue Assume that Apple delivers the iPods a month later (but still within the fiscal quarter).
  44. Accrued Expenses (Liabilities) Assume that Apple’s sales staff earns $100 of sales commissions this period that will not be paid until next period. When paid, the liability is reduced as is cash.
  45. Accrued Revenues (Assets) Assume that Apple delivers iPods to a customer in Germany who will pay next quarter. The sales price for those units is $500 and the cost is $400.
  46. Trial Balance The trial balance is a listing of all accounts and their balances at a point in time. Its purpose is to prove the mathematical equality of debits and credits, provide a useful tool to uncover any accounting errors, and help prepare the financial statements.
  47. Adjusted Trial Balance For Apple
  48. Preparation of the Financial Statements Income Statement
  49. Preparation of the Financial Statements Retained Earnings Computation
  50. Preparation of the Financial Statements Balance Sheet
  51. Preparation of the Financial Statements Statement of Stockholders’ Equity
  52. Statement of Cash Flows – Indirect Method Operating cash flows
  53. Changes to Working Capital Accounts
  54. Formal Presentation of Apple’s SCF
  55. Closing Process The closing processrefers to the ‘zeroing out’ of revenue and expense accounts (the temporary accounts) by transferring their ending balances to retained earnings. Balance sheet accounts carry over from period to period and are called permanent accounts.) The result is that all income statement accounts begin the next period with zero balances.
  56. Closing Process Journal Entries