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