“Accounting is the Language of Business” Module 3 Introduction to Financial Statements “Accounting is the Language of Business” ANDREA D. GARZON

Why study Financial Statements? Analyzing a firm’s financial statements can help financial managers carry out three important tasks: To assess the current performance of the firm. Monitor and control operations. Plan and forecast financial performance. ANDREA D. GARZON

What are the basic financial statements? Balance Sheet Income Statement / Profit and Loss Statement Cash Flow Statement ANDREA D. GARZON

Balance Sheet Contains information about the firm’s assets (everything of value the company owns); liabilities (the firm’s debts); and shareholders’ equity (the money invested by the company owners). In finance, we use the balance sheet to describe a firm’s investments in assets and the way it has financed the purchase of its assets (Debt or Equity Financing). Internal Financing = from the business itself (profit from operations) External Financing = from the investors and creditors ANDREA D. GARZON

Balance Sheet Total Assets Current Assets Cash Accounts Receivable Inventories Other Current Assets Long-Term (Fixed) Assets Property, Plant and Equipment Other Long-Term Assets (Patents, Trademarks, Royalties, etc) Current Liabilities Accounts Payable Short-Term Debt Other Current Liabilities Long-term Liabilities Long-Term Debt Stockholders’ Equity Paid-In Capital Retained Earnings Left-Hand Side Right-Hand Side ANDREA D. GARZON

Assets (Left – Hand Side) Current Assets – assets that the firm expects to convert into cash in 12 months or less. Examples Cash Accounts Receivable Inventory ANDREA D. GARZON

Assets (Left – Hand Side) Long-term (Fixed) Assets) – assets that the firm does NOT expect to sell within one year. Land Building Equipment/Machineries ANDREA D. GARZON

Liabilities and Stockholders’ Equity (Right – hand side) Current Liabilities – liabilities that are due and payable within a period of 12 months or less. Accounts Payable Accrued Expenses Other short-term debts that are payable in less than 12 months ANDREA D. GARZON

Liabilities and Stockholders’ Equity (Right – hand side) Non-Current/Long-term Liabilities Long-term debts – loans from banks and other other lenders that have maturities longer than 1 year. ANDREA D. GARZON

Liabilities and Stockholders’ Equity (Right – hand side) Stockholders’ Equity - the money invested by the company owners. Paid-In Capital – the amount of capital the firm raised from investors Retained Earnings – the earnings that have been retained and reinvested in the business rather than being distributed to the company’s shareholders. ANDREA D. GARZON

Key Concepts Firm Liquidity and Net Working Capital Liquidity of an Asset– refers to the speed with which the asset can be converted into cash. Some assets are less liquid since they are more difficult to sell and convert into cash (equipment). Liquidity of a Firm – the firm’s ability to regularly converts in CA into cash so that it can pay its bills on time. Assessing a firm’s overall liquidity involves comparing its current assets to its current liabilities. ANDREA D. GARZON

Net Working Capital = Current Assets – Current Liabilities Key Concepts Firm Liquidity and Net Working Capital Net Working Capital – is a tool to measure the firm’s liquidity. Net Working Capital = Current Assets – Current Liabilities ANDREA D. GARZON

Assessment As a finance manager, what does the firm’s net working capital tells you about the liquidity of a firm? ANDREA D. GARZON

Income Statement Reflects the sales (revenues) earned during a specific period of time less the expenses the firm spent in producing those revenues. In finance, we use the income statement to evaluate the firm’s profitability. ANDREA D. GARZON

Income Statement The firms income statement is typically analyzed by calculating profit margins based on: Gross profits (Sales – Cost of Goods Sold) Operating Income (Gross Profits – Operating Expenses) Net Income (Operating Profits – Interest and Tax Expenses) ANDREA D. GARZON

ABM Inc. Income Statement For the year ended December 31, 2017 (In Millions) Sales P2,700.00 Cost of Goods Sold (2,025.00) Gross Profit P 675.00 Less: Operating Expenses Selling Exp Gen. and Admin Exp Total Operating Exp (P 292.50) Net Operating Income (EBIT) P 382.50 Less: Interest Expense 67.50 Earnings before Taxes (EBT) P 315.00 Less: Income Tax (30% of EBT) ( 94.50) Net Income P 220.50 Cost of Debt Financing ANDREA D. GARZON

How do gross profits, operating income and net income differ? Assessment How do gross profits, operating income and net income differ? ANDREA D. GARZON

Changes in Cash Balance = Ending Cash Balance – Beginning Cash Balance Cash Flow Statement Explain the changes in the cash balances over a period of time by identifying all of the sources and uses of cash for the period. Changes in Cash Balance = Ending Cash Balance – Beginning Cash Balance ANDREA D. GARZON

Sources and Uses of Cash Sources of Cash – is any activity that brings cash into the firm Ex. When the firm sells goods and services or sells an old piece of equipment that it no longer needs. Uses of Cash – is any activity that causes cash to leave the firm Ex. Purchase of a new equipment or payment of taxes ANDREA D. GARZON

Sources and Uses of Cash Sources of Cash Uses of Cash Decrease in an Asset Account Increase in an Asset Account Increase in a Liability Account Decrease in a Liability Account Increase in an Owners’ Equity Account Decrease in n Owners’ Equity Account ANDREA D. GARZON

Classifying Sources and Uses of Cash 3 Broad Categories Operating Activities – represent the company’s core business including sales and expenses(basically any cash activity that affects net income for the period). Investment Activities – include the cash flows that arise out of the purchase and sale of long-term assets such as plant and equipment. Financing Activities – represent changes in the firm’s use of debt and equity (sale of new shares and payment of dividends). ANDREA D. GARZON

Basic Format of the Cash Flow Statement Beginning Cash Balance Plus: Cash Flow from Operating Activities Plus: Cash Flow from Investing Activities Plus: Cash Flow from Financing Activities Equals: Ending Cash Balance ANDREA D. GARZON

Assessment Why is reviewing the cash flow statement of a certain firm important to financial analysts? ANDREA D. GARZON

THANK YOU! END ANDREA D. GARZON