1. 1 16. Understanding Accounting & Financial Statements

2. 2 Topics Accounting, accountants, the accounting process Financial statements Evaluating financial statements

3. 3 Accounting Information contained in the financial statements –Balance sheet –Income statement –Statement of cash flows Accountants –Private/management –Public –CPA –Government Public Company Accounting Oversight Board –Sarbanes-Oxley Act –Sets audit standards & monitors accounting firms

4. 4 Accounting (Cont.) The accounting process –Accounting equation Assets = Liabilities + Owners’ Equity –Double-entry bookkeeping –Accounting cycle Analyze source documents Journalize transactions Post transactions to ledger Prepare trial balance Prepare financial statements & close books

5. 5 The Financial Statements All refer to a given period of time Balance sheet (Fig. 16.4) –Assets Current assets Fixed assets Intangible assets –Liabilities Current liabilities Long-term liabilities –Owners’ equity

6. 6 The Financial Statements (Cont.) The income statement (Fig. 16.5) –Revenues –Cost of goods sold (COGS) –Gross income –Operating expenses –Operating income –Depreciation –Net interest expense –Taxable income –Income taxes –Net income

7. 7 The Financial Statements (Cont.) The statement of cash flows (Fig, 16.6) –Cash flows from operating activities –Cash flows from investing activities –Cash flows from financing activities Net change in cash (or “net cash flow”) –Added to beginning cash balance –To determine ending cash balance (or “free cash flow”)

8. 8 Evaluating Financial Statements Financial ratios (See Table 16.1) –Profitability ratios Return on sales = net income (after taxes) ÷ net sales Return on owners’ equity = net income (after taxes) ÷ owners’ equity Earnings per share = net income (after taxes) ÷ no. of shares of common stock outstanding –Liquidity ratios Current ratio = current assets ÷ current liabilities Acid test ratio = (current assets - inventories) ÷ current liabilities

9. 9 Evaluating Financial Statements (Cont.) Financial ratios (cont.) –Activity ratios Accounts receivable turnover = net credit sales ÷ accounts receivable Inventory turnover = COGS ÷ average value of inventory –Average value of inventory = (beginning inventory value + ending inventory value) ÷ 2 –Leverage ratio = total liabilities ÷ total assets