Chapter 2: A Closer Look at the Financial Statements Learning Objective Describe the balance sheet in terms of equity and debt capital and producing and operating assets A Story that builds a Set of Financial Statements Businesses’ needs are evaluated and can be acquired utilizing capital • Business Plan – shows your ideas on how the • Contributed Capital • business will show a profit • Given in return for ownership interest • Investors expect a return on their investment (dividends and growth) Debt Capital • Capital paid back over time (liability) • Interest charged for the use of the capital A Story that builds a Set of Financial Statements Capital investment (equity and debt) can be used to purchase assets • • Producing assets • Support the generation of revenue • Useful over the long term (several years) • Examples – land, buildings, equipment Operating assets • Support the generation of revenue • Used up quickly – replaced often • Assets that are for sale Concept Practice Learning Objective Explain the concept of net income, who owns it and what they can with it Reporting through the Financial Statements Financial statements communicate the operations and status of the organization • Income Statement • Revenues – Expenses • Revenues are generated from sale of goods/services • Expenses include cost of goods sold and operating expenses needed to run the business • Options with profits • Reinvest in the business • Pay out to owners (dividends) Concept Practice First – calculate Total revenue Next – subtract Expenses for Net Income Then – take out dividends which are paid out to owners What remains in the net income reinvested (becomes part of retained earnings) Learning Objective Define the three major activities of a business 10 Statement of Cash Flows • Cash from financing activities • Cash inflows and outflows associated with outside capital : liabilities and owner investments Total of three sections Reconciliation of the change of cash on the balance sheet 32 Statement of Shareholders’ Equity • Summarizes activity in accounts tracking shareholders’ investment • Sale of equity securities (contributed capital) • Repurchase of equity security (treasury stock) • Profits reinvested in the company (retained earnings) • Dividends paid to owners 33 Statement of Shareholders’ Equity 34 Concept Practice 35 Concept Practice – cont 36 Learning Objective Discuss how the financial statements can be viewed as a package and use the package to assess five fundamental metrics of a company’s performance 37 Five Fundamental Measures of Performance • – How profitable? • Income statement – revenues exceed expenses and by how much? • Balance sheet and statement of retained earnings - retained earnings indicate past profits have financed assets • – How large of an investment was required? • It is more desirable to get a profit return for less investment in assets • This can be measured by comparing Profits/Average Asset Balance = Return on Assets 38 Five Fundamental Measures of Performance • – Where did the assets come from / how financed? • Debt or equity financing? • Take Total Debt/Total Assets on the balance sheet to determine the assets financed by debt • – Cash generated by operating activities and how managed? • Statement of cash flows indicates cash generated and where it has been utilized 39 Five Fundamental Measures of Performance • – What happened to the shareholder investment and what was the return? • Statement of shareholders’ equity indicates increases and decreases in shareholder investments • This can be measured by comparing Profits/Average Shareholder Equity Balance = Return on Equity • More return for less equity investment is desirable 40 Learning Objective (Appendix 2A) Discuss forms of business organizations 41 Organizational Form and the Equity Section *Appendix 2A  Corporation – legal entity separate and distinct from its owners  Shareholders/Stockholders buy an ownership interest  Right to vote on the board of directors  Right to corporate profits  Distinction between contributed capital, what has been contributed vs what has been retained 42 Organizational Form and the Equity Section *Appendix 2A  Proprietorship or partnership – not separate legal entities  Legal liability is not limited to the business assets  Asset distribution is a withdrawal  Equity called owners’ equity  No distinction between contributions and retained earnings  Focus is on each owner’s balance, all contributions less withdrawals 43 Organizational Form and the Equity Section *Appendix 2A 44 A partnership and a corporation differ in that: a a partnership is a legal entity, while a corporation is not b the equity sections of partnership and corporate balance sheets report different items c partnerships always have more cash than corporations d a corporation has an income statement and a partnership does not 45 Wiley © 2017 46 .. .Chapter 2: A Closer Look at the Financial Statements Learning Objective Describe the balance sheet in terms of equity... the concept of net income, who owns it and what they can with it Reporting through the Financial Statements Financial statements communicate the operations and status of the organization • Income... investing 15 Learning Objective Describe the four financial statements in greater detail 16 The Classified Balance Sheet • The balance sheet reports the financial position at a point in time (end of