Chapter 4: Financial Statement Analysis Flashcards
Why Study Financial Statements
- Assess current performance through financial statement analysis
- Monitor and control operations, and
- Forecast future performance.
What Are The Fundamental Concepts and Assumptions?
- Separate Entity Concept
- Cost Principle
- Monetary Measurement Concept
- Going Concern Assumption
The organizational unit for which accounting records are maintained.
Entity
The activities of an entity are to be separate from those of its individual owners.
Separate entity concept
In the Cost Principle
All transactions are recorded at _______________.
historical cost
is assumed to represent the fair market value of the item at the date of the transaction because it reflects the actual use of resources by independent parties.
Historical cost
Accountants measure only those ____________________ that can be measured in monetary terms.
economic activities
Listed values may not be the same as actual market values:
- Inflation
- Measurement issues
An entity will have a continuing existence for the foreseeable future.
The Going Concern Assumption
The life of a business is divided into distinct and relatively short time periods so the accounting information can be timely, generally 12 months or less.
The Time Period Concept
Revenues are recorded when two main criteria are met:
- The earning process is substantially complete
- Cash has either been collected or collection is reasonably assured.
Revenue Recognition
All costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenues.
The Matching Principle
This process of matching expenses with recognized revenues determines the amount of net income reported on the income statement.
The Matching Principle
Basic financial statements:
- Balance Sheet
Income Statement
Statement of Retained Earnings
Statement of Cash Flows
Summary of the financial position of a company at a particular date
The Balance Sheet
financial statement that indicates the worth or financial condition of a business as of a certain date.
The Balance Sheet
Sources owned by the company like cash, accounts receivable, inventory, land, buildings, equipment and intangible items
Assets
The total amount of money the firm owes its creditors like accounts payable, notes payable and mortgages payable
Liabilities
net assets after all obligations have been satisfied or is the difference in the value of the firm’s assets and the firm’s liabilities
Owners’ Equity
consists of firm’s cash plus other assets the firm expects to convert to cash within 12 months or less, such as receivables and inventory.
Current Assets
are assets that the firm does not expect to sell within one year. For example, plant and equipment, land.
Fixed assets
represent the amount that the firm owes to creditors that must be repaid within a period of 12 months or less such as accounts payable, notes payable.
Current liabilities
refer to debt with maturities longer than a year such as bank loans, bonds.
Long-term liabilities
The amount the company received from selling stock to investors.
The stockholder’s equity
It may be shown as common stock in the balance sheet or it may be divided into two components:
- par value
- additional paid in capital above par
is the stated or face value a firm puts on each share of stock.
Par value
is the additional amount the firm raised when it sold the shares.
Paid in capital
the portion of net income that has been retained (i.e., not paid in dividends) from prior years operations.
retained earnings
users can identify significant changes over time. They have more than one year on the Balance Sheet.
Comparative financial statement
are useful to use, since information is then organized into a format that is more readable than a simple listing of all the accounts that comprise a balance sheet.
Classified financial statements a
Balance Sheet Limitations
Assets recorded at historical value
Only recognizes assets that can be expressed in monetary terms
Owners’ equity is usually less than the company’s market value
Shows the results of a company’s operations (activities) over a period of time.
The Income Statement
show the reader how much profit or loss an organization generated during a reporting period.
The Income Statement
Earnings from sale of goods or performance of services
Total Sales
Assets (cash or AR) created through business operations
Revenues
Refunds and adjustments for unsatisfactory merchandise or service
Sales Returns and Allowances
Total sales minus sales returns or allowances
Net Sales
Cost to the business for merchandise or goods sold
Cost of Goods Sold
Overhead or cost incurred in operating a business
Operating Expenses
Revenues - Expenses
Net Income or (Net Loss)
An additional financial statement that identifies changes in retained earnings from one accounting period to the next.
Statement of Retained Earnings
How to get ending retained earnings
Beg. RE + Net Income - Dividends Paid
Net income results in:
Increase in net assets
Increase in retained earnings
Increase in owners’ equity
Dividends result in:
Decrease in net assets
Decrease in retained earnings
Decrease in owners’ equity
Reports the amount of cash collected and paid out by a company in operating, investing and financing activities for a period of time.
Statement of Cash Flows
Complementary to the income statement.
Statement of Cash Flows
Indicates ability of a company to generate income in the future.
Statement of Cash Flows
is used by firms to explain changes in their cash balances over a period of time by identifying all of the sources and uses of cash.
Statement of Cash Flows
Sell goods or services
Sell other assets or by borrowing
Receive cash from investments by owners
Cash inflows
Pay operating expenses
Expand operations, repay loans
Pay owners a return on investment
Cash outflows
Cash Inflow
* Sale of goods or services
* Sale of investments in trading securities
* Interest revenue
* Dividend revenue
Cash Outflow
* Inventory payments
* Interest payments
* Wages
* Utilities, rent
* Taxes
Operating Activities
Cash Inflow
* Sale of plant assets
* Sale of securities, other than
trading securities
* Collection of principal on loans
Cash Outflow
* Purchase of plant assets
* Purchase of securities, other than
trading securities
* Making of loans to other entities
Investing Activities
Cash Inflow
* Issuance of own stock
* Borrowing
Cash Outflow
* Dividend payments
* Repaying principal on
borrowing
* Treasury stock purchase
Financing Activities
is any activity that brings cash into the firm. For example, sale of equipment.
Source of cash
is any activity that causes cash to leave the firm. For example, payment of taxes.
Use of cash
