The Income Statement Another Income Statement Income Statement with Net loss.
Chapter 3 Operating Decisions and the Income Statement.
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Transcript of Chapter 3 Operating Decisions and the Income Statement.
Chapter 3
Operating Decisions and theIncome Statement
© 200422 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-2
Business Background
How do business activitiesHow do business activitiesaffect the income statement?affect the income statement?How do business activitiesHow do business activities
affect the income statement?affect the income statement?
How are these activitiesHow are these activities recognized and measured?recognized and measured?
How are these activitiesHow are these activities recognized and measured?recognized and measured?
How are these activities How are these activities reported on thereported on the
income statement?income statement?
How are these activities How are these activities reported on thereported on the
income statement?income statement?
© 200444 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-4
Underlying Accounting Assumptions
Time Period:Time Period: The long life of a company can be The long life of a company can be reported over a series of shorter time periodsreported over a series of shorter time periods..
Time Period:Time Period: The long life of a company can be The long life of a company can be reported over a series of shorter time periodsreported over a series of shorter time periods..
Recognition Issues :Recognition Issues : When should the effects of When should the effects of operating activities be recognized (recorded)?operating activities be recognized (recorded)?
Recognition Issues :Recognition Issues : When should the effects of When should the effects of operating activities be recognized (recorded)?operating activities be recognized (recorded)?
Measurement Issues:Measurement Issues: What amounts should be What amounts should be recognized?recognized?
Measurement Issues:Measurement Issues: What amounts should be What amounts should be recognized?recognized?
© 200455 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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The Time Period Assumption
To meet the needs of decision makers, we report financial information for
relatively short time periodsrelatively short time periods (monthly, quarterly, annually).
1996 1997 1998 1999 2000 2001 2002 2003
Life of the BusinessLife of the Business
Annual Accounting Periods
© 200466 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Elements on the Income Statement
LossesLossesDecreases in assets or increases in Decreases in assets or increases in
liabilities from peripheral transactions.liabilities from peripheral transactions.
LossesLossesDecreases in assets or increases in Decreases in assets or increases in
liabilities from peripheral transactions.liabilities from peripheral transactions.
RevenueRevenueIncreases in assets or settlement of Increases in assets or settlement of liabilities from ongoing operations.liabilities from ongoing operations.
RevenueRevenueIncreases in assets or settlement of Increases in assets or settlement of liabilities from ongoing operations.liabilities from ongoing operations.
ExpenseExpenseDecreases in assets or increases in Decreases in assets or increases in liabilities from ongoing operations.liabilities from ongoing operations.
ExpenseExpenseDecreases in assets or increases in Decreases in assets or increases in liabilities from ongoing operations.liabilities from ongoing operations.
GainsGainsIncrease in assets or settlement of Increase in assets or settlement of
liabilities from peripheral transactionsliabilities from peripheral transactions..
GainsGainsIncrease in assets or settlement of Increase in assets or settlement of
liabilities from peripheral transactionsliabilities from peripheral transactions..
© 200477 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Papa John’s Primary Papa John’s Primary Operating ActivitiesOperating Activities
Papa John’s Primary Papa John’s Primary Operating ActivitiesOperating Activities
Sell pizzaSell pizzaSell pizzaSell pizza
Sell Sell franchisesfranchises
Sell Sell franchisesfranchises
© 200488 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Papa John’s Primary Papa John’s Primary Operating ExpensesOperating ExpensesPapa John’s Primary Papa John’s Primary Operating ExpensesOperating Expenses
Cost of salesCost of sales(used inventory)(used inventory)
Cost of salesCost of sales(used inventory)(used inventory)
Salaries and benefits Salaries and benefits to employeesto employees
Salaries and benefits Salaries and benefits to employeesto employees
Other costs (like Other costs (like advertising, insurance, advertising, insurance,
and depreciation)and depreciation)
Other costs (like Other costs (like advertising, insurance, advertising, insurance,
and depreciation)and depreciation)
© 200499 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-9
Corporations are taxable Corporations are taxable entities. Income tax entities. Income tax
expense is expense is Income Before Income Before Income TaxesIncome Taxes × × Tax RateTax Rate (Federal, State, Local and (Federal, State, Local and
Foreign).Foreign).
Corporations are taxable Corporations are taxable entities. Income tax entities. Income tax
expense is expense is Income Before Income Before Income TaxesIncome Taxes × × Tax RateTax Rate (Federal, State, Local and (Federal, State, Local and
Foreign).Foreign).
© 20041010 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Earnings Per ShareEarnings Per ShareEarnings Per ShareEarnings Per Share
Net IncomeWeighted Average
Number of Common Shares Outstanding
© 20041111 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-11
Cash Basis Accounting
Revenue is recordedRevenue is recordedwhen cash is received.when cash is received.Revenue is recordedRevenue is recorded
when cash is received.when cash is received.Expenses are recordedExpenses are recorded
when cash is paid.when cash is paid.Expenses are recordedExpenses are recorded
when cash is paid.when cash is paid.
© 20041212 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Assets, liabilities, revenues, and expenses Assets, liabilities, revenues, and expenses should be recognized when the transaction should be recognized when the transaction that causes them occurs, that causes them occurs, not necessarily not necessarily
when cash is paid or received.when cash is paid or received.
Assets, liabilities, revenues, and expenses Assets, liabilities, revenues, and expenses should be recognized when the transaction should be recognized when the transaction that causes them occurs, that causes them occurs, not necessarily not necessarily
when cash is paid or received.when cash is paid or received.
Required by -
Generally
Acceptable
Accounting
Principles
Required by -
Generally
Acceptable
Accounting
Principles
Accrual Accounting
© 20041313 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Revenue Principle
Recognize revenues when . . .Recognize revenues when . . .Delivery has occurred or services Delivery has occurred or services
have been rendered.have been rendered.There is persuasive evidence of an There is persuasive evidence of an
arrangement for customer payment. arrangement for customer payment. The price is fixed or determinable.The price is fixed or determinable.Collection is reasonably assured.Collection is reasonably assured.
Recognize revenues when . . .Recognize revenues when . . .Delivery has occurred or services Delivery has occurred or services
have been rendered.have been rendered.There is persuasive evidence of an There is persuasive evidence of an
arrangement for customer payment. arrangement for customer payment. The price is fixed or determinable.The price is fixed or determinable.Collection is reasonably assured.Collection is reasonably assured.
© 20041414 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Revenue Principle
If cash is received before the company If cash is received before the company delivers goods or services, the liability delivers goods or services, the liability
account account UNEARNED REVENUEUNEARNED REVENUE is recorded. is recorded.
Cash received before revenue is earned -
$Received
Cash (+A) x,xxx Unearned revenue (+L) x,xxx
© 20041515 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Revenue Principle
If cash is received before the company If cash is received before the company delivers goods or services, the liability delivers goods or services, the liability
account account UNEARNED REVENUEUNEARNED REVENUE is recorded. is recorded.
Cash received before revenue is earned -
$Received
Company Delivers
Cash (+A) x,xxx Unearned revenue (+L) x,xxx
Unearned Revenue (-L) x,xxx Fee Revenue (+R) x,xxx
© 20041616 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Revenue Principle
CASH COLLECTED (Goods or services due to
customers)over time will
become
REVENUE (Earned when goods or services provided)
Rent collected in advance Rent revenue
Unearned air traffic revenue Air traffic revenue
Deferred subscription revenue Subscription revenue
Typical liabilities that becomeTypical liabilities that becomerevenue when earned include . . .revenue when earned include . . .
© 20041717 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Revenue Principle
When cash is received on the date When cash is received on the date the revenue is earned, the the revenue is earned, the following entry is made:following entry is made:
$Received
Company Delivers
Cash (+A) x,xxx Fee revenue (+R) x,xxx
AND
© 20041818 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Revenue Principle
If cash is received after the company If cash is received after the company delivers goods or services, an asset delivers goods or services, an asset ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE is recorded. is recorded.
Cash received after revenue is earned -
Accounts receivable (+A) x,xxx Fee revenue (+R) x,xxx
Company Delivers
© 20041919 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-19
Revenue Principle
$Received
Cash (+A) x,xxx Accounts receivable (-A) x,xxx
Accounts receivable (+A) x,xxx Fee revenue (+R) x,xxx
Cash received after revenue is earned -
Company Delivers
If cash is received after the company If cash is received after the company delivers goods or services, an asset delivers goods or services, an asset ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE is recorded. is recorded.
© 20042020 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-20
The Revenue Principle
CASH TO BE COLLECTED
(Owed by customers)
and already earned as
REVENUE (Earned when
goods or services provided)
Interest receivable Interest revenue
Rent receivable Rent revenue
Royalties receivable Royalty revenue
Assets reflecting revenues earned butAssets reflecting revenues earned butnot yet received in cash include . . .not yet received in cash include . . .
© 20042121 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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The Matching Principle
Resources Resources consumed to earn consumed to earn
revenues in an revenues in an accounting period accounting period
should be recorded should be recorded in that period, in that period,
regardless of when regardless of when cash is paidcash is paid..
Resources Resources consumed to earn consumed to earn
revenues in an revenues in an accounting period accounting period
should be recorded should be recorded in that period, in that period,
regardless of when regardless of when cash is paidcash is paid..
© 20042222 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Matching Principle
If cash is paid before the company receives If cash is paid before the company receives goods or services, an asset account goods or services, an asset account
PREPAID EXPENSEPREPAID EXPENSE is recorded. is recorded.
Cash is paid before expense is incurred -
$Paid
Prepaid rent expense (+A) x,xxx Cash (-A) x,xxx
© 20042323 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-23
Matching Principle
ExpenseIncurred
Rent expense (-R) x,xxx Prepaid rent expense (-A) x,xxx
If cash is paid before the company receives If cash is paid before the company receives goods or services, an asset account goods or services, an asset account
PREPAID EXPENSEPREPAID EXPENSE is recorded. is recorded.
Cash is paid before expense is incurred -
$Paid
Prepaid rent expense (+A) x,xxx Cash (-A) x,xxx
© 20042424 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Matching Principle
When cash is paid on the date the When cash is paid on the date the expense is incurred, the following expense is incurred, the following
entry is made:entry is made:
$Paid
ExpenseIncurred
Rent expense (+E) x,xxx Cash (-A) x,xxx
AND
© 20042525 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-25
Matching Principle
If cash is paid after the company receives If cash is paid after the company receives goods or services, an liability goods or services, an liability PAYABLEPAYABLE is is
recorded.recorded.
Cash paid after expense is incurred -
Wages expense (+E) x,xxx Wages payable (+L) x,xxx
ExpenseIncurred
© 20042626 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Matching Principle
$Paid
Wages payable (-L) x,xxx Cash (-A) x,xxx
If cash is paid after the company receives If cash is paid after the company receives goods or services, an liability goods or services, an liability PAYABLEPAYABLE is is
recorded.recorded.
Cash paid after expense is incurred -
Wages expense (+E) x,xxx Wages payable (+L) x,xxx
ExpenseIncurred
© 20042727 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-27
Matching Principle
CASH PAID FORas used over
time becomes EXPENSE
Supplies inventory Supplies expense
Prepaid insurance Insurance expense
Buildings and equipment Depreciation expense
Typical assets and their relatedTypical assets and their relatedexpense accounts include. . .expense accounts include. . .
© 20042828 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-28
Matching Principle
CASH TO BE PAIDand already incurred as EXPENSE
Salaries payable Salaries expense
Interest payable Interest expense
Property taxes payable Property tax expense
Typical liabilities and their relatedTypical liabilities and their relatedexpense accounts include . . .expense accounts include . . .
© 20042929 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Expanded Transaction Analysis Model
Let’s look at an expanded transaction analysis model that
includes the recording of revenues and expenses.
© 20043030 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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A = L + SEA = L + SEASSETSASSETS
Debit for
Increase
Credit for
Decrease
LIABILITIESLIABILITIES
Debit for
Decrease
Credit for
Increase
RETAINED RETAINED EARNINGSEARNINGS
Debit for
Decrease
Credit for
Increase
CONTRIBUTED CONTRIBUTED CAPITALCAPITAL
Debit for
Decrease
Credit for
Increase
Next, let’s see Next, let’s see how Revenues how Revenues and Expenses and Expenses affect Retained affect Retained
Earnings.Earnings.
© 20043131 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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EXPENSESEXPENSES
Debit for
Increase
Credit for
Decrease
REVENUESREVENUES
Debit for
Decrease
Credit for
Increase
RETAINED RETAINED EARNINGSEARNINGS
Debit for
Decrease
Credit for
Increase
Expanded Transaction Analysis Model
Dividends decrease Dividends decrease Retained Earnings.Retained Earnings.
Net Income increases Net Income increases Retained Earnings.Retained Earnings.
© 20043232 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Analyzing Papa John’s Transaction
Let’s apply the complete transaction analysis model to
some of Papa John’s transactions.
All amounts are in thousands of dollars.
© 20043333 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Identify & Classify the AccountsIdentify & Classify the Accounts
Determine the Direction of the EffectDetermine the Direction of the Effect
Papa John’s sold franchises for $400 cash. The company earned $100 immediately. The rest will
be earned over several months.
Identify & Classify the Accounts1. Cash (asset)2. Franchise fee revenue (revenue)3. Unearned franchise fees (liability)
Identify & Classify the Accounts1. Cash (asset)2. Franchise fee revenue (revenue)3. Unearned franchise fees (liability)
Determine the Direction of the Effect1. Cash increases.2. Franchise fee revenue increases.3. Unearned franchise fees increases.
Determine the Direction of the Effect1. Cash increases.2. Franchise fee revenue increases.3. Unearned franchise fees increases.
© 20043434 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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= +Cash 400 Unearned franchise
revenue300 Franchise fees
revenue100
Stockholders' EquityLiabilitiesAssets
Papa John’s sold franchises for $400 cash. The company earned $100 immediately. The rest will
be earned over several months.
© 20043535 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-35The company sold $36,000 of pizzas for cash. The costs of the pizza ingredients for those
sales were $9,600.
Identify & Classify the AccountsIdentify & Classify the Accounts
Determine the Direction of the EffectDetermine the Direction of the Effect
Identify & Classify the Accounts1. Cash (asset)2. Restaurant sales revenue (revenue)3. Cost of sales- restaurant (expense)4. Inventories (asset)
Identify & Classify the Accounts1. Cash (asset)2. Restaurant sales revenue (revenue)3. Cost of sales- restaurant (expense)4. Inventories (asset)
Determine the Direction of the Effect1. Cash increases.2. Restaurant sales revenue increases.3. Cost of sales- restaurant increases. 4. Inventories decrease.
Determine the Direction of the Effect1. Cash increases.2. Restaurant sales revenue increases.3. Cost of sales- restaurant increases. 4. Inventories decrease.
© 20043636 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-36
= +Cash 36,000 Restaurant sales
revenue36,000
Inventory (9,600) Cost of sales (9,600)
Stockholders' EquityLiabilitiesAssets
The company received $35,200 for pizza sales. The cost of the pizza ingredients for those sales
was $9,600.
© 20043737 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-37How are Unadjusted Financial Statements Prepared?
After posting all of the After posting all of the January transactions to January transactions to
T-accounts, we can T-accounts, we can prepare Papa John’s prepare Papa John’s unadjusted financial unadjusted financial
statementsstatements..
After posting all of the After posting all of the January transactions to January transactions to
T-accounts, we can T-accounts, we can prepare Papa John’s prepare Papa John’s unadjusted financial unadjusted financial
statementsstatements..
© 20043838 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-38
Revenues Restaurant and commissary sales 66,000$ Franchise fees 2,800 Total revenues 68,800 Costs and expenses Cost of sales 30,000 Salaries and benefits expense 14,000 Rent expense - Advertising expense - General and administrative expenses 7,000 Depreciation and amortizaation expense - Other operating costs - Total costs and expenses 51,000 Operating income 17,800 Other revneues and gains (expenses and losses) Investment income 1,000 Interest expense - Gain on sale of land 3,000 Income before income taxes 21,800 Income tax expense - Net income 21,800$
Earnings per share (for the month) 0.88$
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIESUnadjusted Consolidated Statement of Income
For the Month Ended Janaury 31, 2001(Dollars in thousands)
Several expenses, Several expenses, including income tax including income tax expense, have not expense, have not determined at this determined at this
point in the point in the accounting process.accounting process.
© 20043939 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-39
Beginning balance, December 30, 2000 165,000$ Unadjusted net income 21,800 Dividends (3,000) Ending balance, January 31, 2001 183,800$
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIESUnadjusted Consolidated Statement of Retained Earnings
For the Month Ended Janaury 31, 2001(Dollars in thousands)
Beginning balance, December 30, 2000 165,000$ Unadjusted net income 21,800 Dividends (3,000) Ending balance, January 31, 2001 183,800$
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIESUnadjusted Consolidated Statement of Retained Earnings
For the Month Ended Janaury 31, 2001(Dollars in thousands)
Unadjusted Statement of Retained Earnings
The unadjusted net income comes from the The unadjusted net income comes from the Income Statement just prepared.Income Statement just prepared.
The unadjusted net income comes from the The unadjusted net income comes from the Income Statement just prepared.Income Statement just prepared.
© 20044040 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-40UnadjustedBalance Sheet
Assets
Current assets: 1/31/01
Cash 33,900$
Short-term investments 7,000
Accounts receivable 19,200
Inventories 17,000
Prepaid expenses 16,000
Other current assets 6,000
Total current assets 99,100
Property and equipment, net of depreciation 255,000
Notes receivable 20,000
Intangibles 49,000
Other assets 18,000
Total assets 441,100$
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable 34,000$
Accrued expenses payable 45,000
Other current liabilities 1,000
Total current liabilities 80,000
Unearned franchise fees 6,300
Long-term notes payable 160,000
Other long-term liabilities 8,000
Total liabilities 254,300
Stockholders' equity:
Contributed capital 3,000
Retained earnings 183,800
Total stockholders' equity 186,800
Total liabilities and stockholders' equity 441,100$
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES
Unadjusted Consolidated Balance Sheets
(Dollars in thousands)
The ending balance from The ending balance from the Statement of Retained the Statement of Retained
Earnings flows into the Earnings flows into the equity section of the equity section of the
Balance Sheet.Balance Sheet.
The ending balance from The ending balance from the Statement of Retained the Statement of Retained
Earnings flows into the Earnings flows into the equity section of the equity section of the
Balance Sheet.Balance Sheet.
© 20044141 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-41
Focus on Cash FlowsEffect on
Cash FlowsCash received from: Customers +
Investments +Cash paid to: Suppliers -
Employees -Interest paid -Income taxes paid -
Nature of Operating Activity
Cash InflowsCash InflowsCash InflowsCash Inflows
Cash OutflowsCash OutflowsCash OutflowsCash Outflows
© 20044242 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
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Operating Activities
Cash from: Customers 69,000$
Franchises 3,900
Interest on investments 1,000
Cash to: Suppliers (35,000)
Employees (14,000)
Net cash provided by operating activities 24,900
Investing Activities
Sold land 4,000
Purchased property and equipment (2,000)
Purchased investments (1,000)
Lent funds to franchisees (3,000)
Net cash used in investing activities (2,000)
Financing Activities
Issued common stock 2,000
Borrowed from banks 6,000
Paid dividends (3,000)
Net cash provided by financing activities 5,000
Net increase in cash 27,900
Cash at beginning of month 6,000
Cash at end of month 33,900$
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES
Unadjusted Consolidated Statement of Cash Flows
For the Month Ended Janaury 31, 2001
(Dollars in thousands)
The ending cash The ending cash balance agrees balance agrees with the amount with the amount on the Balance on the Balance
Sheet.Sheet.
The ending cash The ending cash balance agrees balance agrees with the amount with the amount on the Balance on the Balance
Sheet.Sheet.
© 20044343 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-43
Financial Analysis
Measures the sales Measures the sales generated per dollar generated per dollar
of assets.of assets.
Measures the sales Measures the sales generated per dollar generated per dollar
of assets.of assets.
Creditors and analysts used Creditors and analysts used this ratio to assess a this ratio to assess a
company’s effectiveness at company’s effectiveness at controlling current and controlling current and
noncurrent assets.noncurrent assets.
Creditors and analysts used Creditors and analysts used this ratio to assess a this ratio to assess a
company’s effectiveness at company’s effectiveness at controlling current and controlling current and
noncurrent assets.noncurrent assets.
AssetAssetTurnoverTurnover
RatioRatio
Sales (or Operating) RevenuesSales (or Operating) Revenues
Average Total AssetsAverage Total Assets==
© 20044444 The McGraw-Hill CompaniesMcGraw-Hill/Irwin
3-44
End of Chapter 3