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The Elements

The Elements. Position and Performance. The elements. Assets – what it has Liabilities – what it owes Equity – what’s left over Revenues - resources coming in Expenses – resources going out Cash flow – Money! These definitions are simplistic but a beginning. Financial statements tell us.

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The Elements

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  1. The Elements Position and Performance

  2. The elements • Assets – what it has • Liabilities – what it owes • Equity – what’s left over • Revenues - resources coming in • Expenses – resources going out • Cash flow – Money! These definitions are simplistic but a beginning International Business Program Financial Accounting

  3. Financial statements tell us • Cash movements • Wealth generated • Wealth accumulated Using: • Balance sheet • Income statement • Cash flow statement International Business Program Financial Accounting

  4. Filippo’s Kites • Look at the example pp. 38-40 • You should notice • Don’t know how many kites nor how much each one costs. Don’t need to. • Flow of cash and flow of wealth are different International Business Program Financial Accounting

  5. Balance Sheet • Let’s start here • What does it show? • Financial position • Assets, liabilities, owner’s equity • Specific point in time • Status, not flow International Business Program Financial Accounting

  6. adidas-Salomon pg. 41 • NB! You will see this company again! • Two initial observations: • In terms of money • Going concern • Accounting Equation A = L + OE • Introduce concept of minority interest International Business Program Financial Accounting

  7. Basic Accounting Equation • One of Br. Paciolo’s greatest contributions • Duality concept – two piles of tablets Assets = Liabilities + Owners’ Equity • Every transaction and event has two sides International Business Program Financial Accounting

  8. Day to Day Transactions • Paolo’s shop pp. 45 – 51. • Things to observe • Cash and cash equivalents • Current vs. non-current assets • Current vs. non-current liabilities We will get more specific definitions shortly International Business Program Financial Accounting

  9. Basic concepts • Business cycle or operating cycle • Cash, acquire goods, sell goods or services, cash again • For most businesses is one year; occasionally longer • More about this later International Business Program Financial Accounting

  10. Basic concepts (Continued) • Current assets – used or consumed in one business cycle or one year. • Non-current assets – more than one cycle • Current liabilities – one cycle or use current assets • Non-current – after one cycle or do not use current assets International Business Program Financial Accounting

  11. Financial Structure • Three sources to pay for total assets: • Owners’ contributions (also minority) • Borrow long-term • Short-term credit • Remember assets can be • Current • Non-current International Business Program Financial Accounting

  12. Financial Structure (Continued) • Leverage or gearing • Examples from physics and mechanics • Use borrowed money to finance assets and enhance return to investors • Can be risky • Balance sheet discloses information to assess risk (More about this in later chapters) International Business Program Financial Accounting

  13. Financial Structure (Continued) • Working capital • Current assets vs. current liabilities • Another indicator of risk and potential • Balance sheet discloses information to assess (More about this later also) International Business Program Financial Accounting

  14. Format • Examples in textbook • Varies considerably, but basic concepts are the same • One element of dealing with ambiguity International Business Program Financial Accounting

  15. Definitions Again • Assets • Acquired in a transaction • Economic resource; future benefits • Controlled by enterprise; not necessarily owned • Cost or value at acquisition can be measured • Activity 3-1 pg. 57 International Business Program Financial Accounting

  16. Definitions Again (Continued) • Liabilities • Pay money or use resources • Result from past transaction • Owners’ equity • Contributed • Issued and reserves • Earned (Retained earnings) International Business Program Financial Accounting

  17. Balance sheet conventions • Money measurement • Historic cost • Exception for impairment (later chapter) International Business Program Financial Accounting

  18. Structure of statement and ratios • Textbook pp. 61-64 • Varies with industry – ambiguity • NB Puma and adidas-Solomon; you will see them again! • Same industry • Percentage analysis • Current ratio vs. quick ratio International Business Program Financial Accounting

  19. Income Statement • Results of operations • Flow, not position • Economic resources, not Cash!! • Based on natural business cycle, which is almost always one year or less International Business Program Financial Accounting

  20. Purpose of income statement • Wealth generated or destroyed over a period • Based on equation Profit = Revenue -Expenses • Revenue-inflow of resources from business activity • Expenses-outflow of resources to generate revenue International Business Program Financial Accounting

  21. Accounting Equation • Brother Paciolo again • A = L + OE • A=L + (capital + profit) • A = L + (capital + (revenues – expenses)) • Look at Paolo’s shop again pp 71-75 International Business Program Financial Accounting

  22. Layout of income statement • Start with revenues first • Why? Hint: go back and look at purpose of business • Otherwise, variation – ambiguity • Look at adidas-Solomon and Puma pg. 76. NB! You will see them again International Business Program Financial Accounting

  23. Income Statement Conventions • Prudence and realization • Recognize revenues when earned • Examples page 78 • Matching – most fundamental of all • First recognize revenues • Then match expenses when the expense contributed to earning revenue • Basis of accrual accounting • Examples pp 79-81; know well! International Business Program Financial Accounting

  24. Income statement Ratios • Profit margin • Portion of revenues that becomes profit • Varies considerably among industries • Related to leverage and gearing • Gross profit margin • Portion of revenues that is gross profit • Applies to certain industries, e.g. retailing International Business Program Financial Accounting

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