Three Primary Financial Statements

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Three Primary Financial Statements

• Balance Sheet
• Income Statement
• Cash Flow Statement

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The Balance Sheet

• Presents assets and liabilities

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The Balance Sheet Equation

• Assets Liabilities Shareholders' equity
• Shareholders' equity Assets - Liabilities Net
  assets

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Recognition Criteria and Valuation Method
Determination

• GAAP sets balance sheet recognition criteria and
  valuation rules

Assets Cash Accounts receivable Marketable
securities Inventory Property, plant,
equipment
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Recognition and Valuation (continued)

• GAAP sets balance sheet recognition criteria and
  valuation rules

Liabilities Accounts payable Accruals Short term
debt Long term debt Contingencies
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Recognition and Valuation (continued)

• GAAP sets balance sheet recognition criteria and
  valuation rules

Why isnt Net Assets (or Equity) the Value of the
firm?
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The Income Statement

• is closely related to the balance sheet
• Change in shareholders' equity
• Change in net assets

Equity Beginning equity Net income
Dividends New stock
Change in Equity Net income Dividends New
stock
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The Income Statement Continued

• Lists those items that affected the income

Revenues
Expenses
Special Items
Gains
Losses
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The Income Statement Continued
Revenues include

• 1. Increases in net assets from selling goods
  and services in the normal course of business.

How does this increase net assets?
2. Other income such as interest earned (but not
earnings from sales of assets other than
inventory).
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The Income Statement Continued

• Expenses are decreases in net assets from
  producing normal goods and services

Advertising
Depreciation
Salaries
Taxes
Rent
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The Income Statement Continued
Gains are like revenues

• They represent increases in net assets
• Gains are not like revenues
• They do not arise in the ordinary course of
  business

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The Income Statement Continued

• Losses are
• Decreases in net assets resulting from
  transactions not part of normal course of
  business operations

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The Income Statement Continued

• Special Items include
• Extraordinary items
• Changes in accounting principles
• Discontinued operations

What are nonrecurring items and how do they
differ from the Special Items?
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Accounting Analysis of the Income Statement

• Focuses on earnings quality

• Conservative accounting methods

• Earnings free of manipulation

• Exclusion of nonrecurring items

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Conservative Accounting Methods

• Lead to lower values for reported net assets
• Lower income in early years
• Increase income in later years

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Earnings Free of Manipulation

• The analyst should try to undo any management
  manipulation before using historical data

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Exclusion of Nonrecurring Items

• The analyst can ignore unusual or nonrecurring
  items
• For example
• Loss from an earthquake
• Earnings from discontinued operations

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The Cash Flow Statement

• Not a GAAP statement
• Reconciles net income to the change
  in cash

?
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The Cash Flow Statement Cont.

Consists of three sections
Cash flow from operations
Cash flow from investing
Cash flow from financing
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The Cash Flow Statement Cont.

• Cash Flow from Operations
• Includes items that relate to the determination
  of net income

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The Cash Flow Statement Cont.

• Cash Flow from Investing
• Cash flow from activities in which the firm
  acquires or divests long-term assets or
  investment securities

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The Cash Flow Statement Cont.

• Cash Flow from Financing Includes
• Borrowing money
• Repaying debt
• Obtaining funds from stockholders
• Paying dividends
• Repurchasing shares

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Summary

• We have learned
• Balance sheet
• Income statement
• Cash flow statement
• Recognition criteria and valuation
  methods