microsoft powerpoint - lecture 11--understanding financial
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Lecture 11:UnderstandingFinancial Statements
61.068 Agribusiness ManagementDr. Jared Carlberg
TodayThe Importance of Financial StatementsThe Accounting ProcessFinancial Statements
The Balance SheetThe Income StatementStatement of Owners’ EquityStatement of Cash Flows
Pro Forma StatementsImportant Accounting Principles
Financial Statementsneed financial info. for 2 main reasons:
used internally for decision makingmanagerial accounting
used for financial reporting to stockholders, lenders, authorities, etc.
financial accounting
two most important financial statements:(1) balance sheet(2) income statement (also sometimes called profit & loss statement or operating statement)
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Financial Statementsgood info. required for good managementfinancial records system should be:
simple & easy to understandreliable, accurate, consistent, timelybased upon the business’ uniquenesscost-effective to implement & maintain
need professional help to design systemmost agribus. hire bookkeepers/accountants
The Accounting Systemthe accounting system helps prevent errors and safeguard the business’ resources
need accurate, honest records to do this!system of checks and balances requiredauditors verify proper record keeping
if the accounting system is built properly, there is little reason to suspect impropriety!
Accounting System Usesgood financial records provide the basis for:
determining the business’ successshowing the financial health of the businesspredicting the ability of the business to meet the demands of creditors, change, and expansionrelating performance to managers’ decisionschoosing among alternative courses of action for the future
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The Accounting Processbased largely on original documents
sales slips, bills, cheques, invoices
transactions recorded in the “journal”also called “book of original entry”records all of the business’ transactionsinfo. then transferred into other fin. statementsalso have “ledger” with classes of receipts and expenses grouped together
(1) The Balance Sheetshows the financial makeup and condition of a business at a specific point and time
shows what a business owns, what it owes, and what the owners have investeddetails the “balance” between assets and claims against them (liabilities and owners’ equity)assets: things of value owned by the businessliabilities: amounts that must be paidowners’ equity: amount invested by owners
The Balance Sheetthe balance sheet always balances
assets = liabilities + owners’ equityfor each thing of value (asset), the business owes somebody for it (liability) or an investor has a claim on it (owners’ equity)if the balance sheet doesn’t balance, you’ve done something wrong!
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Assetsare sources of value the business owns
note: only corporations can “own” assets, but we do this for all types of businesses anyway
three usual types of business assets:current assetsfixed assetsother assets
Current Assetscash or assets that will be converted to cash within one operating cycle (usually a year)
reflect the firm’s ability to generate cash
there are several types of current assetscash: immediately available fundsaccounts receivable: amounts owed for salesinventory: items to be sold/used in productionprepaid expenses: paid for but not yet utilizedother current assets: e.g. marketable securities
Fixed Assetsassets that have a relatively long life
typically used to produce or sell goods/services
there are three main types of fixed assets:land: real estate owned by the business
land is usually valued at the purchase price
buildings: facilities the business ownsequipment: used for any aspect of operations
have to recognize that assets depreciateshow this on balance sheet to ensure accuracy!
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Other Assetsmiscellaneous assets that aren’t exactly current or fixed
many things don’t fit into those categorieslonger life than current assetsusually nondepreciable in natureexamples of “other assets” include:
bonds held for longer than one year“intangible” assets such as patents, copyrights, and goodwill
Liabilitiesconsist of money the business owes to “outsiders” (not original investors)are claims against the business’ assets
but not usually against specific assets
two main types of liabilitiescurrent liabilitieslong-term liabilities
Current Liabilitiesclaims against the business that will fall due within one business cycle
show the business’ short-term obligationstypes of current liabilities include:
accounts payable: payment for things purchased on creditnotes payable: loans due within one yearaccrued expenses: day-to-day expenses accrued but not yet paid e.g. wages, taxes payableadvances: payment for goods in advance
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Long-term Liabilitiesoutsiders’ claims not due within one operating cycle
those liabilities that are not “current”
examples of long-term liabilities include:bonded indebtedness: issued by the firmmortgages: taken out on certain assetslong-term loans: to banks or individuals
Owners’ Equityclaims of owners against firm assets
summary of accounts showing contributions
two usual accounts for owners’ equity:common stock: appears on books at original valueretained earnings: net gain on initial investment
represent net profit left in the business as capital
proprietorship/partnership often shows only one account for owners’ equity instead of two
(2) The Income Statementshows revenues & expenses for a specific period of time & profit/loss from operations
gives a measure of profit and performanceprovides insight into managerial efficiencyshows how changes in the balance sheet came aboutshows revenue taken in and money spent to generate that revenue
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The Income Statementthe basic format of the income statement is:
Sales
- Cost of Goods Sold (COGS)Gross Profit (sometimes called gross margin)
- ExpensesNet Income Before Taxes
-Income TaxesNet Profit After Taxes
Cash Accounting Vs. Accrual Accounting
two different approaches to preparing the income statement can be takencash-basis approach: says revenue and expenses occur when cash is paid/received
can under-or-overstate true net profit
accrual-basis approach: says revenue and expenses exist when they first take place
this approach more accurately reflects reality
Salestotal dollar value of goods and services sold during the income statement period
include cash and credit salesmay include special lines for items such as returns and/or discounts & allowancesoften broken down into different products
this provides best information but also takes up more space on the income statement
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Cost of Goods Sold(COGS)
gives the total cost to the business of goods sold during the reporting period
what it cost the business to purchase the goods it later re-sold
more complicated for a processing or manufacturing firm than a retailing firm
should provide details as to cost breakdownsincludes raw materials costs and direct labourhave to factor inventory changes into COGSfreight and transportation charges are in COGS
Gross Profit (or Gross Margin)shows difference between sales and COGS
money available to cover operating expenses
important to retail agribusinessesthey have very little control over COGS
changes in output price have big impact on gross margins for retailers
because COGS stay the same regardless
manufacturers can try to reduce COGS to increase margins
Operating Expensescosts incurred as a result of business operations during the reporting period
have to pay for things to conduct business
can break them down into major categories:marketing: wages, salaries, commissionsadministrative: mgr. salaries, office, travelgeneral: depreciation, insurance, taxes, rent, repairs, utilities
all these expenses are operating expenses
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Net Operating Profitamount left over when operating expenses are deducted from gross marginaffected by same factors that influence gross margins
output price, COGS
can influence net operating profit by controlling operating expenses
cost-cutting measures can make the firm more profitable
Net Profit Before Taxesamount remaining after taking account of any non-operating revenue or expensesnon-operating revenue includes things like interest or dividends received
for a local co-op, this could include patronage refunds from the regional/federated co-op
non-operating expenses include items such as interest expense
interest paid on borrowed money
Net Profit After Taxes(or Net Income)
what is left after business taxes are paidtax rates vary by jurisdiction and by profit level
this is the so-called “bottom line”appears on the bottom line of the income statement
can also be a “net loss”yes, businesses sometimes lose money!
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Statement of Owners’ Equityshortest & least complicated of the financial statements
shows changes to owners’ equity accounts over a period of time
most common change: retained earningsif the business makes a profit, retained earnings increases unless all profit is paid in dividends and/or withdrawals by firm owners
can also increase or decrease common stockthis is only done very occasionally
Statement of Cash Flowsshows a business’ cash inflows and outflows for a period of time
can be used to report what happened to cashconstructed at end of reporting period
can be used to help budget cash flowsconstructed at beginning of period (pro forma)
cash flow statement always “balances”, too!sources of cash = uses of cash
Statement of Cash Flowsthree primary categories for this statement:
cash flows from operationscash flows from investments/disinvestmentscash flows from financing transactions
contributions from owners, borrowing from lenders, repaying debt, etc.
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Pro Forma Statementsfinancial statements usually reflect history
but sometimes want to assess future plans!
can use “pro forma” statements to do thisthey are statements prepared for a future periodoften used to estimate the impact of potential courses of action upon the business
often have to do pro forma statements to borrow money for a new/existing business
Important Accounting Principles
important things about financial accounting:only facts that can be recorded in monetary terms should be on balance sheet/inc. statementkeep personal & business transactions separateaccounting methods assume ongoing operation of the businessassets are usually recorded at the lower of their actual cost or market value
this is the “cost basis” of valuationbook value does not always equal market value!
Important Accounting Principles
more important fin. accounting principles:every accounting event has to balance: a change in assets necessarily requires a change in either liabilities or owners’ equity, or bothmost accounting is done on an accrual basisthe format of the income statement should reflect the unique needs of the organizationfin. statement format can evolve to meet needsthe purpose of fin. statements is to provide info!
necessary for informed decision making
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Next Classtopic: Analyzing Financial Statementsreading: Chapter 13Using Statements to Evaluate PerformanceRatio Analysis
profitability ratiosliquidity ratiossolvency ratiosoperating/efficiency ratios
Discussion question: What are the advantages of ROE as a tool of analysis for agbus. managers?