The Purpose of
Financial
Statements
Financial Analysis
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Purposes of Financial
Statements
 Presents
financial position of the business
 Shows effectiveness of management
 Can be an indicator of future
performance when compared to past
performance
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Types of Financial Statements
Balance Sheet
Income Statement
Statement of Changes in Owner’s
Equity
Cash Flow Statement
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Balance Sheet


Also called Statement of Financial Position
Based upon the Accounting Equation:
 Assets = Liabilities + Owner’s Equity
 Provides
a “snapshot” of a company’s
position on a particular date in time
 Shows what a company owns (assets), owes
(liabilities), and the difference between
them (stockholder’s or owner’s equity)
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Balance Sheet
ABC Corporation
Condensed Balance Sheet
October 31, 20-Cash
Accounts
Receivable
Inventory
Buildings
$ 2,000
6,000
Current Liabilities
Long-term Liabilities
$ 12,000
40,000
50,000
Total Liabilities
52,000
100,000
Owner’s Equity
106,000
Total Assets
$ 158,000
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Total Liabilities and
Owner’s Equity
$ 158,000
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Income Statement
 Also
called a Profit and Loss Statement
 Shows gains and losses for an accounting
period
 Takes into account different revenue and
expense items during the period
 General calculation of net income/loss:


Sales- Cost of Goods Sold = Gross Profit
Gross Profit- Expenses = Net Income/Loss
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Income Statement
ABC Corporation
Condensed Income Statement
For the Month Ended October 31, 20-Net sales
Cost of goods sold
Gross profit
Expenses
Net Income
Dividends
Retained Earnings
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$ 95,000
(55,000)
$ 40,000
(25,000)
$ 15,000
(3,000)
$ 12,000
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Revenue Relationships

Relationship among total revenue, marginal
revenue, output, and profit:


Marginal revenue is the addition to total
revenue due to the sale of another unit of
output that maximizes profit.
Calculation of marginal revenue example:

If the first item brings $20 in revenue and an
additional item sold brings $15, the marginal
revenue is $5:


Change in total revenue / the number of
additional units of output sold
20 – 15 = 5 so 5 / 1 additional unit = $5
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Statement of Changes in
Owner’s Equity
 Also
called Statement of Retained
Earnings
 Shows the balance of stockholder’s equity
from the beginning of an accounting
period to the end of the period and the
changes that took place in the account
during that time
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Statement of Changes in
Owner’s Equity
ABC Corporation
Statement of Changes in Owner’s Equity
For the Year Ended December 31, 20-Beginning Capital
$ 17,000
Add: Contributions by owner
Net Income
15,000
20,000
Subtotal
$ 52,000
Less: Withdrawals by owner
$
Dividends
Ending Capital (or Retained Earnings)
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7,000
2,000
$ 43,000
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Cash Flow Statement

Examines the sources and uses of cash as a result
of the following activities:
 Operating activities- associated with
delivering goods for sale or providing services
for sale; includes receipts from sales as well as
payments for inventories and wages and
other common operating expenses
 Investing activities- includes sale of
predominantly long-term assets and interest
received from loans or vice versa, i.e., buying
long-term assets as investments and making
loans with other companies
 Financing activities- selling securities as well as
paying out dividends to investors
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Cash Flow Statement
ABC Corporation
Condensed Cash Flow Statement
For the Year Ended October 31, 20--
Operating cash flow
$ 17,000
Investing cash flow
(25,000)
Financing cash flow
20,000
Net change in cash
$ 12,000
Cash balance, January 1, 20--
$
Cash balance, December 31, 20--
$ 19,000
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7,000
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Budget vs. Financial Statements
 Budgets




Use estimated numbers to make predictions
Compares estimated to actual to
determine variances
Usually short term (less than one year)
Includes mainly income and expenses
 Financial


statements
Use actual numbers
Use analysis methods to make forecasts
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Financial Statement Relationships
Statement of Changes in Owner’s Equity
Income Statement
Revenues
$ 35,000
- Expenses
31,000
Net Income
$4,000
Beginning Capital
(Retained Earnings)
+ Net Income
- Dividends
Ending Capital Balance
$ 35,000
4,000
(2,000)
$37,000
Balance Sheet
Cash
+ All other Assets
Total Assets
Liabilities
+ Capital
Total Liabilities &
Stockholder’s Equity
$ 7,000
39,000
$46,000
$9,000
37,000
$46,000
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Statement of Cash Flows
Cash Flow from operating
$ (2,000)
activities
Cash Flow from investing
1,000
activities
Cash Flow from financing
3,000
activities
Change in Cash
Cash at Beginning of period
2,000
5,000
Cash at End of period
$7,000
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Footnotes to Financials
 Includes
explanations for items that are
not typical in financial statements
 May explain how certain items are
accounted for
 Occasionally includes an explanation of
depreciation methods or goodwill
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Analyzing Financial Statements
Horizontal, or trend analysis- compares the same
accounts across different time periods
Vertical analysis, or common-size analysiscompares different accounts to a total within the
same time period
Ratio analysis- a comparison of different accounts
on a statement and typically compared over
different time periods
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Limitations of Financial
Statements
 No
right or wrong numbers to compare to
 Finding accurate competitors to compare
to can be difficult due to differences even
between similar companies
 Making future predictions based on the
past is not an exact science
 Management expertise is difficult to
quantify but should be an important factor
in analyzing company performance.
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Independent Practice Assignments

Financial Statement Venn Diagram Assignment #1


Financial Statement Acrostic Assignment #2


Have students create a Venn diagram, either on paper or using a diagram
feature on the computer, containing any three of the four main financial
statements: Balance Sheet, Income Statement, Statement of Changes in
Owner’s Equity, and/or Cash Flow Statement. They should list the component
accounts found on each statement, and where the circles overlap, list the
accounts that are found on more than one financial statement.
Students will select one of the four financial statements and create an acrostic
for that statement. They should use phrases or sentences related to the chosen
statement that show the student thoroughly understands what that financial
statement is all about. For example, for Balance Sheet, the ‘B’ could say
“Balances of Total Assets should equal the balances of Liabilities plus Owner’s
Equity.”
Financial Statement Interrelationships Assignment #3

In pairs, students will create each of the four financial statements in condensed
form with fictitious numbers. This will show that students understand the
Accounting Equation of Assets = Liabilities + Owner’s Equity, and they must
show how the statements relate to each other as they did in the presentation.
They should create these on a small poster or flip chart paper.
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