Introduction to Financial Statements Donald S. Appleby

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Introduction to Financial Statements Donald S. Appleby

  1. 1. Introduction to Financial Statements Donald S. Appleby Adjunct Assistant Professor Dept. of Electrical and Computer Engineering The University of Alabama at Birmingham © Donald S. Appleby, 2009. All rights reserved.
  2. 2. Why Analyze Statements?  Management  To evaluate business performance  To compare performance with others  To discern trends  To make decisions  Creditors  To assess credit worthiness/risk  Investors, analysts, unions, government  For general information 2
  3. 3. The Financial Statements  Preliminary Concepts  Read the footnotes that accompany the statements  Verify that the statements were independently audited  Look for qualified opinions from the accountants expressing areas of concern  Understand the accounting principles being used  Ex. LIFO and FIFO 3
  4. 4. 1 - The Balance Sheet 4
  5. 5. The Balance Sheet  Also called the Statement of Financial Position  Reports financial position at a point in time  Lists assets, liabilities, and owners equity  The Accounting Equation  Assets = Liabilities + Owners Equity 5
  6. 6. The Balance Sheet  Look at an example of a comparative balance sheet  Accounts are listed in order of decreasing liquidity  Ease of conversion to cash  Grouped as  Current  duration of a year or less  Non-current  duration over a year 6
  7. 7. Assets  Current  Long-term 7
  8. 8. Current Assets  Cash  Marketable Securities  Accounts Receivable (less allowance for bad debts)  Inventory (at lower of cost or market)  Raw materials  Work in process  Finished goods 8
  9. 9. Long-Term Assets  Investments and Intangible Assets  Patents, trademarks, copyrights  Goodwill  Ownership of other companies, joint ventures  Fixed Assets  Property  Plant  Equipment 9
  10. 10. Net Book Value  Gross book value  Less: Accumulated Depreciation  Equals: Net Book Value  Gross book value is a record of the original price paid for the asset.  Accumulated depreciation is the total depreciation expense recorded against the asset. 10
  11. 11. Depreciation Methods  Always seek professional guidance  Modified Accelerated Cost Recovery System (MACRS)  Accelerated Cost Recovery System (ACRS)  Terms you may encounter  Straight line  Accelerated  Double declining balance  Sum of the years digits 11
  12. 12. Liabilities  Current  Long-term 12
  13. 13. Current Liabilities  Accounts Payable  Notes Payable  Current-Portion of Long-Term Debt 13
  14. 14. Long-Term Liabilities  Long-Term Debt 14
  15. 15. Stockholders’ Equity  Preferred Stock  Receives dividends (but not an obligation)  Less risk than common stock (liquidation priority)  Not considered owners; generally don’t vote  Common Stock  Ownership of the business  Amount shown is historical not market value  Paid-In Capital  Capital paid-in in excess of par value of stock  Retained Earnings  Total of all profits that were re-invested in the business rather than distributed as dividends 15
  16. 16. 2 - The Income Statement 16
  17. 17. Income Statement  Also called  Statement of Earnings  Profit and Loss Statement  Objective is to match expenses to revenue for a given period of time  Revenue – Expenses = Profit 17
  18. 18. Components: Gross Profit  Revenue (or sales)  Less: Cost of Goods Sold …directly allocated cost of production  Gross Profit (or gross margin)  Cost of Good Sold  Raw materials  Purchased components  Direct labor  Operation and repair of manufacturing equipment  Other manufacturing expenses such as utilities, maintenance of the manufacturing facility 18
  19. 19. Components: Operating Income  Gross Profit  Less: Operating Expenses …not directly allocated to COGS  General and administrative expenses  Depreciation (a non-cash expense)  Other expenses  Operating Income (excludes investment income, interest, and taxes)  General and administrative expenses  Staff expenses, executive salaries  Selling expenses, promotions, advertising  R&D 19
  20. 20. Putting It Together  Revenue  Less: COGS  Equals: Gross Profit  Less: Operating Expenses  Equals: Operating Income  Operating income is focused on the profit being generated by operations. It excludes, or filters out, the effects of interest and taxes. See EBIT. 20
  21. 21. Earnings  EBIT: Earnings Before Interest and Taxes  EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization  Focuses more on cash flow / cash management  Depreciation and amortization are non-cash expenses 21
  22. 22. 3 – Statement of Cash Flows 22
  23. 23. Statement of Cash Flows  FASB requires a report on the firm’s cash flows for the accounting period  Statement is also called  Sources and Uses of Funds  Need to understand Working Capital  “Working capital” refers to the funds used to carry out the daily operations of the business  Invested in inventory  Invested in A/R 23
  24. 24. Sources and Uses of Cash  Increase* of an asset is a use of cash  So decrease of an asset is a source of cash  Increase of a liability is a source of cash  So decrease of a liability is a use of cash  Comments  Depreciation reflects a decrease in the value of an asset, so it is a source of cash  Think of net worth as a “liability”  An increase in net income increases net worth and is thus a source of cash *Increase and decrease refer to changes from the beginning of the accounting period to the end of the accounting period. 24
  25. 25. Comments regarding cash  Accrual method of recognizing income  Effect of lags in collecting cash  Effect of depreciation on cash flow  More about cash later 25

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