Slide 1: Lecture 11: Understanding Financial Statements
61.068 Agribusiness Management Dr. Jared Carlberg
Today
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The Importance of Financial Statements The Accounting Process Financial Statements
– – – – The Balance Sheet The Income Statement Statement of Owners’ Equity Statement of Cash Flows
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Pro Forma Statements Important Accounting Principles
Midterm Exam: Next Class!
Covers lectures 1 through 10.2 as well as the FCC guest presentation
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Slide 2: Financial Statements
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need financial info. for 2 main reasons:
– used internally for decision making
» managerial accounting
– used for financial reporting to stockholders, lenders, authorities, etc.
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two most important financial statements:
– (1) balance sheet – (2) income statement (also sometimes called profit & loss statement or operating statement)
Financial Statements
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good info. required for good management financial records system should be:
– – – – simple & easy to understand reliable, accurate, consistent, timely based upon the business’ uniqueness cost-effective to implement & maintain
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need professional help to design system
– most agribus. hire bookkeepers/accountants
The Accounting System
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the accounting system helps prevent errors and safeguard the business’ resources
– need accurate, honest records to do this! – system of checks and balances required – auditors verify proper record keeping
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if the accounting system is built properly, there is little reason to suspect impropriety!
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Slide 3: Accounting System Uses
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good financial records provide the basis for:
– determining the business’ success – showing the financial health of the business – predicting the ability of the business to meet the demands of creditors, change, and expansion – relating performance to managers’ decisions – choosing among alternative courses of action for the future
The Accounting Process
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based largely on original documents
– sales slips, bills, cheques, invoices
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transactions recorded in the “journal”
– – – – also called “book of original entry” records all of the business’ transactions info. then transferred into other fin. statements also have “ledger” with classes of receipts and expenses grouped together
(1) The Balance Sheet
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shows the financial makeup and condition of a business at a specific point and time
– shows what a business owns, what it owes, and what the owners have invested – details the “balance” between assets and claims against them (liabilities and owners’ equity) – assets: things of value owned by the business – liabilities: amounts that must be paid – owners’ equity: amount invested by owners
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Slide 4: The Balance Sheet
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the balance sheet always balances assets = liabilities + owners’ equity
– for each thing of value (asset), the business owes somebody for it (liability) or an investor has a claim on it (owners’ equity) – if the balance sheet doesn’t balance, you’ve done something wrong!
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Assets
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are sources of value the business owns
– note: only corporations can “own” assets, but we do this for all types of businesses anyway
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three usual types of business assets:
– current assets – fixed assets – other assets
Current Assets
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cash or assets that will be converted to cash within one operating cycle (usually a year)
– reflect the firm’s ability to generate cash
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there are several types of current assets
– – – – – cash: immediately available funds accounts receivable: amounts owed for sales inventory: items to be sold/used in production prepaid expenses: paid for but not yet utilized other current assets: e.g. marketable securities
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Slide 5: Fixed Assets
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assets that have a relatively long life
– typically used to produce or sell goods/services
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there are three main types of fixed assets:
– land: real estate owned by the business
» land is usually valued at the purchase price
– buildings: facilities the business owns – equipment: used for any aspect of operations
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have to recognize that assets depreciate
– show this on balance sheet to ensure accuracy!
Other Assets
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miscellaneous assets that aren’t exactly current or fixed
– many things don’t fit into those categories
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longer life than current assets usually nondepreciable in nature examples of “other assets” include:
– bonds held for longer than one year – “intangible” assets such as patents, copyrights, and goodwill
Liabilities
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consist of money the business owes to “outsiders” (not original investors” are claims against the business’ assets
– but not usually against specific assets
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two main types of liabilities
– current liabilities – long-term liabilities
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Slide 6: Current Liabilities
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claims against the business that will fall due within one business cycle
– show the business’ short-term obligations
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types of current liabilities include:
– accounts payable: payment for things purchased on credit – notes payable: loans due within one year – accrued expenses: day-to-day expenses accrued but not yet paid e.g. wages, taxes payable – advances: payment for goods in advance
Long-term Liabilities
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outsiders’ claims not due within one operating cycle
– those liabilities that are not “current”
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examples of long-term liabilities include:
– bonded indebtedness: issued by the firm – mortgages: taken out on certain assets – long-term loans: to banks or individuals
Owners’ Equity
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claims of owners against firm assets
– summary of accounts showing contributions
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two usual accounts for owners’ equity:
– common stock: appears on books at original value – retained earnings: net gain on initial investment
» represent net profit left in the business as capital
– proprietorship/partnership often shows only one account for owners’ equity instead of two
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Slide 7: (2) The Income Statement
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shows revenues & expenses for a specific period of time & profit/loss from operations
– gives a measure of profit and performance – provides insight into managerial efficiency – shows how changes in the balance sheet came about – shows revenue taken in and money spent to generate that revenue
The Income Statement
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the basic format of the income statement is:
Sales - Cost of Goods Sold (COGS) Gross Profit - Expenses Net Profit
Cash Accounting Vs. Accrual Accounting
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two different approaches to preparing the income statement can be taken cash -basis approach: says revenue and expenses occur when cash is paid/received
– can under-or-overstate true net profit
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accrual-basis approach: says revenue and expenses exist when they first take place
– this approach more accurately reflects reality
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Slide 8: Sales
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total dollar value of goods and services sold during the income statement period
– include cash and credit sales – may include special lines for items such as returns and/or discounts & allowances – often broken down into different products
» this provides best information but also takes up more space on the income statement
Cost of Goods Sold (COGS)
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gives the total cost to the business of goods sold during the reporting period
– what it cost the business to purchase the goods it later re-sold
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more complicated for a processing or manufacturing firm than a retailing firm
– – – – should provide details as to cost breakdowns includes raw materials costs and direct labour have to factor inventory changes into COGS freight and transportation charges are in COGS
Gross Profit (or Gross Margin)
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shows difference between sales and COGS
– money available to cover operating expenses
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important to retail agribusinesses
– they have very little control over COGS
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changes in output price have big impact on gross margins for retailers
– because COGS stay the same regardless
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manufacturers can try to reduce COGS to increase margins
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Slide 9: Operating Expenses
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costs incurred as a result of business operations during the reporting period
– have to pay for things to conduct business
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can break them down into major categories:
– marketing: wages, salaries, commissions – administrative: mgr. salaries, office, travel – general: depreciation, insurance, taxes, rent, repairs, utilities
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all these expenses are operating expenses
Net Operating Profit
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amount left over when operating expenses are deducted from gross margin affected by same factors that influence gross margins
– output price, COGS
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can influence net operating profit by controlling operating expenses
– cost-cutting measures can make the firm more profitable
Net Profit Before Taxes
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amount remaining after taking account of any non-operating revenue or expenses non-operating revenue includes things like interest or dividends received
– for a local co-op, this could include patronage refunds from the regional/federated co-op
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non-operating expenses include items such as interest expense
– interest paid on borrowed money
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Slide 10: Net Profit After Taxes (or Net Income)
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what is left after business taxes are paid
– tax rates vary by jurisdiction and by profit level
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this is the so-called “bottom line”
– appears on the bottom line of the income statement
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can also be a “net loss”
– yes, businesses sometimes lose money!
Statement of Owners’ Equity
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shortest & least complicated of the financial statements
– shows changes to owners’ equity accounts over a period of time
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most common change: retained earnings
– if the business makes a profit, retained earnings increases unless all profit is paid in dividends and/or withdrawals by firm owners
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can also increase or decrease common stock
– this is only done very occasionally
Statement of Cash Flows
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shows a business’ cash inflows and outflows for a period of time
– can be used to report what happened to cash
» constructed at end of reporting period
– can be used to help budget cash flows
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cash flow statement always “balances”, too!
– sources of cash = uses of cash
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Slide 11: Statement of Cash Flows
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three primary categories for this statement:
– cash flows from operations – cash flows from investments/disinvestments – cash flows from financing transactions
» contributions from owners, borrowing from lenders, repaying debt, etc.
Pro Forma Statements
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financial statements usually reflect history
– but sometimes want to assess future plans!
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can use “pro forma” statements to do this
– they are statements prepared for a future period – often used to estimate the impact of potential courses of action upon the business
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often have to do pro forma statements to borrow money for a new/existing business
Important Accounting Principles
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important things about financial accounting:
– only facts that can be recorded in monetary terms should be on balance sheet/inc. statement – keep personal & business transactions separate – accounting methods assume ongoing operation of the business – assets are usually recorded at the lower of their actual cost or market value
» this is the “cost basis” of valuation » book value does not always equal market value!
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Slide 12: Important Accounting Principles
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more important fin. accounting principles:
– every accounting event has to balance: a change in assets necessarily requires a change in either liabilities or owners’ equity, or both – most accounting is done on an accrual basis – the format of the income statement should reflect the unique needs of the organization – fin. statement format can evolve to meet needs – the purpose of fin. statements is to provide info!
» necessary for informed decision making
Next Class
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topic: Analyzing Financial Statements reading: Chapter 13 Using Statements to Evaluate Performance Ratio Analysis
– profitability ratios – liquidity ratios – solvency ratios – operating/efficiency ratios
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Discussion question: What are the advantages of ROE as a tool of analysis for agbus. managers?
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