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Reading & Understanding Basic Financial Statements …make better use of the information in financial statements. Lewis & Knopf CPAs, P.C. AICPA MACPA Builders Association of Metro Flint Flint, Fenton & Grand Blanc Chambers of Commerce West Flint Business Association. - PowerPoint PPT Presentation


  • Reading & Understanding Basic Financial Statementsmake better use of the information in financial statements

  • Lewis & Knopf CPAs, P.C.AICPAMACPABuilders Association of Metro FlintFlint, Fenton & Grand Blanc Chambers of CommerceWest Flint Business Association

  • Lewis & Knopf CPAs, P.C.Services Include:Profitability and Efficiency AnalysisProjections and Business PlansBusiness ValuationsAuditing & AssuranceEstate and Gift PlanningTax Planning and PreparationTraditional Accounting, Bookkeeping and Payroll Services

  • AgendaPurpose of financial statementsThe Balance SheetThe Income StatementStatement of Retained EarningsStatement of Cash FlowsNotes to the financial statementsFundamental concepts and assumptionsAccrual vs. cash-basis accountingStandards for comparisonTools of analysis

  • Primary Financial StatementsBasic financial statements:Balance SheetIncome Statement Statement of Retained EarningsStatement of Cash Flows

  • Primary Financial StatementsPrimary financial statements answer basic questions including:What is the companys current financial status?What was the companys operating results for the period?How did the company obtain and use cash during the period?

  • Summary of the financial position of a company at a particular dateAssets: cash, accounts receivable, inventory, land, buildings, equipment and intangible itemsLiabilities: accounts payable, notes payable and mortgages payableOwners Equity: net assets after all obligations have been satisfiedThe Balance Sheet

  • The Balance SheetWhat are the resources of the company?What are the companys existing obligations?What are the companys net assets?

  • Accounting EquationAssets = Liabilities + Owners EquitySources of FundingCreditorsclaimsagainstresources=+OwnersclaimsagainstresourcesResources

    Resources to use to generate revenues

  • AssetsCash $ 40Accounts receivable 100Land 200 Total assets$340Sample Balance SheetMust Equal

  • Classified and Comparative Balance SheetsThey distinguish between:Current and long-term assetsCurrent and long-term liabilitiesListed in decreasing order of liquidityComparative so financial statement users can identify significant changes over time. They have more than one year on the Balance Sheet.

  • Balance Sheet LimitationsAssets recorded at historical valueOnly recognizes assets that can be expressed in monetary terms Owners equity is usually less than the companys market value

  • The Income StatementShows the results of a companys operations over a period of time.What goods were sold or services performed that provided revenue for the company?What costs were incurred in normal operations to generate these revenues?What are the earnings or company profit?

  • The Income StatementRevenuesAssets (cash or AR) created through business operationsExpensesAssets (cash or AP) consumed through business operationsNet Income or (Net Loss)Revenues - ExpensesMcGraw-Hill/Irwin, 2003

  • The Example CompanyIncome StatementFor the Years Ended December 31, 2010 and 2011

    20112010Revenues:Sales$100$ 85Other revenue 30 15 Total revenues$130$100

    Expenses:Cost of goods sold$ 62$ 58Operating & admin.1612Income tax 20 18 Total expenses$ 98$ 88

    Net Income$ 32$ 12

  • An additional financial statement that identifies changes in retained earnings from one accounting period to the next.Statement of Retained Earnings

  • Statement of Cash FlowsReports the amount of cash collected and paid out by a company in operating, investing and financing activities for a period of time.How did the company receive cash?How did the company use its cash?Complementary to the income statement.Indicates ability of a company to generate income in the future.

  • Statement of Cash FlowsCash inflowsSell goods or servicesSell other assets or by borrowingReceive cash from investments by owners

    Cash outflowsPay operating expensesExpand operations, repay loansPay owners a return on investment

  • Match Classification ofCash FlowsOperating activities Transactions and events that enter into the determination of net income.Investing activities Transactions and events that involve the purchase and sale of securities, property, plant, equipment, and other assets not generally held for resale, and the making and collecting of loans.Financing activities Transactions and events whereby resources and obtained from, or repaid to, owners and creditors.

  • Operating ActivitiesCash InflowSale of goods or services Sale of investments in trading securitiesInterest revenueDividend revenueCash OutflowInventory paymentsInterest paymentsWagesUtilities, rent Taxes

  • Investing ActivitiesCash InflowSale of plant assetsSale of securities, other than trading securitiesCollection of principal on loansCash OutflowPurchase of plant assetsPurchase of securities, other than trading securitiesMaking of loans to other entities

  • Financing ActivitiesCash InflowIssuance of own stockBorrowingCash OutflowDividend paymentsRepaying principal on borrowingTreasury stock purchase

  • CASH OUTFLOWSCASH INFLOWSStatement of Cash Flows

  • Statement of Cash Flows AnalysisOperatingInvestingFinancingGeneral ExplanationBuilding up pile of cash,Possibly looking forAcquisition

    Operating cash flow beingUsed to buy fixed assetsAnd pay down debt

    Operating cash flow and sale of fixed assets being used to pay down debt.

    Operating cash flow and borrowed money being used to expand1.










  • Statement of Cash Flows AnalysisOperatingInvestingFinancingGeneral ExplanationOperating cash flow problems covered by sale of fixed assets, borrowing and owner contributions.

    Rapid growth, short falls in operating cash flow; purchase of fixed assets.

    Sale of fixed assets is financing operating cash flow shortages.

    Company is using reserves to finance cash flow short falls.5.








  • The Example CompanyStatement of Cash FlowsDecember 31, 2011Cash Flows From Operating Activities:Receipts 48 Payments (43)5

    Cash Flows From Investing Activities:Receipts0 Payments(4)(4)

    Cash Flows Used By Financing Activities:Receipts10 Payments (6) 4 Net Cash Flow5

  • Balance Sheet 12/31/10Cash $ 80,000Other 4,550,000 Total $4,630,000

    Liabilities $2,970,000Cap. stock 900,000R/E 760,000 Total $4,630,000

    Cash $ 110,000Other 4,975,000 Total $5,085,000

    Liabilities $2,860,400Cap. stock 1,000,000R/E 1,224,600 Total $5,085,000

    Balance Sheet 12/31/11R/E 12/31/10 $ 760,000Net income 864,600Dividends (400,000) R/E 12/31/11 $1,224,600Stmt of Retained Earnings

  • Notes to the Financial StatementsNotes are used to convey information required by GAAP or to provide further explanation.

  • Notes to the Financial StatementsFour general types of notes:Summary of significant accounting policies: assumptions and estimates.Additional information about the summary totals.Disclosure of important information that is not recognized in the financial statements.Supplementary information required by the FASB or the SEC.

  • Separate Entity ConceptArms-Length TransactionsCost PrincipleMonetary Measurement ConceptGoing Concern AssumptionWhat Are The Fundamental Concepts and Assumptions?

  • Entity The organizational unit for which accounting records are maintained.

    Separate entity concept The activities of an entity are to be separate from those of its individual owners.ProprietorshipPartnershipCorporationSeparate Entity Concept

  • The Cost PrincipleAll transactions are recorded at historical cost.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.

  • The Monetary Measurement ConceptAccountants measure only those economic activities that can be measured in monetary terms.Listed values may not be the same as actual market values:InflationMeasurement issues

  • The Going Concern AssumptionAn entity will have a continuing existence for the foreseeable future.

  • Why Use Accrual Accounting?GAAP Generally Accepted Accounting PrinciplesBusiness requires periodic, timely reportingAccrual-basis accounting better measures a firms performance than does cash flow data.

  • The Time Period ConceptThe 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.

  • Define Accrual AccountingA system of accounting in which revenues and expenses are recorded as they are earned and incurred, not necessarily when cash is received or paid.Provides a more accurate picture of a companys profitability.Statement users can make more informed judgments concerning the companys earnings potential.

  • Revenue RecognitionRevenues are recorded when two main criteria are met: Cash has either been collected or collection is reasonably assured.The earning process is substantially complete

  • The Matching PrincipleAll costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenues.This process of matching expenses with recognized revenues determines the amount of net income reported on the income statement.costs and expensesrelated revenues

  • Cash-Basis AccountingRevenues and expenses are recognized only when cash is received or payments are made.Mainly used by small businesses.Not an accurate picture of true profitability.

  • During 2010, Crown Consulting billed its client for $48,000. On December 31, 2010, it had received $41,000, with the remaining $7,000 to be received in 2011. Total expenses during 2010 were $31,000 with $3,000 of these costs not yet paid at December 31. Determine net income under both methods.Cash-Basis AccountingCash receipts$41,000Cash disbursement 28,000 Income$13,000Accrual-Basis Accounting Revenues earned $48,000 Expenses incurred $31,000 Income $17,000Accrual vs. Cash-Basis Accounting

  • Purpose of AnalysisInternal UsersManagersOfficersInternal AuditorsExternal UsersShareholdersLendersCustomersFinancial statement analysis helps users make better decisions.

  • MarketAbility to meet short-term obligations and to efficiently generate revenuesAbility to generate future revenues and meet long-term obligationsAbility to generate positive market expectationsAbility to provide financial rewards sufficient to attract and retain financingBuilding Blocks of Analysis

  • Intra-company Competitor Industry GuidelinesStandards for Comparison

  • Tools of AnalysisHorizontal AnalysisComparing a companys financial condition and performance across time.

  • Tools of AnalysisVertical AnalysisComparing a companys financial condition and performance to a base amount.

  • Debt Ratio and its PurposeMeasure of leverageVaries from industry to industry, but should be around 50%

  • Current Ratio and its Purpose Measure of liquidityAlso called Working Capital RatioSome successful companies have current ratios less than 1.0

  • Asset Turnover and its PurposeMeasure of company efficiencyThe higher the asset turnover ratio, the more efficient the company is using its assets to generate sales.

  • Return on Sales and its PurposeMeasure of the amount of profit earned per dollar of sales.Evaluated within the appropriate industry.McGraw-Hill/Irwin, 2003

  • Return on Equity and its PurposeOverall measure of performanceprofit earned per dollar of investment.Typically between 15% and 25%.

  • Thank You!