CHAPTER 2 FINANCIAL STATEMENTS FINANCIAL STATEMENTS

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CHAPTER 2 FINANCIAL STATEMENTS FINANCIAL STATEMENTS

  1. 1. CHAPTER 2 FINANCIAL STATEMENTS
  2. 2. FINANCIAL STATEMENTS <ul><li>Income Statement </li></ul><ul><li>Common Size Income Statement </li></ul><ul><li>Balance Sheet </li></ul><ul><li>Common Size Balance Sheet </li></ul><ul><li>Statement of Cash Flows </li></ul>
  3. 3. Income Statement <ul><li>Summarizes the results of the firm’s operations over a period of time </li></ul><ul><li>Shows total revenues and expenses for the time period </li></ul><ul><li>Shows different measures of profit </li></ul><ul><li>Prepared for different time periods: Monthly, quarterly, and annually </li></ul>
  4. 4. Income Statement <ul><li>The order of the items that should be entered in the income statement is as follows: </li></ul><ul><li>1. Sales: Total $ income incurred by sales (revenue) </li></ul><ul><li>2. Cost of Goods Sold : This item includes raw material, labor, etc... </li></ul><ul><li>3. Gross Profit : Profit from goods sold, not including any expense other than cost of goods </li></ul><ul><li>Gross Profit = Sales - Cost of Goods Sold </li></ul>
  5. 5. Income Statement <ul><li>4. Selling, G&A Expenses : Selling, General and Administrative Expenses. Marketing, paperwork, etc... </li></ul><ul><li>5. Fixed Expenses </li></ul><ul><li>6. Depreciation Expense : Depreciation of machinery </li></ul><ul><li>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 </li></ul><ul><li>EBIT = Gross Profit - (Selling, G&A Expenses + Fixed Expenses + Depreciation Expense) </li></ul>
  6. 6. Income Statement <ul><li>8. Interest Expense : Interest paid on the firm’s debt </li></ul><ul><li>9. Earnings Before Taxes : This item shows the income generated without including taxes </li></ul><ul><li>Earnings Before Taxes = EBIT - Interest Expense </li></ul><ul><li>10. Taxes : Assume 40% tax rate . Enter as follows: </li></ul><ul><li>Taxes @ 40%, or Taxes (40%) </li></ul><ul><li>Taxes = 0.4*Earnings Before Taxes </li></ul><ul><li>11. Net Income : </li></ul><ul><li>Net Income = Earnings Before Taxes - Taxes </li></ul>
  7. 7. Common-Size Income Statements <ul><li>Common-size income statements display data not as $ amounts but as percentages of firm’s total revenues ( Sales ) </li></ul><ul><li>Benefits: </li></ul><ul><li>- Easy comparison between firms of different sizes </li></ul><ul><li>- Show important trends which may not be seen in $ amounts </li></ul>
  8. 8. Balance Sheet <ul><li>Balance sheet describes assets, liabilities, and equity of the firm at a specific time (like a snapshot) </li></ul><ul><li>Assets : (Tangible/intangible): </li></ul><ul><li>- Things that a firm owns. </li></ul><ul><li>-Assets are entered on the top or on the left of the balance sheet </li></ul>
  9. 9. Balance Sheet <ul><li>Liabilities: </li></ul><ul><li>- Debts of the firm </li></ul><ul><li>- Entered below Assets, or on the right of the balance sheet </li></ul><ul><li>Equity : </li></ul><ul><li>- Difference between what firm owns and what it owes to others </li></ul><ul><li>- Entered below liabilities in the balance sheet </li></ul>
  10. 10. Balance Sheet <ul><li>NOTE: </li></ul><ul><li>Balance sheet must balance : </li></ul><ul><li>Total Assets = Total Liabilities + Total Equity </li></ul><ul><li>should satisfy </li></ul>
  11. 11. Balance Sheet <ul><li>A. ASSETS: (Top, or left of balance sheet) </li></ul><ul><li>1. Current Assets : </li></ul><ul><li>Firm’s short term assets. </li></ul><ul><li>-Cash and Marketable Securities, </li></ul><ul><li>-Accounts Receivable, </li></ul><ul><li>-Inventories </li></ul><ul><li>2. Fixed Assets : </li></ul><ul><li>- Assets that have long life, like plant and equipment </li></ul><ul><li>3. Net Fixed Assets : </li></ul><ul><li>-You deduct the accumulated depreciation of the fixed assets from the value of fixed assets to find Net Fixed Assets </li></ul><ul><li>Net Fixed Assets=Fixed Assets - Accumulated Depreciation </li></ul>
  12. 12. Balance Sheet <ul><li>B. LIABILITIES (Below Assets or on the right of Balance Sheet) </li></ul><ul><li>1. Current Liabilities : </li></ul><ul><li>Short term liabilities </li></ul><ul><li>Typically, current liabilities are: </li></ul><ul><li>-Accounts payable </li></ul><ul><li>-Notes payable </li></ul><ul><li>-Accruals </li></ul><ul><li>2. Long-term Liabilities : </li></ul><ul><li>Bonds, bank loans, etc.. </li></ul><ul><li>3. Total Liabilities : </li></ul><ul><li>Current Liabilities + Long-term Liabilities </li></ul>
  13. 13. Balance Sheet <ul><li>C. SHAREHOLDER’S EQUITY (Below Liabilities) </li></ul><ul><li>1. Preferred Stock : </li></ul><ul><li>2. Common Stock : </li></ul><ul><li>3. Retained Earnings : </li></ul><ul><li>4. Total Shareholder’s Equity : </li></ul><ul><li>Preferred Stock + Common Stock + Retained Earnings </li></ul>
  14. 14. Balance Sheet <ul><li>D. TOTAL LIABILITIES AND EQUITY (below Total Shareholder’s Equity) </li></ul><ul><li>Total Liabilities + Total Shareholder’s Equity </li></ul><ul><li>NOTE: </li></ul><ul><li>Again remember that </li></ul><ul><li>Total Assets = Total Liabilities and Equity </li></ul>
  15. 15. Common-size Balance Sheet <ul><li>Preparing common-size balance sheet is similar to the one we did for income statement. </li></ul><ul><li>Instead of Sales, for Balance Sheet, we use Total Assets to form the percentages, and </li></ul><ul><li>Explain all data as a percentage of Total Assets, i.e. Format cells as %, 0.00% </li></ul>
  16. 16. Statement of Cash Flows <ul><li>Financial Transactions of Firms: </li></ul><ul><li>1. Sources of Funds: </li></ul><ul><li>Cash inflows that increase cash balance </li></ul><ul><li>2. Uses of Funds : </li></ul><ul><li>Cash outflows that decrease cash balance </li></ul>
  17. 17. Statement of Cash Flows <ul><li>How Well Managers Perform? </li></ul><ul><li>- Analyze how management uses shareholders’ money: </li></ul><ul><li>-Use Statement of Cash Flows </li></ul>
  18. 18. Statement of Cash Flows <ul><li>Statement of Cash Flows: </li></ul><ul><li>-Summarizes changes in firm’s cash balance </li></ul><ul><li>Ending Cash Balance = </li></ul><ul><li>Beginning Cash Balance + </li></ul><ul><li>Cash Inflow (Sources) - </li></ul><ul><li>Cash outflow (Uses) </li></ul>
  19. 19. Statement of Cash Flows <ul><li>Most of the items in statement of cash flows come from change in balance sheet items </li></ul><ul><li>Therefore, we need balance sheets of two years </li></ul><ul><li>We also need income statement </li></ul><ul><li>Operational Cash Flow ( Net Income + Depreciation ) comes from Income Statement </li></ul>
  20. 20. Statement of Cash Flows <ul><li>Statement of Cash Flows separates firm activities into three parts: </li></ul><ul><li>1. Operating Activities </li></ul><ul><li>2. Investing Activities </li></ul><ul><li>3. Financing Activities </li></ul>
  21. 21. Statement of Cash Flows <ul><li>1. Cash Flows from Operations : </li></ul><ul><li>Typically these are: </li></ul><ul><li>Net income, depreciation, </li></ul><ul><li>changes in -accounts receivable </li></ul><ul><li>-inventories </li></ul><ul><li>-accounts payable </li></ul><ul><li>-notes payable </li></ul><ul><li>-other current liabilities </li></ul>
  22. 22. Statement of Cash Flows <ul><li>2. Cash Flows from Investing </li></ul><ul><li>Typically these are change in fixed assets like change in plant and equipment (investment in these assets or sale of these assets) </li></ul>
  23. 23. Statement of Cash Flows <ul><li>3. Cash Flows from Financing </li></ul><ul><li>Typically these are: </li></ul><ul><li>Dividends paid to shareholders, and </li></ul><ul><li>Change in -debt </li></ul><ul><li>-stock </li></ul>
  24. 24. Statement of Cash Flows <ul><li>Increase and Decrease in Cash Flows : </li></ul><ul><li>- Uses of funds decrease cash flows: Increase in assets, Decrease in liabilities </li></ul><ul><li>- Sources of funds increase cash flows: </li></ul><ul><li>Decrease in assets, Increase in liabilities </li></ul><ul><li>Therefore, for uses of funds, we should use a - sign in the Excel sheet. </li></ul>

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