Risk Management & Financial Statements

 Also called the statement of condition or the statement of financial position  Shows the financial condition of a company on a particular date  Summarizes what the firms owns and what the firm owes to outsiders and to internal owners

 Assets are what the firm owns.  Liabilities are what the firm owes to outsiders.  Stockholders’ equity is what the firm owes to internal owners.

Balance Sheet Date  The date the balance sheet is prepared  Could be the end of the calendar year, fiscal year, quarter, etc.

Segregated according to how they are utilized  Current Assets  Property, Plant, and Equipment  Other Assets

Current Assets  Expected to be converted to cash within one year or one operating cycle  Continually used up and replenished

Current Assets  Operating cycle ◦ Time required to purchase or manufacture inventory, sell the product, and collect the cash  Working capital ◦ Also called net working capital ◦ Current assets less current liabilities

Current Assets  Cash and cash equivalents  Marketable securities  Accounts receivable  Inventories  Prepaid expenses

Current Assets – Cash and Cash Equivalents  Cash awaiting deposit  Cash in a bank account  Short-term investments that can be converted to cash within three months

Current Assets – Marketable Securities  Short-term investments that can be converted to cash within a year  Three categories ◦ Held to maturity ◦ Trading securities ◦ Securities available for sale

Current Assets – Accounts Receivable  Customer balances outstanding on credit sales  Net realizable value – actual amount of account less an allowance for doubtful accounts

Current Assets – Accounts Receivable  Allowance for doubtful accounts ◦ Affects balance sheet valuation ◦ Important in assessing earnings quality ◦ Should reflect volume of credit sales, past experiences with customers, customer base, credit policies, collections practices, and economic conditions

Current Assets – Inventories  Items held for sale  Items used in the manufacture of products that will be sold  Major revenue producer for most companies

Current Assets – Inventories  Retail companies ◦ Finished goods  Manufacturing companies ◦ Raw materials ◦ Work-in-process ◦ Finished goods  Service –oriented companies ◦ Little to no inventory

Current Assets – Inventories  Inventory Accounting Methods ◦ First in, first out (FIFO) ◦ Last in, first out (LIFO) ◦ Average cost

Current Assets – Prepaid Expenses  Expenses paid in advance ◦ Insurance ◦ Rent ◦ Property taxes ◦ Utilities  Included in current assets if they expire within one year or one operating cycle  Generally not material to the balance sheet

Property, Plant, and Equipment (PP&E)  Encompasses a company’s fixed assets  Not used up during annual operations  Produce economic benefits for more than one year  Have physical substance  Shown at book value on the balance sheet

Property, Plant, and Equipment (PP&E)  The relative proportion of fixed assets in a company’s asset structure will largely be determined by the nature of the business.  Manufacturing firms typically have higher percentages of fixed assets than retailers or wholesalers.  Firms with newly purchased assets will have higher percentages of fixed assets than firms with older fixed assets.

Depreciation Methods  Straight-line method allocated an equal amount of expense to each year of the depreciation period.  Accelerated methods apportions larger amounts of expense to earlier years of the asset’s depreciable life.  Units-of-production method bases depreciation expense on actual use.

Goodwill  Arises when one company acquires another company for a price in excess of the fair market value of the net identifiable assets acquired  Evaluated annually ◦ If no loss of value has occurred, goodwill remains on the balance sheet. ◦ If the book value exceeds the fair value, the excess must be written off as an impairment expense

Other Assets  Can include a multitude of other noncurrent items ◦ Property held for sale ◦ Start-up costs associated with a new business ◦ Cash surrender value of life insurance policies ◦ Long-term advance payments ◦ Intangible assets (other than goodwill)

 Represent claims against assets  Current liabilities ◦ Must be satisfied in one year or one operating cycle  Noncurrent liabilities ◦ Obligations with maturities beyond one year

Current Liabilities  Accounts payable  Notes payable  Current portion of long-term debt  Accrued liabilities  Unearned revenue

Current Liabilities – Accounts Payable  Short-term obligations that arise from credit extended by suppliers for the purchase of goods and services  Eliminated when the bill is satisfied  Increase and decrease depending on credit policies, economic conditions, and cyclical nature of operations

Current Liabilities – Notes Payable  Also referred to as short-term debt  Short-term obligations in the form of promissory notes  Lines of credit to suppliers or financial institutions

Deferred Taxes  Result of temporary differences in the recognition of revenue and expense for taxable income relative to reported income  Depreciation methods are the most common source for temporary differences.

Deferred Taxes  Other temporary differences arise from methods used to account for ◦ Installment sales ◦ Long-term contracts and leases ◦ Warranties and service contracts ◦ Pensions and other employee benefits ◦ Subsidiary investment earnings

Noncurrent Liabilities  Long-term debt  Capital lease obligations  Postretirement benefits other than pensions  Commitments and contingencies  Hybrid securities

Noncurrent Liabilities – Long-term Debt  Bonds  Long-term notes payable  Mortgages  Obligations under leases  Pension liabilities  Long-term warranties

Noncurrent Liabilities – Pensions and Postretirement Benefits  Pensions are cash compensation paid to retired employees.  Postretirement benefits are benefits other than pensions that employers promise to pay for retired employees.  Can appear under the liability section of the balance sheet

Noncurrent Liabilities – Commitments and Contingencies  Commitments refer to contractual agreements that will have a significant financial impact in the future.  Contingencies refer to potential liabilities (such as possible damage awards assessed in lawsuits).  Intended to draw attention to the fact that required disclosures can be found in the notes to the financial statements.

 Also called shareholders’ equity  Residual interest in assets that remains after deducting liabilities  Owners bear greatest risk and benefit from greatest rewards.

Common Stock  Shareholders ◦ do not ordinarily receive a fixed return ◦ have voting privileges in proportion to ownership interest ◦ can benefit through price appreciation ◦ can suffer through price depreciation

Common Stock Dividends are declared at the discretion of a company’s board of directors Amount listed on the balance sheet is based on the par or stated value of the shares issued (which bears no relationship to actual market price).

Additional Paid-In Capital  Reflects the amount by which the original sales price of the stock shares exceeded par value

Retained Earnings  Sum of every dollar a company has earned since inception less any payments made to shareholders  Funds a company has elected to reinvest in the operations of the business rather than pay out in stock  Measurement of all undistributed earnings

Other Equity Accounts  Preferred stock  Accumulated other comprehensive income (expense)  Treasury Stock  Employee benefit trusts  Equity attributable to non controlling interests

Other Equity Accounts – Preferred Stock  Carries a fixed annual dividend payment  Carries no voting rights

Other Equity Accounts – Accumulated Other Comprehensive Income (Expense)  Unrealized gains or losses in the market value of investments in available-for-sale securities  Any change in the excess of additional pension liability over unrecognized prior service cost  Certain gains and losses on derivative financial instruments  Foreign currency translation adjustments resulting from converting financial statements from a foreign currency into U.S. dollars

Other Equity Accounts – Treasury Stock  Repurchased shares of stock that are not retired  Shown as an offsetting account

Other Equity Accounts – Equity Attributable to Noncontrolling Interests  Represents the equity interest a firm has in companies whose financial statement have been consolidated with the firm’s statements but that are not 100% owned by the firm