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Financial Statements

and Business Decisions


Chapter 1

McGraw-Hill/Irwin

2009 The McGraw-Hill Companies, Inc.

Understanding the Business


The Players
Investors

Creditors

Managers
1. Purchase parts
and labor

2. Manufacture
product

The
Business
Operatio
ns
4. Collect cash from
customers and pay
creditors
McGraw-Hill/Irwin

3. Sell products
to customers

Slide 3

The Accounting System


Accounting System

Financial Accounting System

Managerial Accounting System

Periodic financial statements and


related disclosures

Detailed plans and continuous


performance reports

External Decision Makers

Internal Decision Makers

Investors, creditors,
suppliers, customers, etc.

Managers throughout the


organization

McGraw-Hill/Irwin

Slide 4

The Four Basic Financial Statements


1.
1. On
Onaacompanys
companysBALANCE
BALANCESHEET
SHEET,,all
allresources
resourcesowned
ownedand
and
amounts
amountsowed
owedare
arelisted
listedininorder
orderof
ofliquidity.
liquidity.The
Thedifference
differencebetween
between
the
theresources
resourcesowned
ownedand
andthe
theamounts
amountsowed,
owed,represents
representsthe
the
stockholders
stockholdersequity
equityininthe
thebusiness.
business.
2.
2. On
Onaacompanys
companysINCOME
INCOMESTATEMENT
STATEMENT,,all
allthe
therevenues
revenuesearned
earned
from
fromsales
salesto
tocustomers
customersare
arelisted
listedalong
alongwith
withthe
theexpenses
expensesincurred
incurred
to
toproduce
producethose
thoserevenues.
revenues.
3.
3. On
Onaacompanys
companysSTATEMENT
STATEMENTOF
OFRETAINED
RETAINEDEARNINGS
EARNINGS
accumulated
accumulatednet
netearnings
earningsless
lessthe
thedividends
dividendspaid
paidto
toowners
owners
represent
representreinvestments
reinvestmentsininthe
thecore
corebusiness.
business.
4.
4. On
Onaacompanys
companysSTATEMENT
STATEMENTOF
OFCASH
CASHFLOWS,
FLOWS,all
allsources
sourcesand
and
uses
usesof
ofcash
cashare
arelisted.
listed.Cash
Cashisisgenerated
generatedby
bythe
thecompanys
companys
operations.
operations.Cash
Cashisisspent
spenton
oninvestments
investmentsininbuildings,
buildings,manufacturing
manufacturing
equipment,
equipment,and
andother
otherassets.
assets.Financing
Financingactivities
activitiesinvolve
involveamounts
amounts
borrowed
borrowedfrom
fromlong-term
long-termcreditors
creditorsand
andsale
saleof
ofstock
stockto
toowners.
owners.
McGraw-Hill/Irwin

Slide 5

The Accounting Equation

A = L + SE
(Assets)

Economic
Resources

(Liabilities)

(Stockholders
Equity)

Sources of Financing for Economic


Resources
Liabilities: From Creditors
Stockholders Equity: From Stockholders

McGraw-Hill/Irwin

Slide 6

Relationships Among the Statements


1. Net income from the income statement results
in an increase in ending retained earnings on
the statement of retained earnings.

Income Statement
$
Revenues 15,500
Expenses (8,500)
Net
$
income
7,000

McGraw-Hill/Irwin

Statement of Retained Earnings


Beginning retained
$
earnings
59,000
Net income

7,000

Dividends
Ending retained
earnings

(2,500)
$
63,500

Slide 7

Relationships Among the Statements


2. Ending retained earnings from the statement of
retained earnings is one of the two components
of stockholders equity on the balance sheet.

McGraw-Hill/Irwin

Statement of Retained
Earnings

Beginning retained
$
earnings
59,000

Cash

Net income

7,000

Other assets

Dividends
Ending retained
earnings

(2,500)
$
63,500

Balance Sheet
$
14,000

171,500
$
Total assets
185,500
$
Liabilities
42,000
Stockholders' Equity
Common stock
Retained earnings
Total liabilities and
equity

80,000
63,500
$
185,500

Slide 8

Relationships Among the Statements


3. The change in cash on the statement of
cash flows is added to the beginning-ofyear balance in cash to arrive at end-ofyear cash on the balance sheet.
Statement of Cash Flows

Cash flows from operating


$
activities
21,000
Cash flows from investing
activities
(16,000)
Cash flows from financing
activities
3,500

$
Increase in cash
8,500

Cash
Other assets

$
14,000

Liabilities

171,500
$
185,500
$
42,000

Stockholders' Equity

Ending cash balance

5,500

$
14,000

Retained earnings
Total liabilities and
equity

Beginning cash balance

McGraw-Hill/Irwin

Balance Sheet

Total assets

Common stock

80,000
63,500
$
185,500

Slide 9

Management Uses of Financial


Statements
Marketing managers and credit managers use
customers financial statements to decide
whether to extend credit.

Purchasing managers use suppliers financial


statements to decide whether suppliers have the
resources to meet the demand for products.

Employees union and human resource


managers use the companys financial
statements as a basis for contract negotiations
regarding pay rates.
McGraw-Hill/Irwin

Slide 10

Generally Accepted Accounting


Principles
Securities Act of 1933
Securities and Exchange Act of 1934

The Securities and Exchange Commission (SEC)


has been given broad powers to determine
measurement rules for
financial statements.

McGraw-Hill/Irwin

Slide 11

Generally Accepted Accounting


Principles
The SEC has worked closely with the
accounting profession to
work out the detailed rules that have
become known as GAAP.

Currently, the Financial Accounting


Standards Board (FASB) is recognized
as the body to formulate GAAP.

McGraw-Hill/Irwin

Slide 12

Generally Accepted Accounting


Principles
Companies incur the cost of preparing
the financial statements and bear the
following economic consequences . . .

Effects on the selling price of stock.


Effects on the amount of bonuses
received by managers and other employees.
Loss of competitive information to other
companies.

McGraw-Hill/Irwin

Slide 13

Independent Auditors
Auditors

express an
opinion as to the
fairness of the financial
statement
presentation.
Independent auditors
have responsibilities
that extend to the
general public.
McGraw-Hill/Irwin

Overall, I believe
these financial
statements are
fair.

Slide 14

End of Chapter 1

2008 The McGraw-Hill Companies, Inc.

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