Income Statement and Balance Sheet Instructor : Ryan Williams

Learning Objectives 1. Recognize items that belong on an Income Statement. 2. Prepare an Income Statement. 3. Calculate COGS given information about changes in inventory. 4. Calculate net profit margin. 5. Recognize items that belong on a Balance Sheet. 6. Prepare a Balance Sheet. 7. Calculate accumulated depreciation, net fixed assets and gross fixed assets. 8. Discuss the purpose and potential shortcomings of the Income Statement and Balance Sheet. 9. Calculate dividends paid, number of shares outstanding, earnings per share, and the P/E ratio using the current Income Statement and two most recent Balance Sheets.

Income Statement Other names: Statement of income, statement of earnings, “P&L” (profit and loss). This matches revenues & expenses for the same period, it is a SUMMARY of FLOWS, or a recording of cumulative historical activity. Think of it like a history book.

Basic Income Statement – 2.1 Company Name For the time period ending date Net Sales - Cost of Goods Sold (COGS) = Gross Profit - Operating Expenses =Operating Profit (EBIT) Interest Expense =Profit Before Taxes (=EBT) Taxes =Net Income

Coca-Cola’s Income Statement Three Months Ended April 3, 2009   NET OPERATING REVENUES $ 7,169 Cost of goods sold 2,590 GROSS PROFIT 4,579 Selling, general and administrative expenses 2,624 Other operating charges 92 OPERATING INCOME 1,863 Interest income 60 Interest expense 85 Equity income — net 17 Other income (loss) — net (40) INCOME BEFORE INCOME TAXES 1,815 Income taxes 456 CONSOLIDATED NET INCOME 1,359

Basic Income Statement Items NET SALES: sale revenue is recorded when the ownership is transferred from the seller to the buyer. Consider, though, that some revenue is never collected (bad creditors, trial periods, money-back guarantee…) Net sales= Gross sales – (returns & allowances) COST OF GOODS SOLD (COGS): direct costs of manufacturing/selling a product COGS = Beginning Inventory + Materials purchases – Ending inventory

Basic Income Statement Items OPERATING EXPENSES: Include management salaries, advertising expenditures, lease payments, repairs & maintenance, R&D, general & administrative expenses INTEREST EXPENSE: cost of borrowing money TAXES: Federal, state and/or local levels NET INCOME: it is the ‘bottom line’ of income statement, and it represents the base profit earned during accounting period

We will go through Assignment 2.1 Net Sales - Cost of Goods Sold (COGS) = Gross Profit - Operating Expenses =Operating Profit (EBIT) Interest Expense =Profit Before Taxes (=EBT) Taxes =Net Income

Income Statement Earnings per share (EPS) : it indicates the profit earned by each share of stock. P/E ratio Net Profit Margin: Net income divided by Net Sales

Total Assets = Total Liabilities + Shareholders’ Equity Balance Sheet Company’s resources are identified as: Assets Liabilities Owner’s equity Balance sheet identity: “Stock” measure statement: each value is the value of the account at the specific date associated with the balance sheet. Assets and Liabilities ordered by liquidity (from the most liquid to the less liquid) Total Assets = Total Liabilities + Shareholders’ Equity

Another way to think about it Balance sheet: Assets: The stuff a company owns. Liabilities & Equity: How a company paid for their stuff. Income Statement: How much money the company’s stuff is making for them.

Balance Sheet – Table 2.2

Current assets CURRENT ASSETS: assets that can be converted into cash within a year (arbitrary) Cash Most liquid asset. It includes highly liquid marketable securities Net accounts receivable (Net A/R) Companies sell products/services on credit, they do not always ask for cash. Some customers don’t pay up: Allowance for doubtful accounts Net A/R = Gross A/R – allowance for doubtful accounts

Current assets – cont. Inventory Raw materials, work in process, finished goods FIFO, LIFO, average cost End of year inventory = Beginning of year inventory + purchases - COGS Total current assets = Cash + Net A/R + Inventory

= original historical cost – allowable depreciation Long-term assets FIXED ASSETS Equipment, buildings, vehicles, computers etc Permanent nature; needed for business operations Reported at book value = original historical cost – allowable depreciation Gross fixed assets: original cost of assets Accumulated depreciation Straight-line Accelerated cost recovery Net fixed assets = gross fixed assets – accumulated depreciation

Total assets (final left hand side) Total assets = Current assets + long-term assets Assets (LHS of balance sheet) must be financed by a combination of liabilities and owner’s equity (RHS of balance sheet) In other words, the balance sheet has to balance. If you have constructed a balance sheet and it does not balance, you have done something wrong.

Liabilities = current liabilities + L.T. debt CURRENT LIABILITIES Notes payable Accounts payable (A/P) Accrued expenses (accruals) Current portion of long-term debt → SUM = TOTAL CURRENT LIABILITIES LONG-TERM DEBT Liabilities with maturities in excess of 1 year Total liabilities = current liabilities + L.T. debt

Equity RETAINED EARNINGS COMMON STOCK Common stock at par Additional paid-in capital (capital surplus): additional money generated when company sold stocks RETAINED EARNINGS Cumulative total of all net income reinvested into the company: this income is NOT available o shareholders! Annual addition to retained earnings = net income – dividends paid

Total Equity Shareholders’ equity = common stock at par + additional paid-in capital + retained earnings Shareholders’ equity also known as Net worth, owners’ equity or book value of firm’s equity

Preferred Stock PREFERRED STOCK Hybrid security – Mixture of Debt & Equity Debt component: pays fixed periodic amount (like the interest on debt). Equity component: if payment is not made, company is not in default (in the case of debt there is default). Preferred dividends usually cumulative; no voting rights.

Total Liabilities and equity (right hand side) preferred stock (if any) + shareholders’ equity In other words, the balance sheet has to balance. If you have constructed a balance sheet and it does not balance, you have done something wrong.

Net Sales - Cost of Goods Sold (COGS) = Gross Profit - Operating Expenses =Operating Profit (EBIT) Interest Expense =Profit Before Taxes (=EBT) Taxes =Net Income

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