Financial Statements Decision-making usefulness Pippy’s $2 Enterprise Mary Low Waikato Management School The University of Waikato © Mary Low

Accounting Process The accounting process involves: Identification of economic events affecting the business Recording, classifying, summarising and preparing financial statements Communication of financial information to internal and external users © Mary Low

Decision-making usefulness According to the New Zealand Framework (2004 (paragraph 12)), the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. © Mary Low

Users of financial Information: Internal Users Management Owner (s) External Users Investors Creditors Government Customers Labour Unions (employees) Public © Mary Low

Users of financial statements: The New Zealand Framework (2004, paragraph 9) provide the following information about the users of Financial Statements. The users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. They use financial statements in order to satisfy some of their different needs for information. © Mary Low

Illustration of using financial information for decision making: Pippy started “Pippy’s $2 Enterprise” on January 1, 2006 with a $25,000 cash investment into the business. Her receipts and payments show that for the first three months, she made cash sales of $26,000, bought inventory using cash for $26,000 (one-half was sold), paid $5,000 for rent, $800 for power, $200 for insurance and $3,000 for Equipment and Furniture. Pippy wants to expand this business and is exploring building her own store rather than paying rent. To identify the growth potential of this business, we need to know how Pippy’s $2 Enterprise has performed over the 3 month period? Financial statements need to be prepared to help Pippy with her decision making. © Mary Low

Pippy’s $2 Enterprises Income Statement For the three months ending March 31 2006 Sales Less Cost of Goods Sold Gross Profit Less Expenses: Rent Power Insurance Total Expenses Net Profit $26,000 $13,000 $13,000 $5,000 $800 $200 $6,000 $7,000 © Mary Low

Capital at start of period + Net Profit Capital at end of period Pippy’s $2 Enterprises Statement of Changes in Equity For the three months ending March 31 2006 Capital at start of period + Net Profit Capital at end of period $25,000 $7,000 $32,000 © Mary Low

Pippy’s $2 Enterprises Balance Sheet as at March 31 2006 Assets: Cash Inventory Equipment & Furniture Liabilities: Equity: Capital at 31 March 2006 Total Liabilities + Equity $16,000 $13,000 $3,000 $32,000 $0 $32,000 $32,000 © Mary Low

Pippy’s $2 Enterprises Statement of Cash Flow For the three months ending March 31 2006 Operating Activities: Cash Inflow: Sales $26,000 Cash Outflow: Purchase of inventory ($26,000) Payment of operating expenses ($6,000) ($32,000) Net cash outflow from operating activities ($6,000) Investing Activities: Purchase of Equipment and Furniture ($,3000) Net cash outflow from investing activities ($3,000) Financing Activities: Capital investment by owner $25,000 Net cash inflow from financing activities $25,000 Net Changes in cash balance $16,000 Cash balance January 1 2006 0 Cash balance March 31 2006 $16,000 © Mary Low

Decision-making Pippy has made $7,000 in Net Profit for the three month period. Cash has decreased from $25,000 to $16,000 Initial set up cost – Equipment and Furniture Significant amount of inventory purchased. Only half was sold. Negative operating activities shown in cash flows statement There might be concerns about cash flows if she continues to generate negative operating cash flows . To build her own store, Pippy will probably need to borrow money, this will increase the risk of her business. She might not achieve the profitability and solvency objectives of running the business if she expands too quickly. She might get into financial difficulties and be unable to service her debt and interest obligations. Note however that this is a very short financial period to be evaluating properly how well her business will do in the future. Possibly more information and a longer period of operation would provide a better evaluation and assessment for this expansion decision. © Mary Low