Chapter 3 Basic Financial Statements

CHAPTER 3
BASIC FINANCIAL
STATEMENTS
Introduction to Financial Statements
 What is financial statement?
 Financial statement is a structured representation
of the financial position (Balance Sheet), financial
performance (Income Statement) of an entity and
the inflow and outflow of cash (cash flow
statement).
 The objective of financial statements is to provide
information about
 the financial position,
 financial performance and

 cash flows of an entity
 Financial statements is also help to assess the

probability that an enterprise will be able to make
future cash.
Three Basic Financial Statements are
Balance Sheet Describes where the
Depicts the enterprise stands at a
revenue and Income Statement specific date.
expenses for Statement of Cash Flows
a designated Depicts the ways
period of cash has
time. changed during a
designated
period of time.
 These financial statements are windows to a

company's performance and health.
THE BALANCE SHEET
What is Balance sheet?
 The balance sheet represents a record of a company's
assets, liabilities and equity at a particular point in time.
Balance sheet is named by the fact that a business’s
financial structure balances in the following manner:
 Assets = Liabilities + Shareholders' Equity
 Assets represent the resources that the business owns or
controls at a given point in time. This includes items such as
cash, inventory, machinery, buildings etc.
 The other side of the equation represents the total value of
the financing the company has used to acquire those
assets. Liabilities represent debt, while equity represents the
total value of money that the owners have contributed to
the business – including retained earnings, which is the
profit made in previous years.
The Balance Sheet
ASSETS LIABILITIES EQUITY
Cash Accts Payable Pref Stock
Inventory Wages Common
Land/Bldgs = Payable
+
Stk
Taxes Payable Retained
Equipment
Earnings
Notes Payable
Accts
Rcvbl Short term
Securities Long Term
Why do we need Balance sheet?
 Because
 Balance sheet provides investors with a snapshot of

a company's health as of the date provided on the
financial statement.
 If a company assets are large relative to liabilities,

it's in good shape. Conversely, if a company with
a large amount of liabilities relative to assets has
risk to creditors.
 The higher the debt ratio, the greater risk will be

associated with the firm's operation. In addition,
high debt to assets ratio may indicate low
borrowing capacity of a firm, which in turn will
lower the firm's financial flexibility.
THE INCOME STATEMENT
What is Income Statement?
 The income statement shows an information about
the revenues, expenses and profit that was
generated as a result of the business' operations for
that period and it measures a company's
performance over a specific time frame.
 The components of income Statement are:
 Revenue (how much the company earned)
 Expenses (how much the company has spent)
 Net Income before and after Tax (the profits of the

company)
Why do we need an Income Statement ?
 Because
 Income statement answers the question,
"How well is the company's business?
 “Does it performing well?
 Basically, the question is "Is it making
money?"
 Firms with low expenses and high profits

relative to revenues are typically more
desirable for investment because it brings
more money directly to a shareholder.
THE STATEMENT OF CASH FLOWS
What is statement of cash flow?
 The statement of cash flows represents a record of a
business' cash inflows and outflows over a period of time.
 It is the most sensitive statement and it focuses on the
following cash-related activities:
 Operating Cash Flow: Cash generated from day-to-day
business operations.
 Cash from Investing: Cash used for investing in assets,
as well as the proceeds from the sale of other
businesses, equipment or long-term assets
 Cash from financing: Cash paid or received from the
issuing and borrowing of funds
Why do we need Statement of Cash Flows ?
 Statement of cash flows is very important to investors,
because
 It shows how much actual cash a company has
generated.
 It shows the ability of firms to generate cash. Many
companies have shown “profits” on the income
statement but struggled later because of insufficient cash
flows. Because, the income statement includes non-cash
revenues or expenses, which the statement of cash flows
excludes.
 It shows correct figures of firms, because cash flow
statement is very difficult for a business to manipulate its
cash situation. Earnings can be manipulated, but it's
tough to “fake” cash in the bank. For this reason some
investors use the cash flow statement as a more
conservative measure of a company's performance.
Bringing the financial statements All Together
 The three financial statements (Balance sheet, Income
statement and cash flow statement) are all related.
 The changes of assets and liabilities that is indicated on
the balance sheet are also reflected in the revenues
and expenses which are stated on the income
statement, which shows the company’s gains or losses.
 Cash flows provide more information about cash assets
listed on a balance sheet and are related, but not
equivalent, to net income shown on the income
statement.
 Therefore, no one financial statement tells the
complete story of firms.
To explain how the income statement reports an enterprise’s
financial performance for a period of time in terms of the
relationship of revenues and expenses.
Abeba's Care Service

Income Statement
For the Month Ended May 31, 2017
Sales Revenue $ 750

Operating Expense:
Gasoline Expense 50
Net Income $ 700
Investments by and payments to the owners

are not included on the Income Statement.
To explain how the statement of cash flows presents the change in
cash for a period of time in terms of the company’s operating,
investing, and financing activities.
Abeba's Care Service

Statement of Cash Flows
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Purchase of office equipment $ (2,500)
Purchase of truck (2,000)
Collection for sale of repair parts 75
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125
Cash balance, May 1, 2017 -
Cash balance, May 31, 2017 $ 4,125
Abeba’s Care Service
Operating activities include
Purchase of truck the cash effects of revenue
Collection for sale of repair parts
(2,000)
75
Payment for repair parts and expense transactions.
(150)
Abeba Care Service
Investing activities include the
cash effects of purchasing and
Increase in cash for month
Cash balance, May 1, 2007
$ 4,125
-
selling assets.
Abeba Care Service
Financing activities include the cash
effects of transactions with the owners
Purchase of office equipment
Purchase of truck
$ (2,500)
(2,000)
and creditors.
Abeba's Care Service Company
Balance Sheet
May 31, 2017
Assets Liabilities
Cash $ 4,125 Notes payable $ 13,000
Accounts receivable 75 Accounts payable 150
Tools & equipment 2,650 Owners' Equity
Truck 15,000 Capital stock 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850
Assets = Liabilities + Owners’ Equity
$21,850 = $13,150 + $8,700

To explain the important relationships among the statement of
financial position, income statement, and statement of cash flows,
and how these statements relate to each other.
Relationships Among Financial

Statements
Date at Date at
beginning end of
of period Time period
Balance Balance
Sheet Sheet
Income Statement
Financial Statement Articulation
Abeba's Car service company
For the Month Ended May 31, 2017 Abeba's Car service company
Cash flows from operating activities: Income Statement
Cash flows from investing activities: Sales Revenue $ 750
Purchase of lawn mower $ (2,500) Operating Expense:
Collection for sale of repair parts 75 Gasoline Expense 50
Payment for repair parts (150) Net Income $ 700
Abeba’s Care Service Company
Balance Sheet
May 31, 2017
Assets Liabilities
Cash $ 4,125 Notes payable $ 13,000
Accounts receivable 75 Accounts payable 150
Tools & equipment 2,650 Owners' Equity
Truck 15,000 Capital stock 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850
END OF CHAPTER THREE

Chapter 3 Basic Financial Statements

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Chapter 3 Basic Financial Statements

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CHAPTER 3

 financial performance and

 Financial statements is also help to assess the

 These financial statements are windows to a

 Balance sheet provides investors with a snapshot of

 If a company assets are large relative to liabilities,

 The higher the debt ratio, the greater risk will be

 The components of income Statement are:

 Revenue (how much the company earned)

 Expenses (how much the company has spent)

 Net Income before and after Tax (the profits of the

 Firms with low expenses and high profits

Abeba's Care Service

Sales Revenue $ 750

Investments by and payments to the owners

Abeba's Care Service

Assets = Liabilities + Owners’ Equity

$21,850 = $13,150 + $8,700

Relationships Among Financial

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