Foundations of Business

1. Foundations of Business Introduction to Financial ReportingThe Income Statement

2. 6 Roles of Financial Management • Recording transactions • Budgeting • Allocating capital to the best projects for the company • Board decides: • Reinvest earnings • Pay dividends • Projecting • Raising capital • Issue stock • Borrow (loans/bonds) • Preparing financial reports

3. Financial Reporting • Financial accounting for external users (e.g. the IRS & SEC) through financial statements • Generally Accepted Accounting Principles (GAAP, US-GAAP) • 4 primary statements • Income statement • Balance Sheet • Statement of Cash Flows • Statement of Changes in Stockholders’ Equity

4. Sales (Revenue) Expenses Net Income (Net Loss) = $ value of what customers have bought e.g. # ice cream cones X $ price e.g. 3 cones X $2.50 = $7.50 total sales  Recorded when transacted = Costs used up in generating sales  Recorded when incurred = What’s left over from sales after accounting for all expenses in the period What are Earnings? Sales – Expenses = Net Income(earnings, profit, the bottom line) INCOME STATEMENT EQUATION

5. EXPENSES Matching principle: costs incurred (used up) must be matched with the sales that these costs helped generate in the same period 2 types of expenses • Fixed: do not fluctuate when sales change • Variable: fluctuate with sales

6. Sales (Revenue) Expenses: Cost of Goods sold (Cost of Revenue) Gross Profit Waste/Spoilage Wages Salaries Payroll Remittances Rent/Permits Advertising Maintenance and Repair Operating Expenses Operating Profit (EBIT) Interest Pre-Tax Profit Taxes (35%) Net Income $3,000 (1,000) 2,000 50 500 50 50 100 100 50 (900) 1,100 (500) 600 (210) $ 390 Covers a period of time. Champ Creemee CompanyIncome Statement (for the Year ending 12/31/10)

7. Champ Creemee CompanyCost of Goods Sold 2 gallons of ice cream cones napkins We sell 1 ice cream cone. What have we used up? 1 cone 3 scoops 1 napkin Direct product costs (COGS) = VARIABLE costs

8. Unqualified (= “clean”) Opinion by the Independent Auditors Independent auditors: “Nothing is wrong with the financial statements.” Report of Independent Registered Public Accounting Firm(link from finance.yahoo.com to Form 10-K, SEC document, pp. 181) To the Board of Directors and Shareholders of Merck & Co., Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of equity and of cash flows present fairly, in all material respects, the financial position of Merck & Co., Inc. and its subsidiaries at December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Merck maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Merck’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report under Item 9A. Our responsibility is to express opinions on these financial statements and on Merck’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. PricewaterhouseCoopers LLP Florham Park, New Jersey February 27, 2007 PricewaterhouseCoopers LLP Florham Park New Jersey February 26, 2010 Independent Auditors

9. Homework Assignment to prepare for the Finance Application Assignment • You may work with a partner to prepare the research and financial analysis, but you must write the memo individually. • Select two publicly traded U.S. companies in similar businesses, i.e. in the same industry.  Consult the major industries on Valueline (http://www3.valueline.com/secure/vlispdf/stk1700/industry.aspx)(NOTE: Do not choose financial institutions, e.g. banks, or automobile manufacturers and make sure the companies are profitable, produce a product, and are listed in Value Line.)  You may identify 2 companies from this list and get information by clicking on its name.An alternate source for a list of major industries is Yahoo's Industry Index at http://biz.yahoo.com/ic/ind_index.html. • Find your two comparable companies on Valueline. Click the radio button for Company and type in the name of your company.  Confirm that the companies are listed on a U.S. stock exchange (NYSE--New York Stock Exchange, NASDAQ, American) and note the "Ticker Symbol"--you will need this later. • Download or copy the pages from Value Line for both companies.. • For each company, get the Balance Sheet and Income Statement for the latest year.  These can be found under Financials on the company's site in Yahoo!Finance (http://finance.yahoo.com/) or in the company's Annual Report (also called 10-K) on either the company's Web site or under the SEC filings on the Yahoo!Finance site, MSN-Money (http://moneycentral.msn.com/investor/research/profile.asp), or another source.  Make sure you get the annual (not quarterly) financial statement.

10. Do NOT use this as the “Current Stock Price” as it is not current. Get the current stock price from Yahoo!Finance. Value Line Investment Survey sheet for Merck www.valueline.com SMC subscription to Value Line Business description, recent company events Date of Report