RECAP LECTURE 12 FINANCIAL STATEMENTS A Financial Statements

RECAP LECTURE 12

FINANCIAL STATEMENTS • A Financial Statements is a collection of data organized according to logical and consistent accounting procedures. • Its purpose is to convey an understanding of some financial aspects of a business firm. • It may show a position at a moment in time, as in the case of statement of financial position (balance sheet) or may reveal a series of activities over a given period of time, as in the case of an Income Statement

FINANCIAL STATEMENTS Funds and Working Capital • The terms funds is commonly used with a number of meanings, ranging from the broad to the very restricted. • Some managers use the term funds to refer to all financial resources held by a firm. In this usage, all the firm’s assets both fixed and current would be forms of funds.

FINANCIAL STATEMENTS Funds and Working Capital For our purposes, we define these terms precisely; • CASH: we mean currency, money deposited in a bank or money held in highly liquid money market investments, we will use the term cash. • The term marketable securities will be used for short-term investments that do not mature in the next week or so

FINANCIAL STATEMENTS Funds and Working Capital Funds or working capital: These two terms will be used synonymously to refer to a firm’s current assets • Net working Capital: The difference between current assets and shortterm debts will be defined as net working capital. This reflects an important measure of a firm’s liquidity. Is the excess debtors & stock held by the firm above the level of short-term obligations.

FINANCIAL STATEMENTS • Three major financial statements are; 1. Income Statement 2. Statement of financial position (old name is balance sheet) 3. Statement of cash flow (flow-of-funds statements) • (Will be discussed in detailed in lecture 13)

FINANCIAL STATEMENTS Statement of Financial Statement • SFP shows the assets, liabilities and equity for the firm as of the last day of the accounting period. • In effect, it matches resources assets with sources liabilities and equity • Many different accounts can be listed, depending upon different factors as the nature of the firm’s business

FINANCIAL STATEMENTS Assets 1. Current Assets 2. Fixed assets

FINANCIAL STATEMENTS Currents Assets 1. Cash and Cash Equivalents 2. Marketable Securities (stock or bonds of other firms or government agencies that the firm has purchased) 3. Receivables / Debtors 4. Inventories / stock

FINANCIAL STATEMENTS Fixed Assets Fixed assets is the subsection that contains the assets used by the firm to generate revenues. These assets will not be converted into cash in the current accounting period unless they are damaged, become obsolete, or are otherwise replaced.

FINANCIAL STATEMENTS 1. 2. 3. 4. Fixed Assets 4 Representative accounts are: Plant and equipment at cost Accumulated depreciation Real Estate (lists the property owned by the firm) Other fixed assets (long-term assets not covered in the first 3 accounts)

FINANCIAL STATEMENTS Liabilities are debts of the firm. They represent sources of assets since the firm either borrows the money or makes use of certain assets that have not yet been paid for. Liabilities are divided into current and long-term

FINANCIAL STATEMENTS Current Liabilities Are the debt of the firm that must be paid during the current accounting period, normally one year. Examples are; 1. Accounts Payable (purchases on credit) 2. Short-term notes payable (money against promissory notes) 3. Other Payables (wages, tax, federal/state/local)

FINANCIAL STATEMENTS Long-term Liabilities Are the firm’s debts that will not be paid off during the next year. Examples are; 1. Long-term secured financing (where building or other fixed assets are pledged) 2. Long-term unsecured financing (consists largely of notes and bonds

FINANCIAL STATEMENTS Long-term Liabilities Bonds are a major source of long-term financing for many firms. Bonds are usually sold to the general public in the form of debentures. A debenture is a general obligation of the firm and is not secured by specific physical assets. Frequently SFP lists all major bond offerings currently outstanding and the interest owed on the bonds on an annual basis

FINANCIAL STATEMENTS Equity represents the ownership rights in a company and arises from several sources. Owners purchase the preferred or common stock either through an initial offering or through later sales by the firm or the firm retains a portion of its profits and reinvest them in the firm

FINANCIAL STATEMENTS Equity Types of Equity include: 1. 2. 3. 4. Preferred Stock Common Stock Contributes Capital in Excess of Par Retained earnings

FINANCIAL STATEMENTS • Draw horizontal and vertical formats for SFP

FINANCIAL STATEMENTS Limitations of the SFP (balance sheet) Although it provides useful information, the SFP has its limitations. It does not show the events or activities that resulted in the SFP in each of the accounts or the accounting techniques used to prepare them

FINANCIAL STATEMENTS Limitations of the SFP (balance sheet) • Many accounting methods are standard, but some variance is permitted, which could greatly change the amounts reported in certain accounts. • Another weakness is that the analyst preparing SFP may make improper assumptions either mistakenly or to distort the picture shown on SFP

FINANCIAL STATEMENTS Limitations of the SFP (balance sheet) Example: • Assumptions as to when obligations have been incurred or when revenues have accrued can have marked affects on the final figure on the statement of financial position

FINANCIAL STATEMENTS Uses of the SFP (Balance sheet) • The major use of the SFP as a financial tool is as a statement of a firm’s financial condition at a given point in time • It shows balances in permanent accounts and the results of all the accounting transactions since the first day of operations

FINANCIAL STATEMENTS Uses of the SFP (Balance sheet) It lists the accounting (not market) value of the firm’s assets and shows the portion of the assets financed by debt and equity Most SFP are comparative. A comparative SFP displays the current balances and the prior year’s balances for each account in two columns. This allows analyst to compare the beginning and end-of -year positions and to measure the changes in each account during the course of the year