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7/31/2019 FM-3-06 (1)
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Financial Management Winter 2005 1 February to 3 March
The 3 basic business activities
The subject of financial accounting & reporting:
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Financial Management Winter 2005 1 February to 3 March
Equity
Financing
Debt
Financing
Investment
in Producing
Assets
Goods &Services
NetEarnings
Operating
Activities
Investing
Activities
Financing
Activities
Reinvested
DebtPayment
Dividends
Businesses are like Fruit Trees
Roots
Branches
Trunk &
Fruit
7/31/2019 FM-3-06 (1)
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Financial Management Winter 2005 1 February to 3 March
The 3 basic activities involved in conducting a business are:
Financing activities (Roots):
- Owners contribute cash and receive equity shares in return.
- Creditors loan cash in return for the promise of interest and principal payments.
Investing activities (Trunk and branches):
Once the capital is collected it is invested in producing assets, like buildings,
equipment, machinery and vehicles.
Operating activities (Fruit):The assets are operated to produce goods & services which are sold to customers.
The Net Income of these sales can be used in three ways:
1. Reinvested in the producing assets
2. Returned to the creditors in the form of debt payments
3. Returned to the owners in the form of dividends
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Financial Management Winter 2005 1 February to 3 March
The three basic activities of businesses and theirfinancial flows:
Operating revenuesOperating costs
Sale of assetsPurchase of assets
Operating
activities
Investing
activities
Financing
activities
Equity, debtDividends, debt payments
Financial boundaries of the corporation
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Financial Management Winter 2005 1 February to 3 March
The three basic activities of businesses and theirenvironmental flows:
Emissions to air
Economic
goods & services
Energy
Operating
activities
Investing
activities
Financing
activities
Solid wasteLand, etc.
Environmental boundaries of the corporation
Emissions to water
Raw materials
Economic
goods & services
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Financial Management Winter 2005 1 February to 3 March
What information is contained in the 4 financial statements
How are the financial flows of the 3 basic business activities
reflected in the 4 financial statements?
The 4 Financial Statements:
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Financial Management Winter 2005 1 February to 3 March
The Financial Statements are designed to measure different aspects
of the business (the fruit tree):
The Balance Sheet
Is a picture of the tree (fruit, branches, trunk & roots) at a certain point in time.
It includes assets (inventory of goods and producing assets) and financing sources(equity, debt and reinvestments from net income) of the business.
The Income Statement
Accounts for all activities involved in the operation of the business (growing and
selling the fruit) over a period of time. It contains a list of all operating expenses and
revenues of the business.
The Statement of Retained Earnings
Reports how much of the net income from the operating activities are retained by the
business and how much paid as dividends.
The Statement of Cash Flows
Details all the cash inflows and outflows that occurred over a period of time
associated with the operating (fruit), investing (trunk and branch) and financing (roots)
activities of the business.
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Financial Management Winter 2005 1 February to 3 March
The Income Statement
measures operating performance over a particular period of time.
Operating Revenues
Operating Expenses
= Operating Income
+ Other Revenues
Other Expenses= Net Income before Taxes
Income Taxes
= Net Income after Taxes
/ Number of Shares
= Income per Share
Net income is the most important number disclosed on the financial statements.
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Financial Management Winter 2005 1 February to 3 March
The three basic activities of businesses and the financial flows
oftheincome statement:
Operating revenuesOperating costs
Sale of assetsPurchase of assets
Operating
activities
Investing
activities
Financing
activities
Equity, debtDividends, debt payments
Financial boundaries of the corporation
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Financial Management Winter 2005 1 February to 3 March
The Statement of Retained Earnings
Beginning retained earnings balance
+ Net Income
Dividends
= Ending retained earnings balance
tells us how much of the net income has been retained by the company
and how much has been paid out to the shareholders.
Companies retain profits to finance operations and capital expenditures
and to pay off debt.
The rest is usually returned to the shareholders in the form of dividends.
Retained earnings is a cumulative measure of the amount of company assets
that comes from profitable operations rather than fund raising (debt or equity).
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7/31/2019 FM-3-06 (1)
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Financial Management Winter 2005 1 February to 3 March
The Statement of Cash Flows
The statement of cash flows is a summary of the financial flows into and out of a
companys cash account. (Note that accounting flows are not necessarily cash flows)
Operating activities + Cash collection
Cash paid
= Net cash increase (decrease) from operating activities (1)
Investing activities Purchases of securities or property
+ Sales of securities or property= Net cash increase (decrease) from investing activities (2)
Financing activities + raised capital from issuing equity or entering debt
Dividends or debt payments
= Net cash increase (decrease) from financing activities (3)
(1) + (2) + (3) = Increase (decrease) in cash balance
+ Beginning cash balance
= Ending cash balance
The cash balance provides important information on a companys solvency.
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Financial Management Winter 2005 1 February to 3 March
The three basic activities of businesses and the financial flows
ofthe statement of cash flows:
Operating revenuesOperating costs
Sale of assetsPurchase of assets
Operating
activities
Investing
activities
Financing
activities
Equity, debtDividends, debt payments
Financial boundaries of the corporation
(Cash flows only)
(Cash flows only)
(Cash flows only) (Cash flows only)
(Cash flows only)
(Cash flows only)
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Financial Management Winter 2005 1 February to 3 March
The balance sheet provides a picture of the companys financial situation at one point
in time. It is based on the fundamental accounting equation:
Assets = Liabilities + Equity
The shareholders own the company. Its net worth is (Assets Liabilities) = Equity.
This is called book value of the company and different from its stock market value.
Assets:
Items and right acquired through objectively measurable transactions that can be used
in the future to generate economic benefits.
Liabilities:
Primarily a firms debt and payables. The total amount of liabilities is the portion of
assets that a firm has borrowed and must repay.
Stockholders Equity
consists of contributed capital and retained earnings.
The balance sheet is called classified if assets and liabilities are grouped into
classifications, and consolidated if it contains all divisions and subsidiaries of the firm.
The Balance Sheet
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Financial Management Winter 2005 1 February to 3 March
Assets
Current assets Cash
Short-term investments
Accounts receivable
Inventory
Prepaid expenses
Long-term investments
Notes receivable
Land
Debt securities
Equity securities
Property, plant equipment
Intangible assets
Liabilities
Current liabilities Accounts payable
Other payables
Current maturities of long-term debt
Deferred revenues
Long-term liabilities
Notes payable
Bonds payables
Mortgage payable
Equity
Contributed capital
Retained earnings
Balance Sheet Classifications
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Financial Management Winter 2005 1 February to 3 March
The Relationships between the Financial Statements
Balance Sheet12/31/03
Assets
Cash
Other current assets
Long-term investments
Long-lived assetsIntangible assets
Liabilities and
Stockholders Equity
Current liabilities
Long-term liabilities
Contributed capitalRetained earnings
Balance Sheet12/31/04
Assets
Cash
Other current assets
Long-term investments
Long-lived assets
Intangible assets
Liabilities and
Stockholders Equity
Current liabilities
Long-term liabilities
Contributed capitalRetained earnings
Statement of Cash Flows1/1/0412/31/04
Net cash flow from operating activities
Net cash used by investing activitiesNet cash provided by financing activities
Change in cash balance
Beginning cash balance (12/31/03)
Ending cash balance (12/31/04)
Income Statement1/1/0412/31/04
Revenues
Expenses
= Net income
Statement of Retained Earnings
1/1/0412/31/04Beginning retained earnings balance
+ Net income
Dividends
Ending retained earnings balance