chapter 2 financial statements and the

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Chapter 2

Financial Statements and the

Annual Report

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Key Concepts & Objectives

Objectives & Characteristics of Financial Reports Classified Balance Sheet

Multi-Step Income StatementSales – CGS = GM – Op Exp – Income Taxes = Net Income

Financial Statement Analysis» Liquidity Measures» Solvency Measures» Profitability Measures

Components of the Annual Financial Report

Assets = Liabilities + Owners’ Equity

(CA + LTA) = (CL + LTL) + (CC + RE)

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Objectives of Financial Reporting

Primary Objective:

Provide Info for Decision making

Secondary Objectives:

Reflect resources and

claims tothem

Assess cash flows to/from

company

Summarize revenue inflows & expense outflows

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Qualitative Characteristics

Understandable

Relevant

Reliable

To those willing to take the time to understand it

Has capacity to

make a difference

Represents what

it purports to

(What Financial Statement information should be)

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between companies

Comparable

from one period to the next

Consistent

(What Financial Statement information should be)

Why? What doesthis help accomplish?

Why? What doesthis help accomplish?

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Materiality

Can sometimes bendthe accounting rules if

insignificant

ConservatismAll else equal, choose least optimistic alternative, recognize expense and/or liability before event finalized

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Classified Financial Statements

Reflects expansions of basic financial statement equations

Conveys additional information to users Permits financial statement analyses through

a set of ratios Classified by Management Used by Analysts Represents GAAP

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Basic Structure of a Classified Balance Sheet

Current assets (CA)+ Noncurrent (long-term) assets (LTA) Total assets Current liabilities (CL)+ Noncurrent (long-term) liabilities (LTL)+ Stockholders’ equity (CC + RE) Total Liabilities & Stockholders’ Equity

Represents an expansion of the basic accounting equation:

A = L + OE

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Typical Operating Cycle

ACCTS. RECEIVABLE

CASH

INVENTORY

Concept: Time it takes to go from cash back to cash

$$ $$

$$

Important to know, since it takes cash to grow the business !

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Current Asset: One year or the operating cycle -- whichever is longer

Usually one year is longer than operating cycle

Cash plus other assets expected to: To be converted to or realized in Cash, (eg, A/R) Or sold or consumed during

Operating Cycle (generally within a one year period) (eg, Supplies)

Current Assets (CA): Concept

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Examples of Current Assets

Turned into cash or Turned into cash or consumed(used)?consumed(used)?




CashCash

UsedUsed

CashCash

UsedUsed

Once these items are used up, what do they become? Where are they found on the F/S? They become EXPENSES!

Cash and Cash Equivalents (e.g., bank deposits)

Accounts Receivable

(A/R)Inventories

Short-term Investments

Prepaid Expenses (rent)

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Concept: Long-term Assets . . . .» Provide benefits to company, that are» Expected to last beyond one year

Categories:» Investments in Securities of another entity » Property, Plant & Equipment (PP&E)» Intangibles (eg, patents)

Long Term (Noncurrent) Assets (LTA)

Again, L-T Assets turn into Cash or are used up (Expenses)

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Securities of another organization:» Stocks & bonds of another company» Government debt (bonds, U.S. T Bills)

Management’s intentintent is to hold those assets beyond current year

Other less common examples:» LandLand held for future use» Buildings & EquipmentBuildings & Equipment not used in current

operations

Investments: Definition

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Key Concepts: » Tangible, productive assets used in daily operations, and

» Not intended for resale (Helps make the company’s

product/service)

These assets are subject to depreciation expense (means that asset is being “used up” over time):

» Accumulated Depreciation - keeps track of cumulative depreciation expense of all years (CONTRA-ASSET)

Depreciation exception is property -- “Land” Why?

Property, Plant & Equipment

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Assets that» lack in physical substancephysical substance, but

» provide long-term benefitslong-term benefits to entity

Asset’s cost is amortized (used up) over useful

(economic) life as Amortization Expense -- similar to

Depreciation Expense

Examples: Trademarks, Copyrights, Patents, Logos

Intangibles: Concepts

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Debts owed to others and classified similar to assets (Current / Long Term):

» based on the Operating Cycle or 1 year, whichever is longer

Current Liabilities: due within 1 year

Long-term Liabilities: due after 1 year

Liabilities: Concepts

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Definition: Debts due in one year or less Examples:

» Accounts Payable (trade credit)» Wages/salaries Payable» Taxes Payable (various)» Short-term Notes Payable

(eg., due to banks)

Current Liabilities: Concepts

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Definition: Obligations not paid or satisfied:

» due in more than 1 year

Typical accounts include:» Notes Payable/Mortgage Payable» Bonds Payable» Long-term Leases

Long-Term Liabilities: Concepts

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Defn: Owners’ claims to resources (ASSETS)

Claims come from two sources:» Contributed capital -- eg, Common

Stock...represents owners original investment» Earned capital -eg, Retained Earnings

represents earnings (NI) left in the company and reinvested

All other claims (all creditors) have priority over owners’/stockholders’ claims!

Stockholders' Equity: Concepts

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Represents original amount of owners investments and basic ownership form

Most corporations have a single class:» Common Stock

Some corporations have a second class:» Preferred Stock

» Preferences: Generally dividend priority with trade-off of voting rights

Contributed Capital: Concepts

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Financial analysts and managers utilize:» various methods and tools (eg, web), but» primarily ratios and formulas using financial

statements

Analysts generally review the company’s:1. Past performance (Annual Report)

2. Current financial position (SEC’s 10-Q)

3. Future potential (forecasted earnings and cash flow) as well as estimated risks (MDA)

Financial Statement Analysis

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Analysis of Liquidity

Two liquiditymeasures of particular

interest to bankers and

other creditors

CurrentRatio

Working Capital

Defn: Ability of company to pay debts as they

become due. A short-term

solvency measure

QuickRatio

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Ben & Jerry’s Consolidated Balance Sheet

Current Assets $68,113 $68,063

Current Liabilities $18,058 $17,040

Working Capital = C.A. minus C.L. $50,055 $51,023What does this mean? Interpret.

1996 1995

(in 000’s)

What does this mean? Interpret.

Current = Current Assets 3.77:1 3.99:1 Ratio Current Liabilities

CurrentRatio

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Quick Ratio

Concept: Most stringent measure of liquidity for a company

Focus is on most liquid current assets Sometimes referred to as the Acid-Test Ratio Excludes Inventory and A/R – Why?

Quick Ratio

Quick Ratio = Cash + Marketable Securities Current Liabilities

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Analysis of Solvency

Two Solvency

measures are of particular interest to

investors andmany creditors

Defn: Ability ofcompany toremain in

business overthe long run.

Debt-to-equityratio

Debt to Equityratio

Debt to

Total Assets

ratio

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Debt-to-Total-Assets Ratio =

Total liabilitiesTotal assets


$ 53,980 $ 52,543$136,665 $131,074

39.5% 40.1%

Defn: The proportion of assets provided (and claimed) by creditors

1996 1995

(in 000’s)


Debt to Assets Ratio

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Defn: Relative proportion of assets provided by creditors vs. owners –

What does a 50% ratio mean?

Debt-to-Equity Ratio:

Total Liabilities__Stockholders’ Equity


$ 53,980 $ 52,543$ 82,685 $ 78,531

65.3% 66.9%

1996 1995

(in 000’s)


Debt to

Equity Ratio

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Sales– Cost of Goods Sold (Inventory Exp) Gross Profit or Gross MarginOperating expenses:– Selling Expenses– General & Administrative Expenses Income from Operations+/– Other Revenues and Expenses Income before Taxes– Income Tax Expense Net Income (Loss)

Fourimportantsummarymeasures

What does each one tell us?

Basic Structure of a Multi-Step Income Statement

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Analysis of Profitability

Gross

Profit %

Profit

Margin %

Earnings per Share

Return on Stockholders’

Equity

Of particular

interest to current and

potentialinvestors

Price to Earnings Ratio

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DEFN: What percentage (how many cents) of every $ of sales are left over after paying the cost of the product ?

Ben & Jerry’s Consolidated Statement of Income

(in 000’s) 1996 1995 1994

Net sales $ 167,155 $ 155,333 $ 148,802 Cost of sales 115,212 109,125 109,760 Gross profit 51,943 46,208 39,042

Gross profit % = 31.1% 29.7% 26.2%


Gross Profit (Margin) % = Gross Margin Sales

Gross Profit %

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DEFN: How much has the company earned as profit for every dollar of sales it made?

(in 000’s) 1996 1995 1994

Net sales $ 167,155 $ 155,333 $ 148,802

Net income (loss) $ 3,926 $ 5,948 $ (1,869)

Profit margin % = 2.3% 3.8% - 1.3%



Profit Margin % = Net Income Sales

Profit Margin %

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DEFN: What is the proportionate amount of income earned by each share of Common Stock?

(in 000’s) 1996 1995 1994

Net income (loss) $ 3,926 $ 5,948 $ (1,869)Weighted avg. # shares outstanding = 7,230 7,222 7,148

EPS = $ 0.54 $ 0.82 $ (0.26)



EPS = ________ __Net Income______ ___ Wtd. avg. # Common Shares outstanding

Earnings per Share

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Price-Earnings Ratio

Concept: A key measure of how the market values the company

Relationship: The higher the ratio, the greater the (stock market) demand for this company’s stock

P-E Ratio reflects both historical and expected growth in earnings and sales

Price to Earnings = ____________EPS______________Ratio Price per Share of Common Stock

P-E Ratio

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DEFN: What is the percentage return that each owner has earned on their investment?

(in 000’s) 1996 1995 1994

Net income (loss) $ 3,926 $ 5,948 $ (1,869) Average S/E $ 80,608 $ 75,516 $ 73,382

ROE % = 4.9% 7.9% - 2.5%

Ben & Jerry’s Consolidated Financial Statements

Return on S/E = _______Net Income__________ Average Stockholders’ Equity


ROE

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Statement of Retained Earnings

Purpose of statement:

» explains changes to R/E during a reporting period

Two primary components:

» Net Income (or Net Loss) for the period

» Dividends paid during period

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Dixon Sporting Goods, Inc. (“who”) Statement of Retained Earnings (“what”)for the Year Ended December 31, 1999 (“when”)

Retained earnings, January 1, 1999 $ 271,500

Add: Net income for 1999 41,000

$ 312,500

Less: Dividends declared and paid in 1999 (25,000)

Retained earnings, December 31, 1999 $ 287,500

Note: This is a review since we covered R/E in Chapter 1

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Statement of Stockholders’ Equity

Shows changes in all equity accounts including:» Sales and purchases of

capital stock

Includes: Statement ofRetained Earnings

Add: Net IncomeDeduct: Dividends

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Summarizes cash flows (sources and uses) from:

» Operating activities» Investing activities» Financing activities

Required of all public corporations Other entities generally prepare for

management purposes

Statement of Cash Flows (SCF)

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Net income $ 3,926 (NOTE: Adjustments to reconcile Net Income to net cash provided by operating activities - omitted here)

Net cash provided by Operating activities 14,255Net cash used for Investing activities (12,951)Net cash used for Financing activities (446)Effect of exchange rates on cash (160)Increase in Cash and equivalents 698Cash and equivalents at beginning of year 35,406Cash and equivalents at end of year $ 36,104

Ben & Jerry’s (“who”)Statement of Cash Flows (“what”)

for year ended December 28, 1996 (“when”)

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Management's Discussion & Analysis Summary of financial data Letters to stockholders Financial statements Footnotes to financial statements Report of independent auditors

Elements of an Annual Report

Harcourt Brace & Company items and derived items:

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Summary: Key Concepts & Objectives

Objectives & Characteristics of Financial Reports Classified Balance Sheet

Multi-Step Income StatementSales – CGS = GM – Op Exp – Income Taxes = Net Income

Financial Statement Analysis» Liquidity Measures» Solvency Measures» Profitability Measures

Components of the Annual Financial Report

Assets = Liabilities + Owners’ Equity

(CA + LTA) = (CL + LTL) + (CC + RE)

chapter 2 financial statements and the

Documents

cash used cash

examples of current

current assets ca

assets current long

operating cycle cash

productive assets

annual financial report

banks current liabilities