Understanding Financial Statements

Gerald P. Weinstein, PHD, CPAKPMG Professor of AccountancyJohn and Mary Jo Boler School of

Business John Carroll University

Hudson Library and Historical Society’s MBA Lite mini-seriesFebruary 23, 2015

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Forms of Business Forms of Business OrganizationOrganization

Sole proprietorshipSole proprietorship

PartnershipPartnership

CorporationCorporation

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Types of Business ActivityTypes of Business Activity

FinancingFinancing

InvestingInvesting

OperatingOperating

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Financing ActivitiesFinancing Activities Borrowing createsBorrowing creates

liabilitiesliabilities Bank loansBank loans Debt securitiesDebt securities Goods on credit or Goods on credit or

payablespayables

Selling stockSelling stock creates creates stockholders’ stockholders’ equityequity

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Investing ActivitiesInvesting Activities

Obtaining Obtaining resources or resources or assets to operate assets to operate the businessthe business LandLand BuildingsBuildings VehiclesVehicles ComputersComputers FurnitureFurniture EquipmentEquipment

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Operating ActivitiesOperating Activities Primary activity of Primary activity of

business business Selling goodsSelling goods Providing servicesProviding services ManufacturingManufacturing Cost of SalesCost of Sales AdvertisingAdvertising Paying employeesPaying employees Paying utilitiesPaying utilities

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Operating ActivitiesOperating Activities RevenuesRevenues are the increases in are the increases in

assets resulting from the sale of a assets resulting from the sale of a product or serviceproduct or service

ExpensesExpenses are the cost of assets are the cost of assets consumed or services used in consumed or services used in generating revenue.generating revenue.

If revenue If revenue >> expense expense == Net Net IncomeIncome

If revenue If revenue << expense expense == Net Loss!Net Loss!

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Four Financial StatementsFour Financial Statements

Income StatementIncome Statement

Retained Earnings StatementRetained Earnings Statement

Balance SheetBalance Sheet

Statement of Cash FlowsStatement of Cash Flows

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Income StatementIncome Statement

Reports operating success or failure Reports operating success or failure

for a period.for a period.

Summarizes revenues and expenses Summarizes revenues and expenses

for period: for period: month, quarter, year.month, quarter, year.

If revenue If revenue >> expense expense == Net Net

Income.Income.

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Income StatementIncome Statement

Do this statement first!Do this statement first!

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Retained Earnings Retained Earnings StatementStatement

Shows changes in retained earnings Shows changes in retained earnings

for period: for period: month, quarter, yearmonth, quarter, year

Beginning balanceBeginning balance

AddAdd Net Income from income Net Income from income

statement.statement.

Deduct DividendsDeduct Dividends

Ending balanceEnding balance

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Retained Earnings Retained Earnings StatementStatement

Do this statement second!Do this statement second!

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Balance SheetBalance Sheet Reports Reports assetsassets and claims to assets.and claims to assets.

Claims of creditors, Claims of creditors, liabilities.liabilities.

Claims of owners, Claims of owners, stockholders’ equity.stockholders’ equity.

Assets = Liabilities + Stockholders’ Assets = Liabilities + Stockholders’

EquityEquity

Specific date – Specific date – one point in time!one point in time!

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Balance SheetBalance Sheet

From From Retained Retained Earnings Earnings StatementStatement

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Statement of Cash Statement of Cash FlowsFlows

Provides information about cash Provides information about cash

receipts and cash paymentsreceipts and cash payments

Summarizes for period: Summarizes for period: month, month,

quarter, year.quarter, year.

Cash effects of operating, Cash effects of operating,

investing, and financing investing, and financing

activities.activities.

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Statement of Cash Statement of Cash FlowsFlows

Where did the cash come from?Where did the cash come from?

How was cash used during the How was cash used during the

period?period?

What was the change in the cash What was the change in the cash

balance during the period?balance during the period?

A company cannot survive without A company cannot survive without

cash!cash!

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Statement of Cash Flows..Statement of Cash Flows..

Agrees Agrees

withwith Balance Balance SheetSheet

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AssetsAssets Resources owned by Resources owned by

the businessthe business CashCash Accounts Accounts

receivablereceivable InventoriesInventories Furniture and Furniture and

fixturesfixtures EquipmentEquipment SuppliesSupplies

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LiabilitiesLiabilities

Obligations or debts of businessObligations or debts of business Notes payableNotes payable Accounts payableAccounts payable Interest payableInterest payable Salaries payableSalaries payable Unearned revenueUnearned revenue

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Stockholders’ EquityStockholders’ Equity Ownership claims on assetsOwnership claims on assets

Paid-in capitalPaid-in capital Common stockCommon stock

Retained earningsRetained earnings

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Basic Accounting Basic Accounting EquationEquation

Assets = Assets =

Liabilities + Stockholders’ EquityLiabilities + Stockholders’ Equity

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Supplements to the Financial Supplements to the Financial Statements in an Annual Statements in an Annual ReportReport

Management Discussion and Management Discussion and AnalysisAnalysis

Notes to Financial StatementsNotes to Financial Statements

Auditor’s reportAuditor’s report

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Management’s Discussion Management’s Discussion and Analysis covers three and Analysis covers three items:items:

1.1. LiquidityLiquidity

2.2. Capital resourcesCapital resources

3.3. Results of Results of

operationsoperations

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Management’s Discussion Management’s Discussion and Analysisand Analysis

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Notes to Financial Notes to Financial StatementsStatements

Explanatory notes and Explanatory notes and supplementary schedulessupplementary schedules

Clarifies information in financial Clarifies information in financial statementsstatements

Expands with additional detailExpands with additional detail Describes accounting policiesDescribes accounting policies Explains uncertainties and Explains uncertainties and

contingenciescontingencies

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Notes to Financial Notes to Financial StatementsStatements

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Auditor’s ReportAuditor’s Report

Certified Public Accountant – CPACertified Public Accountant – CPA Auditor (CPA) conducts independent Auditor (CPA) conducts independent

examination of financial statementsexamination of financial statements Fair representation?Fair representation? Follow Follow generally accepted generally accepted

accounting principles (GAAP)?accounting principles (GAAP)? Unqualified opinionUnqualified opinion

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Auditor’s ReportAuditor’s Report