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Understanding the Financial Statements

Understanding the Financial Statements. Chapter 13 Understanding Financial Statements. Accounting: The Basis of Decision-Making Financial Statements: Financial Status for Businesses Financial Ratios: Using Ratios to Make Business Decisions.

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Understanding the Financial Statements

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  1. Understanding the Financial Statements (c) 2001 Contemporary Engineering Economics

  2. Chapter 13Understanding Financial Statements • Accounting: The Basis of Decision-Making • Financial Statements: Financial Status for Businesses • Financial Ratios: Using Ratios to Make Business Decisions (c) 2001 Contemporary Engineering Economics

  3. Chapter Opening Story – WorldCom’s False Reporting Accounting Rule Says: Operating expenses should be expensed during the year they incur. What WorldCom Did: Operating expenses are capitalized by spreading them over 7 years, just like capital expenditure. (c) 2001 Contemporary Engineering Economics

  4. Result: WorldCom Reports “Profit” instead of “Loss” (c) 2001 Contemporary Engineering Economics

  5. A. Why Engineers need to understand the financial statements? (c) 2001 Contemporary Engineering Economics

  6. Accounting – The Language of Business (c) 2001 Contemporary Engineering Economics

  7. Financial Status for Business (c) 2001 Contemporary Engineering Economics

  8. The basic accounting equation and the definition of capital How to instantly determine liquidity and too much debt How the firm gets equity: only two ways B. Understanding the Balance Sheet (c) 2001 Contemporary Engineering Economics

  9. The Basic Accounting Equation • For the Balance Sheet Presentation • For the Financial Analysis Assets = Liabilities + Owners’ Equity Assets - Liabilities = Owners’ Equity (c) 2001 Contemporary Engineering Economics

  10. How Items Are Arranged on the Balance Sheet Liabilities Assets Owners’ Equity (c) 2001 Contemporary Engineering Economics

  11. Using the Four Quadrants of the Balance Sheet and Why? ASSETS LIABILITIES Current Liabilities Current Assets = Long-Term Liabilities Long-Term Assets Equity • Owner Contributions • Retained Earnings (c) 2001 Contemporary Engineering Economics

  12. (c) 2001 Contemporary Engineering Economics

  13. How to Instantly Determine Liquidity and Too Much Debt • Liquidity • Too Much Debt? Current Ratio (2:1) Debt To Equity Ratio (c) 2001 Contemporary Engineering Economics

  14. Liquidity – Current Ratio ASSETS LIABILITIES Current Liabilities Current Assets Long-Term Liabilities Long-Term Assets Equity • Owner Contributions • Retained Earnings (c) 2001 Contemporary Engineering Economics

  15. Too Much Debt? – Debt to Equity Ratio ASSETS LIABILITIES Current Liabilities Current Assets Debt Long-Term Liabilities Long-Term Assets Equity • Owner Contributions • Retained Earnings (c) 2001 Contemporary Engineering Economics

  16. How the Firm Gets Equity: Only Two Ways • Owners’ Contributions • Retained Earnings (c) 2001 Contemporary Engineering Economics

  17. C. Using the Income Statement to Manage a Business • How to Use profit check points • Why gross margin is the critical measure for engineers? • How does inventory production impact profit? (c) 2001 Contemporary Engineering Economics

  18. Basic Income Statement Equation Revenue - Expenses Net Income (Loss) (c) 2001 Contemporary Engineering Economics

  19. Why Gross Margin is the Critical Measure for Engineers? Sales Cost of Goods Sold Gross Margin (c) 2001 Contemporary Engineering Economics

  20. How Inventory Production Impacts Profit Calculating the Cost of Goods Sold • Beginning Inventory • + Additions to Inventory • Ending Inventory • Cost of Goods Sold (c) 2001 Contemporary Engineering Economics

  21. How to Use Profit Check Points Bottom line (c) 2001 Contemporary Engineering Economics

  22. (c) 2001 Contemporary Engineering Economics

  23. Operating Margin versus Net Margin Operating margin Net margin (c) 2001 Contemporary Engineering Economics

  24. D. Understanding the Statement of Cash Flows (c) 2001 Contemporary Engineering Economics

  25. The business operating cycle: How a business earns its cash • Sources and Uses of Cash • The engineer’s focus on the investing section: Capital Budgeting (c) 2001 Contemporary Engineering Economics

  26. Shareholders To pay dividend, To purchase back shares From sale of shares Fixed Assets Government To purchase To pay taxes From sale CASH To pay interest and principal From cash sales From sale of debt From credit sales Customers Debt holders To pay labor, materials, and overhead Inventory (c) 2001 Contemporary Engineering Economics

  27. The Cash Flow – Business Cycle • Pay taxes • Pay interest • Pay dividends • Changes in equity • Changes in liabilities Cash Collection of receivable Cash Sales Accounts receivable Production Credit Sales • Labor • Materials • Overhead Inventory Depreciation Fixed assets Investment (c) 2001 Contemporary Engineering Economics

  28. (c) 2001 Contemporary Engineering Economics

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