The Financial

Statements
 Chapter Outline
 Applications to people within & outside the firm
 Financial accounting reports: The four financial
statements
 Relationship among financial statements
 A case study: Financial statements of Apple Inc.
 Appendix: Using spreadsheets for financial
preparation and analysis
 APPLICATIONS TO PEOPLE
WITHIN & OUTSIDE THE FIRM
 Internal users: Managers use financial
statements to plan and control business
activities.

 External users: Investors and lenders use

financial statements to determine if a
company is financially sound.
 FINANCIAL ACCOUNTING
REPORTS:
The 4 Financial Statements
 Together, the 4 statements represent a
business firm in financial terms.
 The financial statements are:
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
 1. Income statement
 An income statement summarizes the revenues
earned and the expenses incurred by a business
over a period of time. The result is a net income
or net loss.
 Revenues – Expenses = Net Income (Net Loss)
A revenue is an increase of assets.
An expense is a decrease of assets.
 Example income statement (Exhibit 2.1)

Fashion Company
Consolidated Statement of Income

Year Ended Year Ended

Dec 31, 20Y2 Dec 31, 20Y1
($ Millions)
1 Net Sales Revenue 600 550
Earnings Expenses
after 2 Cost of Goods Sold 340 330
all 3 Operating Expenses 160 145
expenses. 4 Income Tax Expense 40 35
5 Total Expenses 540 510
6 Net Income 60 40
 Income statement
 The term "net" indicates the result after a
subtraction has occurred.
― Net income is the firm’s profit.
 Cost of goods sold is the cost of the
products a firm sells to its customers.
 An income statement is for a designated
time period.
— A fiscal year is an accounting period of
twelve months.
2. Statement of retained earnings

 Retained earnings is the equity of the

stockholders generated from operations and
reinvested into the company.
 The statement of retained earnings shows
the starting balance, changes, and ending
balance of retained earnings.
 Ending retained earnings = Beginning
retained earnings + Net income – Dividends
Example statement of retained earnings
(Exhibit 2.5)

Fashion Company
Consolidated Statement of Retained Earnings

Year Ended Year Ended

Dec 31, 20Y2 Dec 31, 20Y1
($ Millions)
Retained Earnings
1 Balance, beginning of year 590 580
2 Net income for the year 60 40
3 Less: Cash dividends declared (50) (30)
4 Balance, end of year 600 590

from Ending Balance

Income becomes Beginning Balance
Statement. of the next year
Statement of retained earnings
 Net income is the link between the
income statement and the statement of
retained earnings.
 The ending balance of retained earnings
is used in the balance sheet as a
component of owners equity.
Owners’ equity is the residual interest
in the assets of a business that remains
after deducting liabilities.
 3. Balance sheet
 Balance sheet lists the balances of the
following accounts on a given date:
• Assets
• Liabilities
• Owners’ Equity
 Balance sheet shows a firm's financial
position, what the firm owns (assets) and
owes (liabilities), on a specified day.
 Accounting equation

 The accounts on the balance sheet relate

to each other in the following manner,
known as the accounting equation:
Assets = Liabilities + Owners equity
 Example balance sheet (Exhibit 2.6)
Fashion Company
Consolidated Balance Sheet

Sum of ($ Millions) Dec 31, 2009 Dec 31, 2008

lines ASSETS
1 and 4. 1 Cash 100 90
2 Accounts Receivable 220 180
3 Inventory 180 200
4 Equipment 1,200 1,130
5 Total Assets 1,700 1,600
Sum of lines
6 through 8.
LIABILITIES
6 Accounts Payable 80 30
7 Income Taxes Payable 40 40
8 Long-Term Debt 480 440
Total liabilities 9 Total Liabilities 600 510
plus total STOCKHOLDERS' EQUITY
stockholders 10 Common Stock 500 500
equity should 11 Retained Earnings 600 590
always equal 12 Total Stockholders' Equity 1,100 1,090
total assets. 13 Total Liabilities & Stockholders' Equity 1,700 1,600
 Assets
 Assets are the economic resources owned
by the firm.
 Current assets are those that will be used
up, sold, or converted to cash within the
year, or the normal operating cycle if longer
than one year.
 All other assets are designated long-term
assets.
 Liabilities
 Liabilities are the debts or economic
obligations of the firm.
 Current liabilities are those debts that are
payable within one year, or within the
firm's normal operating cycle if more than
one year.
 All other debts are designated long-term
liabilities.
 Owners’ equity
(Stockholders equity)
 Owners equity is the residual interest in
the assets of the firm after subtracting the
liabilities.
 Owners equity = total assets - total
liabilities
 Corporations label owners equity as
"stockholders equity.“
 4. Statement of cash flows
 The statement of cash flows presents cash
inflows (receipts) and outflows (payments)
under three categories of business activities:
Operating activities
Investing activities
Financing activities

Operating + Investing + Financing =

Increase (or decrease) in cash during the period
 Fashion Company
Consolidated Statement of Cash Flows

Sum of lines 1 Year Ended

through 3. Dec 31, 20Y2
Net cash ($ Millions)
means cash CASH FLOWS FROM OPERATING ACTIVITIES
received 1 Cash received from customers 560
minus cash 2 Cash paid to suppliers and employees (430)
paid. 3 Cash paid for income tax expense (40)
4 Net cash provided by operating activities 90

CASH FLOWS FROM INVESTING ACTIVITIES

Sum of lines
5 Sale of equipment 170
4, 7, and 9.
6 Purchase of equipment (200)
7 Net cash used for investing activities (30)

CASH FLOWS FROM FINANCING ACTIVITIES

8 Cash dividends paid (50)
9 Net cash used for financing activities (50)
Matches
cash on 10 Net increase (decrease) in cash 10
Balance 11 Cash at beginning of year 90
sheet. 12 Cash at end of year 100
Operating activities include:
 Sales that result in cash receipts from
customers are cash inflows.
 Purchases of inventory that result in cash
payments to suppliers are cash outflows.
 Expenses such as employee wages,
rent, and advertising are cash outflows.
 Investing activities include:
Sales and purchases of long-term assets that
are used in business operations.

 Financing activities include:

Borrowing, issuing stock, purchasing treasury
stock, and paying cash dividends.
 RELATIONSHIP AMONG
FINANCIAL STATEMENTS

There are four fundamental questions

that are answered by the four financial
statements…
Fundamental financial questions & answers
(Exhibit 2.5)

 Income Statement
Question: How much did the firm earn or lose
from operations during the period?
Answer: Net income = revenues – expenses

 Statement of Retained Earnings

Question: In what way did the firm’s retained
earnings change during the period?
Answer:
Ending retained earnings = beginning retained
earnings + net income (or – net loss) - dividends
Fundamental financial questions & answers

 Balance Sheet
Question: What is the firm’s financial position at a
point in time?
Answer: Assets = liabilities + owners equity

 Statement of Cash Flows

Question: What amount of cash was generated
and spent during the period?
Answer:
Increase (or decrease) in cash = operating cash
flows + investing cash flow + financing cash flows
Relationships between certain accounts
within the four financial statements
(Exhibit 2.6)…
Income Statement -- For the Year Ended (FYE) December 31, 20Y2
Revenues 600
Total Expenses 540
Net Income 60

Statement of Retained Earnings -- FYE December 31, 20Y2

Retained Earnings, Beginning of the Year 590
Net Income 60
Cash Dividends (50)
Retained Earnings, End of the Year 600

Balance Sheet -- December 31, 20Y2

ASSETS
Cash 100
All Other Assets 1,600
Total Assets 1,700

LIABILITIES
Total Liabilities 600
STOCKHOLDERS' EQUITY
Common Stock 500
Retained Earnings 600
Total Liabilities and Stockholders' Equity 1,700

Statement of Cash Flows -- FYE December 31, 20Y2

Net Cash Flows Provided by Operating Actitivities 90
Net Cash Flows Used for Investing Activties (30)
Net Cash Flows Provided by Financing Activities (50)
Net Increase (Decrease) in Cash 10
Beginning Cash 90
Ending Cash 100
 CASE STUDY – Apple Inc.
 Apple’s income statement, entitled
Consolidated Statements of Operations, is
shown in the following slide.
Marvel is a parent firm, which means it owns
other firms called subsidiaries. The financial
statements show the consolidation of the parent
firm and its subsidiary firms.
 Apple’s income statement (Exhibit 2.7)
Years ended September 25,
20Y3 20Y2 20Y1
(in millions)
Net sales $ 65,225 $ 42,905 $ 37,491
Cost of goods sold 39,541 25,683 24,294
Gross margin 25,684 17,222 13,197
Operating expenses:
Research and development 1,782 1,333 1,109
Selling, general and administrative 5,517 4,149 3,761
Total operating expenses 7,299 5,482 4,870
Operating income 18,385 11,740 8,327
Other income and expenses 155 326 620
Income before income tax expense 18,540 12,066 8,947
Income tax expense 4,527 3,831 2,828
Net income $ 14,013 $ 8,235 $ 6,119

Apple shows three years for comparative

purposes. What is the trend?
 Apple’s retained earnings (Exhibit 2.8)
Years Ended September 25,
20Y3 20Y2 20Y1
(in millions)
Beginning retained earnings $ 23,353 $ 15,129 $ 9,111
Net income 14,013 8,235 6,119
Dividends (197) (11) (101)
Ending retained earnings $ 37,169 $ 23,353 $ 15,129

Having an increase in retained earnings for

three years in a row is a good sign for Apple.
 Apple’s balance sheet (Exhibit 2.9)

Apple’s balance sheet includes two years, as

shown in the next slide.
Did the company’s financial position improve
or decline?
 September 25,
20Y3 20Y2
(in millions)
Assets:
Current assets:
Cash and cash equivalents $ 11,261 $ 5,263
Short-term marketable securities 14,359 18,201
Accounts receivable, net 5,510 3,361
Inventories 1,051 455
Other current assets 9,497 4,275
Total current assets 41,678 31,555
Long-term marketable securities 25,391 10,528
Property, plant and equipment, net 4,768 2,954
Goodwill 741 206
Acquired intangible assets, net 342 247
Other assets 2,263 2,011
Total assets $ 75,183 $ 47,501
Liabilities and Stockholders’ Equity:
Current liabilities:
Accounts payable $ 12,015 $ 5,601
Accrued expenses 5,723 3,852
Deferred revenue 2,984 2,053
Total current liabilities 20,722 11,506
Deferred revenue – non-current 1,139 853
Other non-current liabilities 5,531 3,502
Total liabilities 27,392 15,861
Stockholders’ Equity:
Common Stock 10,668 8,210
Retained earnings 37,169 23,353
Accumulated other comprehensive income (46) 77
Total stockholders’ equity 47,791 31,640
Total liabilities and stockholders’ equity $ 75,183 $ 47,501
 Apple’s statement of cash flows (Exhibit 2.10)
Years Ended September 25,
20Y3 20Y2 20Y1
(in millions)
Net cash provided by operating activities $ 18,595 10,159 9,596
Net cash used in investing activities (13,854) (17,434) (8,189)
Net cash provided by financing activities 1,257 663 1,116
Net increase (decrease) in cash 5,998 (6,612) 2,523
Cash and cash equivalent at beginning of year 5,263 11,875 9,352
Cash and cash equivalent at end of year 11,261 5,263 11,875

Cash flow from operations increased each year.

The company’s overall cash balance has fluctuated
primarily due to investing decisions.
 Using Spreadsheets for Financial
Statement Preparation and Analysis
(with Microsoft Excel)
 In Microsoft Excel, a spreadsheet file is called
a worksheet.
 A worksheet is arranged in columns
designated by letters (A, B, C) and rows
designated by numbers (1, 2, 3). Thus, a
specific cell has an address containing a
letter and number.
 A worksheet should have three parts:
1. Identification area
2. Input area
3. Output area
 Identification area
The identification area provides facts about the
file, such as filename, and outlines the worksheet
requirements -- the information needed as input
and the resulting output.
A B C D E F G
1 IDENTIFICATION AREA:
2 Filename: Statement of Retained Earnings
3 Designer: B. Quick
4 File created:
5 Input required: a. Retained earnings, beginning of year balance
6 b. Net income for the year
7 c. Cash dividends declared
8 Output Required: Statement of retained earnings

Example: creating a statement of retained earnings

 Input area

The input area contains the required input items

along with their respective values.

9
10 INPUT AREA:
11 Balance, beginning of year 150
12 Net income for the year 300
13 Cash dividends declared 100
 Output area
The output area contains the desired results.
Formulas can be used to produce the amounts
within the output area. By typing a formula into
a cell, Excel will automatically compute the
amount.
 A B C
Worksheet
D E F G H I
1 IDENTIFICATION AREA:
2 Filename: Statement of Retained Earnings
3 Designer: B. Quick
4 File created:
5 Input required: a. Retained earnings, beginning of year balance
6 b. Net income for the year
7 c. Cash dividends declared
8 Output Required: Statement of retained earnings
9
10 INPUT AREA:
11 Balance, beginning of year 150
12 Net income for the year 300
13 Cash dividends declared 100
14
15 OUTPUT AREA:
16 Atomic Motor Company
17 Statement of Retained Earnings
18 For Year Ended December 31, 20Y1
19 Retained Earnings: Formulas used:
20 Balance, beginning of year 150 Balance, beginning of year =D11
21 Net income for the year 300 Net income for the year =D12
22 Less: Cash dividends declared 100 Cash dividends declared =D13
23 Balance, end of year 350 Balance, end of year =D20+D21-D22
24