2 A BALANCE SHEET: More on Financial statements Chapter 9/16/2018 201Lec02.PPTX More on Financial statements Chapter A BALANCE SHEET: i - changes constantly (every time an activity occurs) ii - shows assets, liabilities and equities as of a specific date. Prepared at least once per year. iii - uses original cost (historical cost principle) for most items. Current Fair Market Value (FMV) used for some assets like marketable securities since daily price is readily available. iv - Only shows items that can be expressed in monetary units ($) Which assets or liabilities can’t be expressed in $$$? 21

Accounting Mathematics Formula of Balance sheet: Assets = Liabilities + Stockholders’ Equity Known as the “Accounting Equation” If you have a million dollars are you a millionaire? An equivalent common view is “Net Worth” Net worth = Assets – Liabilities Net worth + Liabilities = Assets Assets = Liabilities + Net Worth 2

Generally contains the following standard classifications: 9/16/2018 The Classified Balance Sheet Generally contains the following standard classifications: ASSETS Current Assets Long-Term Investments Property, Plant, and Equipment Intangible Assets Current Liabilities Long-Term Liabilities LIABILITIES Stockholders' Equity 21

9/16/2018 Current Assets Assets that are expected to be converted to cash or used in the business within a short period of time, usually one year. Current assets are listed in order of liquidity (convert them to cash). Examples: Cash Short-term investments Receivables Inventories Supplies on hand Prepaid expenses 22

Assets That A Company Depreciates... 9/16/2018 Assets That A Company Depreciates... CHUCK CORPORATION Balance Sheet December 31, 2017 Subtotals are usually made for current items: Assets Current Assets: Cash $ 2,000 Accounts receivable 4,000 Total Current Assets $ 6,000 Long-term investments: Stocks 5,000 Real estate 90,000 95,000 Property, plant & equipment: Equipment 24,000 Less: Accumulated Depreciation - 8,000 16,000 Intangible assets Patents 50,000 Total assets $167,000 24

Long-Term Investments 9/16/2018 Long-Term Investments Assets whose conversion to cash is not expected within one year. Assets not intended for use within the business. Examples: Investments of stocks, notes and bonds of other corporations. Land held for speculation Rental buildings 23

Property, Plant & Equipment (PP&E) 9/16/2018 Property, Plant & Equipment (PP&E) Assets with relatively long useful lives. Assets used in operating the business. Examples: land buildings machinery delivery equipment furniture and fixtures 24

9/16/2018 PP&E recording rules . . . Record and keep on balance sheet the COST of the asset (NOT value). Expense a portion of asset cost over a number of years. Depreciation expense is recorded each year on most long lived assets used in a business. Accumulated Depreciation appears on the balance sheet as a negative adjustment to PP&E It is the total amount of depreciation expense taken over the life of the asset. 24

Assets That A Company Depreciates... 9/16/2018 Assets That A Company Depreciates... CHUCK CORPORATION Balance Sheet December 31, 2017 PP&E is shown at cost less accumulated depreciation Assets Current Assets: Cash $ 2,000 Accounts receivable 4,000 Total Current Assets $ 6,000 Long-term investments: Stocks 5,000 Real estate 90,000 95,000 Property, plant & equipment: Equipment 24,000 Less: Accumulated Depreciation - 8,000 16,000 Intangible assets Patents 50,000 Total assets $167,000 24

Intangible Assets Like PP&E, usually have long useful life Have no physical substance Examples: patents copyrights trademarks or trade names Franchise Goodwill Goodwill License Trademark Franchise Patent Copyright

Current Liabilities Obligations that are supposed to be paid within the coming year. Examples: notes payable accounts payable wages payable interest payable taxes payable current maturities of long-term debt payable Utilities payable Unearned revenues

Debts expected to be paid after one year Examples… 9/16/2018 Long-term (non-current) Liabilities Debts expected to be paid after one year Examples… bonds payable mortgages payable long-term notes payable obligations under employee pension plans 27

Stockholder’s Equity Remember equity is similar to Net worth. 9/16/2018 Stockholder’s Equity Remember equity is similar to Net worth. How do people get net worth? Two primary ways: Inherit or gift (Not earned by them) Earn it (work or investing) but live on less (save). On a corporation’s balance sheet, similar items: 1. Common stock - investments in the business by the stockholders (Not revenues or earnings) 2. Retained earnings - earnings kept for use in the business (Portion of net income not paid out to stockholders) 28

Ratio Analysis... Uses relationships on statements to evaluate a company. 3 groups of ratios are intended to indicate different things.

Ratio discussed: Earnings Per Share (EPS) 9/16/2018 Profitability Ratios - Measures the success of a company’s ability to generate a profit. Ratio discussed: Earnings Per Share (EPS)

Earnings Per Share (EPS) ...measures the net income earned on each share of common stock. Higher value = improved performance Compare trend for a single company. Not good for comparing one company to another.

Illustration: (EPS) Profitability Ratio BBY FYE February 1 EPS: 2017 = 3.81, 2016 = $2.56, 2015 = $3.49, 2012 = ($3.27), 2011 = $3.14, 2010 = $3.16

9/16/2018 Liquidity Ratios - Measures short-term ability of company to pay its debts. Ratios discussed: Working capital Current Ratio

Working capital equals: current assets – current liabilities 9/16/2018 Working capital equals: current assets – current liabilities Current ratio formula current assets current liabilities Express as x:1 The more working capital and higher current ratio, the more likely current liabilities will be paid when due. Lenders often require that the company maintain a 2:1 ratio at all times. 32

Illustration: Working Capital 2014 = Classified Balance Sheet of $10,485 million – 7,436 million $ 3,049 million

Illustration: Current Ratio Liquidity Ratio Illustration: Current Ratio For every dollar of current liabilities, Best Buy has $1.41 of current assets.

9/16/2018 Solvency Ratios - measures of the ability of a company to survive over a long period of time Ratios discussed: Debt to Asset percentage Free cash flow

Debt to Total Assets Ratio formula 9/16/2018 Debt to Total Assets Ratio formula Total liabilities Total assets Multiply by 100 to create % ...measures % of assets financed by creditors. Often used in risk analysis. The greater the debt to asset ratio, the greater the risk. 32

Illustration: Debt to Assets Solvency Ratio Illustration: Debt to Assets See Best Buy balance sheet on slide 20 for amounts. The 2014 ratio means that every dollar of assets was financed by 72 cents of debt. 24

Cash Provided By Operations – Capital Expenditures Free Cash Flow Ratio Cash Provided By Operations – Capital Expenditures – Dividends Paid Free Cash Flow Considered as excess cash available after spending to maintain operations and satisfy shareholders. 25