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Economics /Management 4Financial Accounting
Financial Reporting
Starting a BusinessFirms Need?
1. A Value Proposition – an idea that offers a benefit to customers at a cost to the firm such that:
$Benefit > $Cost 2. A Business Plan – a document that describes on
the Value Proposition will be developed, advertised, and distributed.
3. A Funding Plan – a portion of the Business Plan that describes on the Firm will be financed, i.e. where the money to get started will come from and how it will be used.
Firms Need Cashto acquire Assets
Financial Capital
• Financial Capital represents the Cash raised when firms sell Financial Securities
1. Stocks – shares of the Firm sold to investors, also called Share-holders – Equity Capital
2. Bonds – loans from creditors, bond-holders – Debt Capital
Stock & Bond Holderswant Information
• Financial Reports are that information
1. The Annual Report to Shareholders
2. Form 10K (audited, annual)
3. Interim (unaudited, quarterly) 10-Q’s
4. Other Disclosures, e.g. Press Releases
The Form 10K
• Issued 45 days after the end of the Firm’s Fiscal Year (“FY”) and contains
1. Selected Financial Data2. MD&A2. Quantitative & Qualitative Disclosures about Risk3. Financial Statements & Footnotes4. Disagreements with Accountants5. Controls and Procedures6. Executive Compensation
Financial Statements
• Stylized Quantitative Summaries of the Firm’s Financial Health
1. Statement of Financial Position, called the Balance Sheet
2. Statement of Earnings, called the Income Statement
3. Statement of Cash Flows “SCF”
4. Statement of Shareholder’s Equity
Financial Statements
• Accrual-based Accounting• Independent but connected• Periodic
Summaries of: 1. What the firm owns and owes2. The firm’s financial performance3. Its sources and uses of Liquidity4. The firm’s owners claims
Accounting
A formal process that transforms commercial events into financial statements …
There are five basic elements of Accounting:1) Assets2) Liabilities3) Equity4) Revenue5) Expense
A
S
S
E
T
S
L I A B I L I T I E S
E Q U I T Y
Balance Sheet
AA = = LL + + EqEq
The Balance Sheet Equation
Financial Capital
Debt and Equity
Monetary – cash, receivables
Non-monetary = Fixed assets
Cash
Receivables
Inventory
Supplies
Pre Paid Expenses
Long-lived Assets
Accum. Depreciation
Customer Advances
Payables
Accrued expenses
Other CL
Bonds, LoansPaid in Capital
Retained
earnings
Trade Credit
Interest-bearing Debt
Capital Stock
Earnings
The 4 sources of capital
Balance Sheet
Single Step Income StatementFor the 3 months ending March 31, 2015
Revenue 18,000
Expenses (13,900)77.2%
Profit 4,100 22.8%
Revenue: inflows of cash or claims to cash
from primary activities *
• Cash received when?1. in Advance – received but not yet earned
2. at Delivery – received and earned
3. the Next accounting period – earned but not received
* Revenue is earned when products are “delivered”.
Expenses: Costs related to primary activities
• Three categories*:1. Direct – outflows matched to the product
2. Indirect – outflows not proportional to the product
3. Periodic – related to the accounting period
* Many types - look at the Chart of Accounts in the Reader.
Expenses: Outflows of cash – costs - or uses of
assets or new obligations
• Cash paid when?1. in Advance – service paid-for but not-yet used.
Booked as a pre-paid Expense
2. at time of Use – paid-for and consumed
3. the Next accounting period – consumed but not paid-for. Booked as accrued Expense
* Revenue is earned when products are “delivered”.
Four-step Income StatementFor the 3 months ending March 31, 2015
Revenue 18,000
COGS ( 6,000)
Gross Profit 12,000
Operating expenses ( 7,600)
Operating Earnings 4,400
Interest ( 300)
Pre-tax Income 4,100
Tax expense 0
Net Earnings 4,100 22.8%
(13,900)
Types of Expenses
Multi-step Income StatementFor the 3 months ending March 31, 2015
Revenue 18,000 Margins
COGS (6,000)
Gross Profit 12,000 66.7%
SG&A (6,600)
EBITDA 5,400 30.0%
Depreciation (1,000)
EBIT 4,400 24.4%
Interest (300)
EBT 4,100
Taxes 0
Net Income 4,100 22.8%
AA = = LL + + EqEq+ + P-in-KP-in-K
++ RE RE00
+(+(RevRev11 – Ex – Ex11) )
RERE11
The Components of Equity