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  2. FINANCIAL STATEMENTS • Income Statement • Common Size Income Statement • Balance Sheet • Common Size Balance Sheet • Statement of Cash Flows

  3. Income Statement • Summarizes the results of the firm’s operations over a period of time • Shows total revenues and expenses for the time period • Shows different measures of profit • Prepared for different time periods: Monthly, quarterly, and annually

  4. Income Statement • The order of the items that should be entered in the income statement is as follows: 1. Sales: Total $ income incurred by sales (revenue) 2. Cost of Goods Sold: This item includes raw material, labor, etc... 3. Gross Profit: Profit from goods sold, not including any expense other than cost of goods Gross Profit = Sales - Cost of Goods Sold

  5. Income Statement 4. Selling, G&A Expenses: Selling, General and Administrative Expenses. Marketing, paperwork, etc... 5. Fixed Expenses 6. Depreciation Expense: Depreciation of machinery 7. EBIT:Earnings Before Interest and Taxes. This is also called as operating income. This is the income generated from the operations of firm and excludes taxes and interest expenses EBIT = Gross Profit - (Selling, G&A Expenses + Fixed Expenses + Depreciation Expense)

  6. Income Statement 8. Interest Expense: Interest paid on the firm’s debt 9. Earnings Before Taxes: This item shows the income generated without including taxes Earnings Before Taxes = EBIT - Interest Expense 10. Taxes: Assume 40% tax rate. Enter as follows: Taxes @ 40%, or Taxes (40%) Taxes = 0.4*Earnings Before Taxes 11. Net Income: Net Income = Earnings Before Taxes - Taxes

  7. Common-Size Income Statements • Common-size income statements display data not as $ amounts but as percentages of firm’s total revenues (Sales) • Benefits: - Easy comparison between firms of different sizes - Show important trends which may not be seen in $ amounts

  8. Balance Sheet • Balance sheet describes assets, liabilities, and equity of the firm at a specific time (like a snapshot) • Assets: (Tangible/intangible): - Things that a firm owns. -Assets are entered on the top or on the left of the balance sheet

  9. Balance Sheet • Liabilities: - Debts of the firm - Entered below Assets, or on the right of the balance sheet • Equity: - Difference between what firm owns and what it owes to others - Entered below liabilities in the balance sheet

  10. Balance Sheet • NOTE: Balance sheet must balance: Total Assets = Total Liabilities + Total Equity should satisfy

  11. Balance Sheet A. ASSETS: (Top, or left of balance sheet) 1. Current Assets: • Firm’s short term assets. -Cash and Marketable Securities, -Accounts Receivable, -Inventories 2. Fixed Assets: - Assets that have long life, like plant and equipment 3. Net Fixed Assets: -You deduct the accumulated depreciation of the fixed assets from the value of fixed assets to find Net Fixed Assets Net Fixed Assets=Fixed Assets - Accumulated Depreciation

  12. Balance Sheet B. LIABILITIES (Below Assets or on the right of Balance Sheet) 1. Current Liabilities: • Short term liabilities • Typically, current liabilities are: -Accounts payable -Notes payable -Accruals 2. Long-term Liabilities: Bonds, bank loans, etc.. 3. Total Liabilities: Current Liabilities + Long-term Liabilities

  13. Balance Sheet C. SHAREHOLDER’S EQUITY (Below Liabilities) 1. Preferred Stock: 2. Common Stock: 3. Retained Earnings: 4. Total Shareholder’s Equity: Preferred Stock + Common Stock + Retained Earnings

  14. Balance Sheet D. TOTAL LIABILITIES AND EQUITY (below Total Shareholder’s Equity) Total Liabilities + Total Shareholder’s Equity • NOTE: Again remember that Total Assets = Total Liabilities and Equity

  15. Common-size Balance Sheet • Preparing common-size balance sheet is similar to the one we did for income statement. • Instead of Sales, for Balance Sheet, we use Total Assets to form the percentages, and • Explain all data as a percentage of Total Assets, i.e. Format cells as %, 0.00%

  16. Statement of Cash Flows • Financial Transactions of Firms: 1. Sources of Funds: Cash inflows that increase cash balance 2. Uses of Funds: Cash outflows that decrease cash balance

  17. Statement of Cash Flows • How Well Managers Perform? - Analyze how management uses shareholders’ money: -Use Statement of Cash Flows

  18. Statement of Cash Flows • Statement of Cash Flows: -Summarizes changes in firm’s cash balance Ending Cash Balance = Beginning Cash Balance + Cash Inflow (Sources) - Cash outflow (Uses)

  19. Statement of Cash Flows • Most of the items in statement of cash flows come from change in balance sheet items • Therefore, we need balance sheets of two years • We also need income statement • Operational Cash Flow (Net Income + Depreciation) comes from Income Statement

  20. Statement of Cash Flows • Statement of Cash Flows separates firm activities into three parts: 1. Operating Activities 2. Investing Activities 3. Financing Activities

  21. Statement of Cash Flows 1. Cash Flows from Operations: Typically these are: Net income, depreciation, changes in -accounts receivable -inventories -accounts payable -notes payable -other current liabilities

  22. Statement of Cash Flows 2. Cash Flows from Investing Typically these are change in fixed assets like change in plant and equipment (investment in these assets or sale of these assets)

  23. Statement of Cash Flows 3. Cash Flows from Financing Typically these are: Dividends paid to shareholders, and Change in -debt -stock

  24. Statement of Cash Flows • Increase and Decrease in Cash Flows: - Uses of funds decrease cash flows: Increase in assets, Decrease in liabilities - Sources of funds increase cash flows: Decrease in assets, Increase in liabilities • Therefore, for uses of funds, we should use a -sign in the Excel sheet.