Introduction to Financial
Analysis
Chapter 1
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1 Forms of Business
Organization
• Sole proprietorship
• Partnership
• Corporation
Sole Proprietorship
• Business owned by one person
• Simple to establish
• Owner controlled
• Tax advantages
• Owner personally liable
• Financing difficult
Partnership
• Two or more owners
• Simple to establish
• Shared controlled
• Broader skills & resources
• Tax advantages
• Personal liability
Corporation
• Separate legal entity owned by
stockholders
• Easy to transfer ownership
• Greater capital raising potential
• Lower legal liability
• Unfavorable tax treatment
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2 Users of Financial Information
Internal
• Managers who plan,
organize and run a
business
– Marketing managers
– Production supervisors
– Finance directors
– Company officers
Users of Financial Information
Internal Users Ask?
Cash to pay bills? Cost per unit?
Give raises? Which product is
profitable?
Users of Financial Information
External
• Investors
• Creditors
• Others
– Regulatory agencies
– Tax authorities
– Customers
– Labor Unions
– Economic planners
Users of Financial Information
External Users Ask?
Earning enough? Compare to competition?
Will the company be able to pay bills
when due?
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3 Types of Business Activity
• Financing
• Investing
• Operating
Financing Activities
• Borrowing creates liabilities
– Bank loans
– Goods on credit or payables
Investing Activities
• Obtaining resources or
assets to operate the
business
– Land
– Buildings
– Vehicles
– Computers
– Furniture
Operating Activities
• Primary activity of business
– Selling goods
– Providing services
– Manufacturing
– Cost of Sales
– Advertising
– Paying employees
– Paying utilities
Operating Activities
• Revenue is generated from sales or
services
• Expenses are the cost of doing business
• If revenue > expense = Net Income
• If revenue < expense = Net Loss!
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4 Describe Content and Purpose
of Financial Statements
• Accountants communicate
with users through four
financial statements
• Income Statement
• Retained Earnings Statement
• Balance Sheet
• Statement of Cash Flows
Income Statement
• Reports operating success or failure for a
period.
• Summarizes revenues and expenses for
period: month, quarter, or year.
• If revenue > expense = Net Income.
Income Statement
Do this statement first!
Retained Earnings Statement
• Shows changes in retained earnings for
period: month, quarter, or year
• Beginning balance
• Add Net Income from income
statement!
• Deduct Dividends
• Ending balance
Retained Earnings Statement
Do this statement second!
Balance Sheet
• Reports assets and claims to assets.
• Claims of creditors, liabilities.
• Claims of owners, stockholders’ equity.
• Assets = Liabilities + Stockholders’ Equity
• Specific date – one point in time!
Balance Sheet
From
Retained
Earnings
Statement
Statement of Cash Flows
• Provides information about cash
receipts and cash payments
• Summarizes for period: month, quarter,
or year.
• Cash effects of operating, investing,
and financing activities.
Statement of Cash Flows
• Where did the cash come from?
• How was cash used during the period?
• What was the change in the cash
balance during the period?
• You can’t survive without cash!
Statement of Cash Flows
Agrees
with
Balance
Sheet
#5 Explain the Meaning of
Assets, Liabilities, and
Stockholders’ Equity.
State the Basic Accounting
Equation
Assets
• Resources owned by the business
– Cash
– Accounts receivable
– Inventories
– Building
– Furniture and fixtures
– Equipment
– Supplies
Liabilities
• Obligations or debts of business
– Notes payable
– Accounts payable
– Interest payable
– Salaries payable
– Unearned revenue
Stockholders’ Equity
• Ownership claims on assets
• Paid-in capital
– Common stock
• Retained earnings
Basic Accounting Equation
Assets =
Liabilities + Stockholders’ Equity
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6 Components that Supplement
the Financial Statements in an
Annual Report
• Managements Discussion and Analysis
• Notes to Financial Statements
• Auditor’s report
Management’s Discussion and
Analysis covers three items:
1. Liquidity
2. Capital resources
3. Results of operations
Management’s Discussion and
Analysis
Notes to Financial Statements
• Explanatory notes and supplementary
schedules
• Clarifies information in financial statements
• Expands with additional detail
• Describes accounting policies
• Explains uncertainties and contingencies
Notes to Financial Statements
Auditor’s Report
• Certified Public Accountant – CPA
• Auditor (CPA) conducts independent
examination of financial statements
• Fair representation?
• Follow generally accepted accounting
principles (GAAP)?
• Unqualified opinion
Auditor’s Report
