Financial Statement Basics

Financial Statement Basics
PRENTICE HALL
Entrepreneurial Finance, 4th Edition ©2007 by Pearson Education, Inc.
By Adelman and Marks 3-1 Upper Saddle River, NJ 07458
Learning Objectives
 Understand how financial statements are used by
businesses.
 Understand the differences and similarities that exist
between a personal cash flow statement and a business
income statement.
 Distinguish between fixed and variable expenses.
 Understand the changes in income statements that exist
with different forms of business.
PRENTICE HALL
Learning Objectives (continued)
 Understand the differences and similarities that exist
between a personal statement of financial position and a
business balance sheet.
 Analyze the components of the basic accounting equation.
 Distinguish between assets and liabilities.
 Understand the relationship between fixed assets and
depreciation.
PRENTICE HALL
Learning Objectives (continued)
 Understand the significance of the statement of cash flows.

 Given the basic data for a company, be able to construct a
financial statement.
 Understand the problems that may exist with financial
statements.
PRENTICE HALL
Financial Statement (Personal Form)
for a Bank Loan
 Single bank loan application form which incorporates two
individual financial forms:
1. Statement of financial position
– Cash
– Cash equivalents
– Invested assets
– Use assets
– Liabilities
– Net worth
2. Personal cash flow statement
– Income
– Fixed expenses
– Variable expenses
PRENTICE HALL
Table 3 -1, Financial Statement, Personal Form
FINANCIAL STATEMENT Personal Form
FIRST ANY KIND OF BANK: OFFICE:
NAME: SOCIAL SECURITY NO:
ADDRESS: BUSINESS PHONE:
CITY, STATE, ZIP HOME PHONE:
SPOUSE NAME: SOCIAL SECURITY NO:
ASSETS IN DOLLARS LIABILITIES: IN DOLLARS
CASH IN THIS BANK: CHECKING LOANS PAYABLE THIS BANK:
LOANS PAYABLE OTHER FINANCIAL
SAVINGS: INSTITUTIONS: (SCHEDULE 6)
ACCOUNTS PAYABLE OTHER FIRMS &
CASH IN OTHER FINANCIAL INSTITUTIONS: INDIVIDUALS: (SCHEDULE 6)
CREDIT CARDS:
MARKETABLE STOCKS AND BONDS; (SCHEDULE 1) INCOME & OTHER TAXES PAYABLE:
ACCOUNTS RECEIVABLE: (SCHEDULE 2) REAL ESTATE TAXES:
TOTAL CURRENT ASSETS TOTAL CURRENT LIABILITIES:
NOTES OR MORTGAGES RECEIVABLE: OTHER REAL ESTATE INDEBTEDNESS
(SCHEDULE 3) (SCHEDULE 5):
CASH SURRENDER VALUE LIFE INSURANCE: LIFE INSURANCE LOANS:
(SCHEDULE 4) (SCHEDULE 4)
VEHICLES (YEAR & MAKE): OTHER LONG-TERM DEBTS: (DESCRIBE)
REAL ESTATE: (SCHEDULE 5)
OTHER PERSONAL PROPERTY: TOTAL LIABILITIES:
TOTAL ASSETS - TOTAL LIABILITIES =
TOTAL ASSETS: NET WORTH
ANNUAL INCOME: ANNUAL FIXED EXPENSES:
GROSS SALARY: REAL ESTATE PAYMENTS: (SCHEDULE 3)
SPOUSE'S GROSS SALARY: RENT
BONUSES & COMMISSIONS: INCOME TAXES:
INCOME FROM SECURITIES: (SCHEDULE 1) PROPERTY TAXES:
RENTAL OR LEASE INCOME (SCHEDULE 3) ALIMONY, CHILD SUPPORT:
MORTGAGES OR CONTRACT INCOME (SCHEDULE 3) INSURANCE PREMIUMS:
OTHER INCOME (DESCRIBE): OTHER (DESCRIBE):
TOTAL GROSS INCOME: TOTAL ANNUAL EXPENSES:

LESS - TOTAL EXPENSES:
NET CASH INCOME:
PRENTICE HALL
Personal Income Statement
(Cash Flow Statement)
 Income—Include all sources
› Wages, tips, overtime
› Interest on savings, stock dividends, etc.
 Fixed expenses
› Contractual, must be paid
› Rent, insurance, utilities, car payments, etc.
 Variable expenses
› You control level of expenses (food, clothing)
PRENTICE HALL
Table 2 Jones Family, Personal Income Statement
The Tom Jones Family
Personal Income Statement
(Cash Flow Statement)
January 1, 2006 to December 31, 2006.
INCOME
Salaries $ 60,000
Interest Income 740
TOTAL INCOME $60,740
FIXED EXPENSES
Mortgage Payment $ 9,600
Automobile Payment 5,040
Property Taxes 1,235
Insurance 4,500
Income Taxes 5,032
Savings & Investment 1,200
Personal Loan Payment 900
TOTAL FIXED EXPENSES $ 27,507
VARIABLE EXPENSES
Food $ 5,485
Transportation 2,500
Utilities 1,800
Clothes & Personal 2,700
Recreation & Vacation 2,780
TOTAL VARIABLE EXPENSES $ 15,265
TOTAL EXPENSES $ 42,772
(Cash Balance at the end of the year) $ 17,968
PRENTICE HALL
Income Statement Business
 Basic Format
› Sales, revenues, income from doing business
› Less cost of goods sold
› Gross profit
› Less operating expenses
› Operating income
› Less interest
› Net income (explain)
PRENTICE HALL
Table 3-3 Income Statement for a Sole Proprietorship, Partnership, Limited
Liability Company, or Subchapter S-Corporation
The Tom Jones Company
Income Statement
January 1, 2006, through December 31, 2006
Gross Sales $ 350,642
Less: Returns and Allowances 2,366
Net Sales $ 348,276
Cost of Goods Sold 124,276
Gross Profit $ 224,000
Operating Expenses:
Salaries Expense $ 95,000
Rent Expense 24,000
Property Taxes Expense 2,500
Depreciation Expense 6,000
Utilities Expense 10,250
Advertising Expense 9,250
Insurance Expense 3,000
Total Operating Expenses 150,000
Operating Income $ 74,000
Other Expenses:
Interest Expense 10,000
Net Income* $ 64,000
*This line on an Income Statement for a Corporation appears as Net Income before
Income Taxes see Table 3-3a
PRENTICE HALL
Balance Sheet for different legal forms
(Statement of Financial Position)
 Basic Accounting Equation
Individual:
Total assets = Total liabilities + Net Worth
Sole Proprietorship:
Total Assets = Total Liabilities + Owner’s Equity
Partnership:
Total Assets = Total Liabilities + Partners’ Equity
Corporation:
Total Assets = Total Liabilities + Stockholders’ Equity
PRENTICE HALL
Balance Sheet
(continued)
 Total assets
› Current assets
– Cash, accounts receivable, inventory, treasuries
– Anything in your possession that can be reasonably be
expected to turn into cash in less than one year
› Fixed assets
– Land
– Building & equipment (less accumulated depreciation)
– Net building & equipment
PRENTICE HALL
Balance Sheet
(continued)
 Total liabilities
› Current liabilities
– Accounts payable, notes payable, taxes payable
› Long-term liabilities (debt)
 Total equity
› Preferred stock
› Common stock par value
› Paid-in capital in excess of par (common)
› Retained earnings
PRENTICE HALL
Table 3-5 Balance Sheet (Statement of Financial Position), Sole Proprietorship
The Tom Jones Company
Balance Sheet
As of December 31, 2006
Assets
Sole proprietorship
Current Assets
Checking Account $ 2,000
Certificates of Deposit 50,000
Accounts Receivable 40,000
Inventory 35,000
Total Current Assets $ 127,000
Fixed Assets
Land $ 50,000
Buildings $ 250,000
Less: Accumulated Depreciation 50,000 200,000
Equipment $ 50,000
Total Fixed Assets $ 294,000
Total Assets $ 421,000
Liabilities and Owner's Equity

Current Liabilities
Accounts Payable--Trade $ 10,000
Notes Payable--Bank 5,000
Taxes Payable 3,000
Total Current Liabilities $ 18,000

Long-Term Liabilities
Building Mortgage $ 180,000
Equipment Loan 30,000
Total Long-Term Liabilities $ 210,000
Total Liabilities $ 228,000

Owner's Equity $ 193,000
Total Liabilities and Owner's Equity $ 421,000
PRENTICE HALL
Balance sheet – “Partners’ equity”
Table 3-6 Balance Sheet, Partnership
Tom Jones and Partners
Partners' Equity
Partnership
Tom Jones $ 18,650

Larry Smith 83,925
Kathy Moore 83,925
Total Partner's Equity $ 186,500
Total Liabilities and Partners' Equity $ 421,000
PRENTICE HALL
Table 3-7 Balance Sheet (Statement of Financial Position), Corporation
The Tom Jones Corporation
Balance Sheet
As of December 31, 2006
Assets
Current Assets
Checking Account $ 2,000
Corporation
Certificates of Deposit 50,000
Accounts Receivable 40,000
Inventory 35,000
Total Current Assets $ 127,000
Fixes Assets
Land $ 50,000
Buildings $ 250,000
Equipment $ 50,000
Total Fixed Assets $ 294,000
Total Assets $ 421,000
Liabilities and Stockholder's Equity

Current Liabilities
Accounts Payable--Trade $ 16,500
Notes Payable--Bank 5,000
Taxes Payable 14,000
Total Current Liabilities $ 35,500

Long-Term Liabilities
Building Mortgage $ 180,000
Equipment Loan 30,000
Total Long-Term Liabilities $ 210,000

Total Liabilities $ 245,500
Stockholders' Equity
Preferred Stock, $5 par (10,000 Shares) $ 50,000
Common Stock, $0.10 par (100,000 Shares) 10,000
Paid-in Capital in Excess of Par--Common 50,000
Total Paid-in Capital $ 110,000
Retained Earnings 65,500
Total Stockholders' Equity $ 175,500
Total Liabilities and Stockholder's Equity $ 421,000
PRENTICE HALL
Statement of Cash Flows
 Statement of cash flows shows how the company’s working
capital flows into and out of the business during the year.
 Statement of cash flows includes:
› Cash flows from operating activities is the difference between all
of the cash received by the business and all of the cash paid out by
the business in conducting its day-to-day operations (usually + flow)
› Cash Flows from Investing Activities:
– Acquisition or sale of Plant Assets (usually - cash flow)
› Cash Flows from Financing Activities:
– Proceeds from issuance or sale of stock (preferred & common),
bonds (+ flow). Purchase of stock or the payment of long-term
debt (- flow).
PRENTICE HALL
Statement of Cash Flows (continued)
› Examples of operating cash flow
– Receipts: All cash received from sales, changes in accounts
receivable, changes in inventory.
• NOTE: An increase in accounts receivable or inventory
represents a negative cash flow (see next slide). A
reduction in receivables or inventory is a positive cash
flow.
– Payments: All payments made by the company to all accounts
(suppliers, employees, rent, utilities, etc.). An increase in
accounts payable is a positive cash flow.
› Net increase (decrease) in cash plus the cash balance, previous

year equals cash balance, current year.
PRENTICE HALL
Table 3-8 Statement of Cash Flows
The Tom Jones Corporation
Statement of Cash Flows
For the Year Ended December 31, 2006
Increase (Decrease) in Cash and Cash Equivalents
Corporation Net Income

(Amounts in thousands)
Cash flows from operating activities
$ 53,000
Adjustments to reconcile net income to net cash

provided by operating activies
Depreciation Expense 6,000
Increase in Accounts Receivable (17,000)
Increase in Inventory (17,000)
Increase in Accounts Payable 8,500
Increase in Notes Payable 1,500
Increase in Taxes Payable 14,000 (4,000)
Net Cash provided by Operating Activities $ 49,000
Cash flows from investing activities:

Acquisition of plant assets (150,000)
Net cash outflow from investing activities (150,000)
Cash flows from financing activities:

Proceeds from issuance of preferred stock 50,000
Proceeds from issuance of common stock 60,000
Proceeds from Mortgage Payable 45,000
Payment of long-term debt (5,000)
Net cash inflow from financing activities $ 150,000
Net increase in cash $ 49,000

Cash balance, December 31, 2005 3,000
Cash balance, December 31, 2006 $ 52,000
PRENTICE HALL

Financial Statement Basics

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Financial Statement Basics

 Understand the significance of the statement of cash flows.

TOTAL GROSS INCOME: TOTAL ANNUAL EXPENSES:

(Cash Balance at the end of the year) $ 17,968

Net Sales $ 348,276

Cost of Goods Sold 124,276

Gross Profit $ 224,000

Total Operating Expenses 150,000

Operating Income $ 74,000

Net Income* $ 64,000

Total Assets $ 421,000

Liabilities and Owner's Equity

Total Current Liabilities $ 18,000

Total Long-Term Liabilities $ 210,000

Total Liabilities $ 228,000

Total Liabilities and Owner's Equity $ 421,000

Tom Jones $ 18,650

Total Partner's Equity $ 186,500

Total Liabilities and Partners' Equity $ 421,000

Total Current Assets $ 127,000

Total Fixed Assets $ 294,000

Total Assets $ 421,000

Liabilities and Stockholder's Equity

Total Current Liabilities $ 35,500

Total Long-Term Liabilities $ 210,000

› Net increase (decrease) in cash plus the cash balance, previous

Corporation Net Income

Adjustments to reconcile net income to net cash

Cash flows from investing activities:

Cash flows from financing activities:

Net increase in cash $ 49,000

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