Financial Statements: A Comprehensive Guide

1. Chapter 2 Financial Statements and the Annual Report Financial Accounting 4e by Porter and Norton

2. To those willing to take the time to understand it Has capacity to make a difference Represents what it purports to Qualitative Characteristics Understandability - Relevance - Reliability -

3. Comparability between companies Consistency from one period to the next Qualitative Characteristics

4. Will it make a difference to the decision maker? All else equal, choose least optimistic alternative Qualitative Characteristics Materiality Conservatism

5. Current liabilities + Noncurrent (long-term) liabilities + Stockholders’ equity Total liabilities and stockholders’ equity Basic Structure of a Classified Balance Sheet Current assets + Noncurrent (long-term) assets Total assets

6. Current Assets Cash Receivables Inventories Prepayments Current Assets Will be converted to cash or consumed within one year or the operating cycle, whichever is longer.

7. Non-Current Assets Investments and Funds Property, Plant, & Equipment Intangibles Other Noncurrent Assets Not expected to be converted to cash or consumed within one year or the operating cycle, whichever is longer

8. Current Liabilities Accounts Payable Notes Payable Accrued Liabilities Current Maturities of Long-Term Debt Current Liabilities Obligations expected to be satisfied through current assets or creation of other current liabilities

9. Non-Current Liabilities Capital Leases Bonds Payable Long-Term Notes Payable Pension Liabilities Long-Term Liabilities Obligations that will not be satisfied within one year or operating cycle, whichever is longer

10. Realized, sold or consumed in one year or operating cycle A = L + SE Hewlett-Packard Co.Consolidated Balance Sheets (in millions) A Assets 20082007 Current assets: Cash and cash equivalents $ 10,153 $ 11,293 Marketable securities 93 152 Accounts receivable, net 25,439 21,582 Inventory 7,879 8,033 Other 8,164 6,342 Total current assets 51,728 47,402 Property, plant and equipment, net 10,838 7,798 Intangibles, net 40,297 25,852 Other assets 10,4687,647 $ 113,331 $ 88,699

11. A = L + SE Satisfied within one year or operating cycle Hewlett Packard Co.Consolidated Balance Sheets Liabilities and Stockholders' Equity (in millions) = L Current liabilities: Accounts payable $ 14,138 $ 11,787 Accrued liabilities 10,176 3,186 Other current liabilities 28,625 24,287 Total current liabilities 52,939 39,260 Long-term liabilities 21,450 10,913 Total liabilities 74,389 50,173 + SE Stockholders' equity: Common stock 24 26 Additional Paid-In-Capital 14,011 16,381 Retained earnings 24,971 21,560 Treasury stock -- -- Accumulated other comprehensive loss ( 64) 559 Total stockholders' equity 38,942 38,526 $ 113,331 $ 88,699 11

12. Analysis of Liquidity Ability of company to pay debts as they become due Of particular interest to bankers and other creditors Working Capital Current Ratio

13. Current assets $ 51,728 $ 47,402 Current liabilities 52,93939,260 Working Capital = C.A. less C.L. $ (1,211) $ 8,142 Hewlett Packard’s Liquidity (in millions) 20082007 What's the trend?? Current = Current Assets .98:1 1.21:1 Ratio Current Liabilities

14. Can you compare the ratios? Comparison of Liquidity Some 2008 current ratios: • Apple 2.46:1 • Campbell Soup 0.70:1 • Fed Ex 1.35:1 Consider composition of current assets and frequency of turnover

15. Income Statement Single Step Revenues $$$ Less: expenses($$) Net income $$

16. Multi-Step Income Statement Sales – Cost of goods sold =Gross profit Operating expenses: – Selling expenses – General and administrative expenses =Income from operations +/– Other revenues and expenses =Income before taxes – Income tax expense =Net income Four important subtotals

17. Hewlett Packard Co.Consolidated Statements of Operations (in millions) 20082007 Net Sales $ 118,364 $ 104,286 Cost of goods sold 87,532 76,965 Gross profit 30,832 27,321 Selling, general and administrative expenses 20,00318,542 Operating income (loss) 10,829 8,779 Other income (loss), net (356) 398 Income (loss) before income taxes 10,473 9,177 Provision (benefit) for income taxes 2,1441,913 Net income (loss) $ 8,329 $ 7,264

18. Analysis of Profitability Of particular interest to current and potential investors Gross Profit % Profit Margin %

19. Gross Profit (Margin) % = Gross Profit Sales (How many cents on every $ of sales are left over after covering the cost of the product) Hewlett Packard’s Profitability (in millions) 2008 2007 2006 Net sales $ 118,364 $ 104,286 $ 91,658 Cost of sales 87,532 76,965 67,678 Gross profit $ 30,832 $ 27,321 $ 23,980 Gross profit % = 26%26.2% 26.2%

20. Profit Margin % = Net Income Sales (How many cents on every $ of sales are left over after covering all expenses) Hewlett Packard’s Profitability (in millions) 2008 2007 2006 Net sales $ 118,364 $ 104,286 $ 91,658 Net income $ 8,329 $ 7,264 $ 6,198 Profit margin % = 7% 6.97% 6.76%

21. Includes: Statement of Retained Earnings Beginning retained earnings Add: net income Deduct: dividends = Ending retained earnings Statement of Stockholders’ Equity • Shows changes in all equity accounts including: • Sales and purchases of capital stock

22. Basic Format of the Statement of Cash Flows Cash flows from operating activities: $$ Cash flows from investing activities: $$ Cash flows from financing activities: $$ Net increase in cash $$ Cash at beginning of year $$ Cash at end of year $$ Reconciles change in cash for the period

23. Basic Format for the Statement of Cash Flows Cash flows from operating activities: $$ Cash flows from investing activities: $$ Cash flows from financing activities: $$ Net increase in cash $$ Cash at beginning of year $$ Cash at end of year $$ Involve the purchase and sale of products or services Involve the acquisition and sale of long-term assets Involve the issuance and payment of long-term liabilities and stock

24. End of Chapter 2