The Financial Statements
Accounting Terms
Account

• A group of items having common

characteristics

Types of Accounts
• Asset

• Income

• Equi...
Chart of Accounts
Listing of all of the accounts
used by a business
Asset Accounts
Items of Value
Characterized as current and

non-current
Liability Accounts
Claims that others have against

the assets
Have a known:
• Amount

• Date to be paid

• Person to wh...
Equity Accounts
Claims that the owner has
against the assets
Sometimes called net worth
Difference between value of

as...
Income and Expense
Accounts
Types of equity accounts

Simple accounting systems
often only contain these

accounts
Double vs Single Entry
Accounting
Single – One account entry for each
transaction
Double – Two account entries for each
...
Basic Accounting Equation
Always maintained in double

entry accounting
Assets will always equal
liabilities plus equity
Transactions
Will be equal and offsetting
Two types:
• Income & Expenses

• Transfers between accounts
Cash and Accrual Accounting
Refers to the timing of entries

into the accounting system
Cash Based Records
Transactions are recorded when

cash is received or paid out
Accrual Based Records
Transactions are recorded when

they take place
Regardless of whether cash is
involved
Accrual Adjusted Statements
Cash based records are kept

throughout the year
Non-Cash adjustments are made
to the cash b...
Account Valuation
Income Accounts
• Value received is recorded

Expense Accounts
• Value paid is recorded

Liability Ac...
Account Valuation
Asset Accounts
• More difficult because they may not

be traded routinely
Asset Valuation
Cost Basis
Market Value Basis
Cost Basis Asset Valuation
Original cost minus depreciation
Must establish a depreciation

method
Market Basis Asset Valuation
Recorded as the price they could

bring if sold, less selling expenses
Based on recent auct...
Depreciation
 Section II page 29, (FFSTF Guidelines)
 Allocation of the expense that reflects the

“using up” of capital...
Depreciation
 Allocation applied to original cost minus salvage

value
 Accelerated versus straight line methods

• Exam...
Financial Reports
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Owner Equity
Balance Sheet
Represents a financial situation at

a single point in time
Has a date on it
Broken down by:

• Type of A...
Balance Sheet
Current Assets

• Cash and other assets that will be

converted into cash during one
operating cycle

Non-...
Balance Sheet
Current Liabilities
• Debts that will come due within one

year from the balance sheet date

Non-Current L...
Balance Sheet
 Intermediate Assets and Liabilities
 Long term Assets and Liabilities
 Can use cost or market valuations...
Income Statement
 Summary of income and expenses
 Represents a period of time between two

balance sheets
 Explains the...
Beginning Balance Sheet
Assets

Liabilities

Ending Balance Sheet
Assets

Equity

+/- Net Income
+/- Valuation Changes
- F...
Income Statement
Will have more than one profit

line
Definition of Profit

• Financial profit is the net return to

bus...
Accrual Adjusted Income
Statement
 Cash incomes and expenses must be adjusted

by:

• Changes in non-cash assets
 Invent...
Statement of Cash Flows
 Not the same as a cash flow plan (Budget)
 Is a historical record of sources and uses of

funds...
Statement of Owner Equity
 Explains the change in owners equity between

two balances sheets
 Changes due to :
• Net inc...
Financial Analysis
All business owners should have a

basic set of financial statements
at their disposal and they should...
Financial Analysis
Two Objectives
• Measure financial condition of the

business
• Measure financial performance of
the b...
Financial Analysis
Horizontal Analysis
Vertical Analysis

Ratio Analysis
Horizontal Analysis
Looks at trends in performance

and strength over time

• For example, percent change in net

income ...
Vertical Analysis
Looks at within year events

rather than over time

• For example, interest expense as a

percent of to...
Ratio Analysis
Allows for consistent comparison

of a single business over time as
well as comparison between
businesses
...
Source of data for Ratio
Analysis
Balance Sheet
Income Statement
Farm Financial Standards
Council (Five Criteria)
Liquidity
Solvency
Profitability
Financial Efficiency
Repayment Capa...
Ratio Analysis
16 different ratios commonly

used
Each has limitations
Proper interpretation is critical
Liquidity
Ability of a business to pay

current liabilities as they come
due
Liquidity

Current Ratio

• Current Assets/Current Liabilities
• Less than one is bad

Working capital

• Current assets...
Solvency
Ability of the firm to repay all of

its financial obligations
Solvency
 Debt to Asset Ratio
• Total liabilities/total assets
• Greater than one bad
 Equity to Asset Ratio
• Total equ...
Profitability
Rate of return on assets
Rate of return on equity
Operating profit margin ratio
Financial Efficiency
Measures the intensity with which

a business uses its assets to
generate gross revenues and the
eff...
Financial Efficiency
Asset turnover ratio
Operating expense ratio
Depreciation ratio
Interest expense ratio
Net incom...
Repayment Capacity
Measures the borrower’s ability

to repay term debts and capital
leases rather than financial
position...
Repayment Capacity
Term debt and capital lease

coverage ratio
Capital replacement and term
repayment margin
Cautions
 Measures are only as good as the data used
 Methods must be consistent between years and

between operations

...
Accounting
Accounting
Accounting
Accounting
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Accounting

  1. 1. The Financial Statements
  2. 2. Accounting Terms Account • A group of items having common characteristics Types of Accounts • Asset • Income • Equity Liability Expense
  3. 3. Chart of Accounts Listing of all of the accounts used by a business
  4. 4. Asset Accounts Items of Value Characterized as current and non-current
  5. 5. Liability Accounts Claims that others have against the assets Have a known: • Amount • Date to be paid • Person to whom payment owed Also current and non current
  6. 6. Equity Accounts Claims that the owner has against the assets Sometimes called net worth Difference between value of assets and liabilities
  7. 7. Income and Expense Accounts Types of equity accounts Simple accounting systems often only contain these accounts
  8. 8. Double vs Single Entry Accounting Single – One account entry for each transaction Double – Two account entries for each transaction • One debit and one credit  Hybrid systems • May not match income with expenses • May not distinguish cash, check, or credit
  9. 9. Basic Accounting Equation Always maintained in double entry accounting Assets will always equal liabilities plus equity
  10. 10. Transactions Will be equal and offsetting Two types: • Income & Expenses • Transfers between accounts
  11. 11. Cash and Accrual Accounting Refers to the timing of entries into the accounting system
  12. 12. Cash Based Records Transactions are recorded when cash is received or paid out
  13. 13. Accrual Based Records Transactions are recorded when they take place Regardless of whether cash is involved
  14. 14. Accrual Adjusted Statements Cash based records are kept throughout the year Non-Cash adjustments are made to the cash based income statement at the end of the year
  15. 15. Account Valuation Income Accounts • Value received is recorded Expense Accounts • Value paid is recorded Liability Accounts • Value is dollar amount owed
  16. 16. Account Valuation Asset Accounts • More difficult because they may not be traded routinely
  17. 17. Asset Valuation Cost Basis Market Value Basis
  18. 18. Cost Basis Asset Valuation Original cost minus depreciation Must establish a depreciation method
  19. 19. Market Basis Asset Valuation Recorded as the price they could bring if sold, less selling expenses Based on recent auctions, appraisals, etc.
  20. 20. Depreciation  Section II page 29, (FFSTF Guidelines)  Allocation of the expense that reflects the “using up” of capital assets employed by the business  Conceptually, this is done over the useful life of the asset in a “systematic and rational” manner
  21. 21. Depreciation  Allocation applied to original cost minus salvage value  Accelerated versus straight line methods • Example of difference between management records and tax records  Can overstate or understate true income
  22. 22. Financial Reports Balance Sheet Income Statement Statement of Cash Flows Statement of Owner Equity
  23. 23. Balance Sheet Represents a financial situation at a single point in time Has a date on it Broken down by: • Type of Asset or liability • Time or life of the account type
  24. 24. Balance Sheet Current Assets • Cash and other assets that will be converted into cash during one operating cycle Non-Current Assets • Those not expected to be converted into cash in one operating cycle
  25. 25. Balance Sheet Current Liabilities • Debts that will come due within one year from the balance sheet date Non-Current Liabilities • Those debts due more that one year from the balance sheet date
  26. 26. Balance Sheet  Intermediate Assets and Liabilities  Long term Assets and Liabilities  Can use cost or market valuations or both  Supporting Schedules are very helpful  Will need a balance sheet for beginning and ending of accounting period
  27. 27. Income Statement  Summary of income and expenses  Represents a period of time between two balance sheets  Explains the change in equity between two balance sheets  Can be divided into enterprise reports  Can be cash or accrual
  28. 28. Beginning Balance Sheet Assets Liabilities Ending Balance Sheet Assets Equity +/- Net Income +/- Valuation Changes - Family living withdrawals + Capital contributions Liabilities Equity
  29. 29. Income Statement Will have more than one profit line Definition of Profit • Financial profit is the net return to business equity
  30. 30. Accrual Adjusted Income Statement  Cash incomes and expenses must be adjusted by: • Changes in non-cash assets  Inventories  Pre paid expenses  Receivables • Changes in non-cash liabilities  Payables  Accrued interest
  31. 31. Statement of Cash Flows  Not the same as a cash flow plan (Budget)  Is a historical record of sources and uses of funds  Divisions of Statement: • Cash from operating activities • Cash from investing activities • Cash from financing activities
  32. 32. Statement of Owner Equity  Explains the change in owners equity between two balances sheets  Changes due to : • Net income • Change in inventory valuation • Family living withdrawals • Capital contributions • Capital distributions
  33. 33. Financial Analysis All business owners should have a basic set of financial statements at their disposal and they should know how to analyze and interpret them.
  34. 34. Financial Analysis Two Objectives • Measure financial condition of the business • Measure financial performance of the business
  35. 35. Financial Analysis Horizontal Analysis Vertical Analysis Ratio Analysis
  36. 36. Horizontal Analysis Looks at trends in performance and strength over time • For example, percent change in net income from year to year
  37. 37. Vertical Analysis Looks at within year events rather than over time • For example, interest expense as a percent of total expenses
  38. 38. Ratio Analysis Allows for consistent comparison of a single business over time as well as comparison between businesses Converts nominal dollar amounts to a common basis
  39. 39. Source of data for Ratio Analysis Balance Sheet Income Statement
  40. 40. Farm Financial Standards Council (Five Criteria) Liquidity Solvency Profitability Financial Efficiency Repayment Capacity
  41. 41. Ratio Analysis 16 different ratios commonly used Each has limitations Proper interpretation is critical
  42. 42. Liquidity Ability of a business to pay current liabilities as they come due
  43. 43. Liquidity Current Ratio • Current Assets/Current Liabilities • Less than one is bad Working capital • Current assets minus current liabilities • Negative number is bad
  44. 44. Solvency Ability of the firm to repay all of its financial obligations
  45. 45. Solvency  Debt to Asset Ratio • Total liabilities/total assets • Greater than one bad  Equity to Asset Ratio • Total equity/total assets  Debt to Equity Ratio • Leverage ratio • Less than one better
  46. 46. Profitability Rate of return on assets Rate of return on equity Operating profit margin ratio
  47. 47. Financial Efficiency Measures the intensity with which a business uses its assets to generate gross revenues and the effectiveness of production
  48. 48. Financial Efficiency Asset turnover ratio Operating expense ratio Depreciation ratio Interest expense ratio Net income from operations ratio
  49. 49. Repayment Capacity Measures the borrower’s ability to repay term debts and capital leases rather than financial position or performance
  50. 50. Repayment Capacity Term debt and capital lease coverage ratio Capital replacement and term repayment margin
  51. 51. Cautions  Measures are only as good as the data used  Methods must be consistent between years and between operations • Example – Asset valuation methods  Measures ask the right questions but do not provide the answers
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