Lecture 14 Lecture 14 Understanding Understanding Financial ...

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Lecture 14 Lecture 14 Understanding Understanding Financial ...

  1. 1. Lecture 14 Understanding Financial Statements ABIZ 0680/1000 Dr. Jared Carlberg In This Lecture The Importance of Financial Statements The Accounting Process Financial Statements The Balance Sheet The Income Statement Pro Forma Financial Statements Important Accounting Principles What is Accounting? accounting is the process of collecting, analyzing, and disseminating financial information financial info forms the basis for two types of accounting: info used internally for decision making this is called “managerial accounting” accounting” info used for financial reporting to stockholders, lenders, authorities, etc. this is called “financial accounting” accounting” 1
  2. 2. Cash Accounting Vs. Accrual Accounting alternate approaches to preparing the income statement cash-basis approach: says revenue and cash- expenses occur when cash is paid/received can under-or-overstate true net profit under- or- accrual-basis approach: says revenue and accrual- expenses exist when they first take place this approach is better: it more accurately reflects the way most businesses operate Importance of Financial Statements accurate & timely information is absolutely critical for effective management financial records system should be: simple & easy to understand reliable, accurate, consistent, timely based upon the business’ unique characteristics business’ cost-effective to implement & maintain cost- professional help is required to design system most agribusinesses hire bookkeepers/ accountants Types of Accountants three types of professional designations: chartered accountants (CA): “pure accountants” accountants” who are trained as such in university typically provide accounting & business advisory services to clients, both corporate and individual often serve corporations & also individuals certified general accountants (CGA) obtain CGA designation to improve mgmt. skills must hold an accounting-based position to qualify accounting- certified management accountants (CMA) tend to focus on business strategy & decision-making decision- more interdisciplinary than other designations 2
  3. 3. Accounting System Uses good financial records provide the basis for: determining the business’ success business’ showing the financial health of the business predicting the ability of the business to meet the demands of creditors, change, and expansion relating performance to managers’ decisions managers’ choosing among alternative courses of action for the future The Accounting Process based largely on original documents sales slips, bills, cheques, invoices cheques, transactions recorded in the “journal” journal” also called “book of original entry” entry” records all of the business’ transactions business’ info. then transferred into other fin. statements also have “ledger” with classes of receipts and ledger” expenses grouped together The Balance Sheet shows the financial makeup and condition of a business at a specific point and time shows what a business owns, what it owes, and what the owners have invested details the “balance” between assets and claims balance” against them (liabilities and owners’ equity) (liabilities owners’ equity) assets: things of value owned by the business liabilities: amounts that must be paid owners’ equity: amount invested by owners owners’ 3
  4. 4. The Balance Sheet the balance sheet always balances because of double-entry accounting double- assets = liabilities + owners’ equity owners’ this is the accounting equation asset, the business owes somebody for it (liability) or an investor has a claim on it (owners’ equity) (owners’ if the balance sheet doesn’t balance, you’ve done doesn’ you’ something wrong! Assets are things of value owned by a business note: only corporations can really “own” assets, but own” we treat businesses thusly for accounting purposes three usual types of business assets: current assets fixed assets other assets Current Assets cash or assets that will be converted to cash within one operating cycle (usually a year) reflect the firm’s ability to generate cash firm’ there are several types of current assets cash: immediately available funds accounts receivable: amounts owed for sales inventory: items to be sold/used in production prepaid expenses: paid for but not yet utilized other current assets: e.g. marketable securities 4
  5. 5. Fixed Assets assets that have a relatively long life typically used to produce or sell goods/services there are three main types of fixed assets: land: real estate owned by the business usually valued at purchase (not market!) price buildings: facilities the business owns equipment: used for any aspect of operations have to recognize that assets depreciate show this on balance sheet to ensure accuracy! Other Assets miscellaneous assets that aren’t exactly current aren’ or fixed many things don’t fit into those categories don’ usually nondepreciable in nature examples of “other assets” include: assets” bonds held for longer than one year “intangible” assets such as patents, copyrights, and intangible” goodwill Liabilities consist of money the business owes to “outsiders” (not original investors) outsiders” are claims against the business’ assets business’ but not always against specific assets two main types of liabilities current liabilities long-term liabilities long- 5
  6. 6. Current Liabilities claims against the business that will fall due within one business cycle show the business’ short-term obligations business’ short- types of current liabilities include: accounts payable: payment for things purchased on credit (e.g. inputs used in production) notes payable: loans due within one year accrued expenses: day-to-day expenses accrued day- to- but not yet paid (e.g. wages; taxes) advances: payment received for goods in advance Long-term Liabilities outsiders’ claims not due within one operating outsiders’ cycle those liabilities that are not “current” current” examples of long-term liabilities include: long- bonded indebtedness: bonds issued by the firm mortgages: taken out on certain assets long-term loans: to banks or individuals long- Owners’ Equity claims of owners against firm assets summary of accounts showing contributions three usual accounts for owners’ equity: owners’ common stock: appears on books at original value paid-in capital: additional money contributed paid- by owners (but not as share capital) retained earnings: net gain on initial investment represent net profit left in the business as capital 6
  7. 7. The Income Statement shows revenues & expenses for a specific period of time & profit or loss from operations gives a measure of profit and performance provides insight into managerial efficiency shows how changes in the balance sheet came about shows revenue taken in and money spent to generate that revenue The Income Statement the basic format of the income statement is: Revenue - Cost of Goods Sold (COGS) = Gross Profit - Operating Expenses = Operating Income - Income Taxes = Net Income (after taxes) Revenues total dollar value of goods and services sold during the income statement period include cash and credit sales may include special lines for items such as returns and/or discounts & allowances often broken down into different products this provides best information but also takes up more space on the income statement 7
  8. 8. Cost of Goods Sold (COGS) gives the total cost to the business of goods sold during the reporting period what it cost the business to purchase the goods it later re-sold re- how to calculate COGS if it is not given to you: COGS = starting inventory + purchases - ending inventory in this course, you will always be given COGS; you won’t have to calculate it directly won’ Gross Profit (or Gross Margin) shows difference between sales and COGS money available to cover operating expenses important to retail agribusinesses because they have very little control over COGS changes in output price have big impact on gross margins for retailers because COGS stay the same regardless of output price manufacturers can try to reduce COGS to increase margins Operating Expenses costs incurred as a result of business operations during the reporting period have to pay for things to conduct business can break them down into major categories: marketing: wages, salaries, commissions administrative: mgr. salaries, office, travel general: depreciation, insurance, taxes, rent, repairs, utilities all these expenses are operating expenses 8
  9. 9. Operating Income amount left over when operating expenses are deducted from gross margin affected by same factors that influence gross margins output price, COGS can influence net operating profit by controlling operating expenses cost-cutting measures can make the firm more cost- profitable Net Income After Taxes what is left after business taxes are paid tax rates vary by jurisdiction and by profit level this is the so-called “bottom line” so- line” appears on the bottom line of the income statement can also be a “net loss” loss” yes, businesses sometimes lose money! Pro Forma Statements financial statements usually reflect history but sometimes want to assess future plans! can use “pro forma” statements to do this forma” they are statements prepared for a future period often used to estimate the impact of potential courses of action upon the business often have to do pro forma statements to borrow money for a new or existing business 9
  10. 10. Important Accounting Principles important things about financial accounting: in general, only facts that can be recorded in monetary terms should be on balance sheet and income statement most accounting is done on an accrual basis assets are usually recorded at the lower of their actual cost or market value the format of the income statement should reflect the unique needs of the organization every accounting event has to balance: a change in assets requires a change in either liabilities or owners’ equity, or both owners’ Next Class topic: Analyzing Financial Statements reading: Chapter 14, continued Using Statements to Evaluate Performance Ratio Analysis profitability ratios liquidity ratios solvency ratios operating/efficiency (activity) ratios discussion question: How is the return on equity (ROE) ratio calculated? 10

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