Lecture 2 and 3 revision notes

Balance sheet what is it?

Balance sheets set out the financial position of the business at a time
Sets out assets of the business against claims

Vertical Layout- begins with the assets at the top of the balance sheet and places capital and
liabilities underneath.

Horizontal Layout- sets out the assets on one side of the balance sheet and the capabilities on the
other side

Horizontal Analysis

When an analyst compares financial information for two or more years for a single company, the
process is referred to as horizontal analysis, since the analyst is reading across the page to compare
any single line item, such as sales revenues. In addition to comparing dollar amounts, the analyst
computes percentage changes from year to year for all financial statement balances, such as cash
and inventory. Alternatively, in comparing financial statements for a number of years, the analyst
may prefer to use a variation of horizontal analysis called trend analysis. Trend analysis involves
calculating each year's financial statement balances as percentages of the first year, also known as
the base year. When expressed as percentages, the base year figures are always 100 percent, and
percentage changes from the base year can be determined.

Vertical Analysis

When using vertical analysis, the analyst calculates each item on a single financial statement as a
percentage of a total. The term vertical analysis applies because each year's figures are listed
vertically on a financial statement. The total used by the analyst on the income statement is net
sales revenue, while on the balance sheet it is total assets. This approach to financial statement
analysis, also known as component percentages, produces common-size financial statements.
Common-size balance sheets and income statements can be more easily compared, whether across
the years for a single company or across different companies.

Balance sheet definitions

Asset
Any item of economic value owned by an individual or corporation, especially that which could be
converted to cash. On a balance sheet, assets are equal to the sum of liabilities, common stock,
preferred stock, and retained earnings.

Assets must have following characteristics:

Should have future probable benefit, future monetary value
Business must have exclusive benefit
Benefit must have arisen from past transaction or event
Capable of measurement in monetary terms
Non-current assets
A long-term, tangible asset held for business use and not expected to be converted to cash in the
current or upcoming fiscal year, such as manufacturing equipment, real estate, and furniture. Also
called plant.

Current asset
Is a short term, tangible asset held for business use, and is expected to be converted to cash in the
current or upcoming fiscal year such as stock.

Tangible asset
Assets having a physical existence, such as cash, equipment, and real estate; accounts receivable are
also usually considered tangible assets for accounting purposes. Opposite of intangible asset.

Intangible asset
Something of value that cannot be physically touched, such as a brand, franchise, trademark, or
patent. Opposite of tangible asset.

Liabilities
Plural of liability. A liability is a financial obligation, debt, claim, or potential loss.

Non-current liabilities
Obligation that is not to require being satisfied within 12 months of the balance sheet date. Also
called long term liability.

Current liabilities
A balance sheet item which equals the sum of all money owed by a company and due within one
year. Also called payables or current debt.

Equity/shareholder funds
Ownership interest or claim of a holder of common stock (ordinary shares) and some types of
preferred stock (preference shares) of a firm. On a balance sheet, equity represents funds
contributed by the owners (stockholders) plus retained earnings or minus the accumulated losses.

Share capital
Invested money that, in contrast to debt capital, is not repaid to the investors in the normal course
of business. It represents the risk capital staked by the owners through purchase of the firm's
common stock (ordinary shares). Its value is computed by estimating the current market value of
everything owned by the firm from which the total of all liabilities is subtracted. On the balance
sheet of the firm, equity capital is listed as stockholders' equity or owners' equity. Also called equity
financing or share capital.

Retained profits
Profits generated by a firm that are not distributed to stockholders (shareholders) as dividends but
are either reinvested in the business or kept as a reserve for specific objectives (such as to pay off a
debt or purchase a capital asset).
Income statement what is it?
Income statement – purpose to report profit/loss of the business over a period of time
May show figures for which cash hasn’t been yet received under sales revenue

Income statements definition

Revenue
The inflow of assets that results from sales of goods and services and earnings from dividends,
interest, and rent. Revenue is often received in the form of cash but also may be in the form of
receivables to be turned into cash at a later date.

Expenses
Any cost of doing business resulting from revenue-generating activities.

Costs of goods
On an income statement, the cost of purchasing raw materials and manufacturing finished products.
Equal to the beginning inventory plus the cost of goods purchased during some period minus the
ending inventory also called Cost of Goods Sold (COGS).

Gross profits
Difference between trading revenue and costs of sales without taking into account expenses. These
costs can include manufacturing expenses, raw materials, labour, selling, marketing and other
expenses.

Operating profit-
Represents the wealth generated during a period of time, taking into account expenses, however
doesn’t take into account cost of finance.

Profit for the year

Represents the wealth generated during a period of time, taking into account tax, finance costs.

Tax
Tax payable by incorporated bodies.

Depreciation
A noncash expense that reduces the value of an asset as a result of wear and tear, age, or
obsolescence. Most assets lose their value over time (in other words, they depreciate), and must be
replaced once the end of their useful life is reached.

Profit
The positive gain from an investment or business operation after subtracting for all expenses

Capital V Revenue

Accounts from four opening transaction

Relationship between income statement and balance sheet:

Perform different functions but supplement each other
Balance sheet shows financial position of business at a particular time where income statement
focuses on flow of wealth over a period.