The document discusses understanding a firm's financial statements. It describes the purpose and key components of an income statement, balance sheet, and cash flow statement. The income statement shows profit/loss over time, the balance sheet shows assets, liabilities, and equity at a point in time, and the cash flow statement shows cash inflows and outflows from operating, investing, and financing activities. Viewing the statements together provides a more comprehensive view of the firm's financial position.

1. Small Business
Management, 18e
Longenecker/Petty/Palich/Hoy
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2. Understanding a Firm’s
Financial Statements
Chapter 10
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3. Learning Goals:
 Describe the purpose and content of an
income statement.
 Describe the purpose and content of a
balance sheet.
 Explain how viewing the income
statement and balance sheets together
gives a more complete picture of a firm’s
financial position.
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4. Learning Goals (cont.):
 Use the income statement and balance
sheets to compute a company’s cash
flows.
 Analyze the financial statements using
ratios to see more clearly how decisions
affect a firm’s financial performance.
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5. Understanding Financial
Statements
 Financial Statements (Accounting
Statements)
Reports of a firm’s financial performance
and resources
Helps determine a startup’s financial
requirements
Assesses the financial implications
of a business plan
10–5
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6. Understanding Financial
Statements (cont.)
 Basic Financial Statements
Income statement
Balance sheet
Cash flow statement
10–6
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or in part, except for use as permitted in a license distributed with a certain product or service or
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7. Understanding the Income
Statement
 Income Statement
A report showing the profit or loss from a
firm’s operations over a given period of
time.
“How profitable is the business?”
Sales (revenue) – Expenses = Profits (income)
 Revenue from product or service sales
 Costs of producing product/service (cost of goods sold)
10–7
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8. Understanding the Income
Statement (cont.)
“How profitable is the business?”
Sales (revenue) – Expenses = Profits (income)
 Operating expenses (marketing, selling, general and
administrative expenses, and depreciation)
 Financing costs (interest paid)
 Tax payments
10–8
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.

9. The Income Statement
(cont’d)
 Cost of Goods Sold
The cost of producing or acquiring goods
or services to be sold by a firm
 Gross Profit
Sales less the cost of goods sold
 Operating Expenses
Costs related to marketing and selling a
firm’s product or service, general and
administrative expenses, and depreciation
10–9
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or in part, except for use as permitted in a license distributed with a certain product or service or
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10. The Income Statement
(cont’d)
 Operating Income
Earnings before interest and taxes are
paid
10–10
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classroom use.

11. The Income Statement
(cont’d)
 Financing Costs
The amount of interest owed to lenders
on borrowed money
 Net Income Available To Owners (Net
Income)
Income that may be distributed to the
owners or reinvested in the company
10–11
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12. The Income Statement
(cont’d)
 Depreciation Expense
Costs related to a fixed asset, such as a
building or equipment, distributed over its
useful life
10–12
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The Income Statement: An Overview
10.1

14. The Income Statement
(cont’d)
10–14
Operating Activities
Sales Revenue
=
=
=
Operating Income
Earnings Before Taxes
Net Income Available
to Owners
Cost of producing or
acquiring product or
service
(cost of goods sold)
Gross profit
Marketing and selling
expenses, general and
administrative
expenses and
depreciation
(operating expenses)
,
–
=
–
Financing Activities
Operating Income
Interest expense
on debt
(financing costs)
–
Taxes
Earnings Before Taxes
Income taxes
–
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10.2 Income Statement for Houser & Associates, Inc.,
for the Year Ending December 31, 2013
35%
–65%
100%
Percent of Sales
12%
–24%
–2%
9%
–2%
7%
Gross profit margin
Operating profit margin
Net profit margin

16. The Balance Sheet
 Balance Sheet
A report showing a firm’s assets,
liabilities, and owners’ equity at a specific
point in time
Total Assets = Debt + Owner’s equity
10–16
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10.3 The Balance Sheet: An Overview

18. The Balance Sheet: Current
Assets
 Current Assets (Working Capital)
Assets that can be converted to cash
within the firm’s operating cycle
Cash
Currency and negotiable instruments
Accounts receivable
Amount of credit extended to customers that is
currently outstanding
10–18
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19. The Balance Sheet: Current
Assets (cont.)
 Current Assets (Working Capital)
(cont.)
◦ Inventory
 Raw materials and products held in anticipation
of sale
10–19
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10.4 The Working Capital Cycle

21. The Balance Sheet: Fixed
Assets
 Fixed Assets (Plant, Property, and
Equipment)
Relatively permanent resources intended
for use in the business (not for resale)
 Depreciable Assets
Assets whose value declines
(depreciates) over time
10–21
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22. The Balance Sheet: Fixed
Assets (cont.)
 Gross Fixed Assets
Original cost of depreciable assets before
any depreciation expense has been taken
 Accumulated Depreciation
Total depreciation expense taken over the
assets’ life
10–22
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use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.

23. The Balance Sheet: Fixed
Assets (cont’d)
 Net Fixed Assets
Gross fixed assets less accumulated
depreciation
 Other Assets
Assets other than current assets and
fixed assets, such as patents, copyrights,
and goodwill that have an estimated value
10–23
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or in part, except for use as permitted in a license distributed with a certain product or service or
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24. The Balance Sheet: Debt
 Debt
Business financing provided by a creditor
 Current Debt (Short-Term Liabilities)
Accounts payable: trade credit payable to
suppliers
Accrued expenses: short-term liabilities
incurred but not paid
Short-term notes: Cash amounts borrowed that
must be repaid within a short period of time
10–24
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or in part, except for use as permitted in a license distributed with a certain product or service or
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25. The Balance Sheet: Debt
(cont.)
 Long-Term Debt
Loans and mortgages with maturities
greater than one year
 Mortgage
A long-term loan from a creditor for which
real estate is pledged as collateral.
10–25
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or in part, except for use as permitted in a license distributed with a certain product or service or
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26. The Balance Sheet: Types of
Financing
 Owners’ Equity
Money that the owners invest in the
business
Owners are “residual owners” of the firm.
Creditors have first claim on the assets of the
firm.
10–26
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or in part, except for use as permitted in a license distributed with a certain product or service or
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27. The Balance Sheet: Types of
Financing (cont.)
 Retained earnings
Profits less withdrawals (dividends) over
the life of the business
10–27
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Owners’
equity =
Owners’
investment
–
Cumulative dividends
paid to owners
Cumulative
profits
+
Owners’
equity =
Owners’
investment +
Earnings retained
within the business

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a password-protected website for classroom use.
The Fit of the Income Statement and Balance Sheet
10.6

29. The Cash Flow Statement
 Cash Flow Statement
A financial report showing a firm’s income
(cash) when it is received and expenses
when they are paid.
Cash flows from normal operations (operating
activities)
Cash flows related to the investment in or sale
of assets (investment activities)
Cash flows related to financing the firm
(financing activities)
10–29
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30. Profits Versus Cash Flows
(cont.)
 Accrual-Basis Accounting
Matches revenues when they are earned
against the expenses associated with
those revenues.
Sales reflect both cash and credit (noncash)
sales.
Inventory purchased on credit is a noncash
expense.
Depreciation is a noncash expense.
Income tax is accrued and not entirely
expensed.
10–30
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or in part, except for use as permitted in a license distributed with a certain product or service or
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31. Profits Versus Cash Flows
(cont.)
 Cash-Basis Accounting
Reports transactions only when cash is
received or a payment is made.
10–31
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or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website for classroom use.

32. Measuring Cash Flows
 Cash Flows from Daily Operations
Net cash flows generated from operating
a business
Calculated by adding back to operating income
depreciation, deducting income taxes, and
factoring in any changes in net working capital.
 Adjusted Income
After-tax cash flow
10–32
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33. Measuring Cash Flows (cont.)
 Net Working Capital
Money invested in current assets less
accounts payable and accruals
10–33
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or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website for classroom use.

34. Measuring Cash Flows
(cont’d)
 Cash Flows from Investment Activities
Cash inflows and outflows resulting from
the sale or purchase of equipment or
another depreciable asset
 Cash Flows from Financing Activities
Cash inflows and outflows resulting from:
Paying dividends and interest expense.
Increasing or decreasing short-term and long-
term debt.
Issuing or repurchasing stock.
10–34
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35. Computing Cash Flows from
Assets
After-Tax Cash Flows
from Operations
Cash
Flows
from Assets
Changes in
Operating
Working Capital
Changes in
Long-Term
Assets
After-tax cash flows
from operations
Investments in
operating
working capital
Investments
in long-term
assets
Cash
flows from
assets
=
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36. Computing Other Cash Flows
 After-Tax Cash Flows From
Operations
10–36
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or in part, except for use as permitted in a license distributed with a certain product or service or
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Net income Depreciation
expense
Interest
Expense
After-tax
cash
flows from
operations
= + +
• Operating Working Capital
Current
assets
Operating
Working
Capital
= – Account payable
and accruals

37. Evaluating a Firm’s
Financial Performance
 Factors Impacting the Firm’s Financial
Situation
The firm’s ability to pay its debt as it
comes due.
The firm’s profitability from assets.
The amount of debt the business is using.
The rate of return earned by the owners
on their equity investment.
10–37
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or in part, except for use as permitted in a license distributed with a certain product or service or
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38. Evaluating a Firm’s
Financial Performance (cont.)
 Financial Leverage
The impact (positive or negative) of
financing with debt rather than with equity.
10–38
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Return on Assets: An Overview
10.9

40. Key Terms
accounts payable (trade credit)
accounts receivable
accrual-basis accounting
accrued expenses
accumulated depreciation
balance sheet
cash
cash-basis accounting
cash flow activities
cash flow statement
common stock
cost of goods sold
current assets (working capital)
current debt (short-term liabilities)
current ratio
debt
debt ratio
depreciable assets
depreciation expense
dividend
financial leverage
financial statements (accounting
statements)
fixed assets (property, plant and
equipment [PPE])
gross fixed assets
gross profits
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

41. Key Terms
income statement (profit and loss
statement)
interest expense
inventory
liquidity
long-term debt
long-term notes
mortgage
net fixed assets
net profits
operating expenses
operating profit margin
operating profits
other assets
owners’ equity
profit margins
profits before taxes (taxable
profits)
retained earnings
return on assets
return on equity
short-term notes
total asset turnover
working capital cycle
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