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

2. 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

3. 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

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

5. 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

6. 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

7. 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

8. 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
Capital at start of period
+ Net Profit
Capital at end of period
$25,000
$7,000
$32,000
© Mary Low

9. 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

10. 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
Cash balance March $16,000
© Mary Low

11. 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