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FIN500 Mod2 The Four Core Financial Statements

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Silence. I'm Larry Walther and this is principlesofaccounting.com Chapter 1. In this particular module, we're going to look at the four core financial statements. Before we begin that though, what I'd ask you to consider is what types of information would you want about a particular company you were considering investing in? I've included in this little thought cloud here things that are financial in blue, you'd want to know about the revenues of the company, the income, the assets - things of that nature. You would also know about though the things that are in red: corporate governance, environmental responsibilities, the management team, what brands are held by the particular company. Accounting is focused primarily on providing the financial information; this other information is necessary for proper decision-making and it can be found on corporate websites, the SEC filings, and so forth. The four core financial statements are the income statement, the statement retained earnings, the balance sheet, and the statement of cash flows. We'll look at each of these in turn. The income statement reports the revenues, expenses, and results of operations for a particular company. The difference between the revenues and expenses is termed the income or net income of the company. Here we have an example for Quartz Corporation importantly note that we're reporting the name of the corporation in the heading, the name of the statement (the income statement), and the time period. This is a statement for a period of time so we labeled it such for the year ending December 31, 20X9. The total revenues of the company were $765,000. The total expenses were $650,000. And the net income was $115,000. This brings us to the statement of returned earnings. You already know that retained earnings is the income for the business that has not been paid out in dividends. Over a period of time retained earnings will either increase or decrease; in the first illustration I'm showing how net income offset by some dividends has still resulted in an increase in retained earnings. But we can also have a decrease in retained earnings during a period of time if we have a net loss or pay excessive dividends. This is activity reported in the second primary financial statement: the statement of retained earnings. Again for a period of time - pay attention to the heading. We're showing the beginning retained earnings plus the net income arriving at a sub total and then subtracting the dividends from that to arrive at the ending retained earnings of $480,000 dollars. The third financial statement we'll look at is the balance sheet. You're, you should already be familiar with the balance sheet, it reflects the fundamental accounting equation: assets equal liabilities plus owners' equity. This time it's not for a period of time; the dating shows that it is at a point in time so I've just dated it December 31, 20X9. And on that date this company had $900,000 in assets, $200,000 in liabilities, total equity of $700,000. Notice within equity we've got retained earnings of $480,000 - that's the same retained earnings that was revealed in the statement of retained earnings in the previous slide. The fourth financial statement is a statement of cash flows, it's a bit more complex, at least initially, in your study of accounting. It shows how cash is generated and expended during a period of time; that is not the same thing as income as you'll see here in a moment. The statement of cash flows has three key sections: the operating activity section, the investing activity section, and the financing activity section. In the operating activity section here we show cash received from customers, we show cash paid for various expenses (like salaries and rent and so forth), and this business generated a net $80,000 cash from operating activities. Not exactly the same thing as net income, because some items might have been measured as they occurred independent of when the cash flows actually happened. So if you, for example, sell on credit you'll recognize the revenue before you actually collect the cash. So there's often times a disconnect between the cash from operations and the net income of the business. There's also other activities that bear, for example, we purchased land for $250,000 dollars, we pay dividends of $35,000 dollars, and this business actually had a $205,000 dollar decrease in cash during the period that despite its income, largely explainable of course by the large purchase of land during the period. But you can begin to appreciate how important it is to study the statement of cash flows when you consider what's happening at a particular business. Finally, I want to close by asking you to consider how the financial statements articulate, are tied together, or mesh together in a self-balancing fashion. And so if you study this illustration very carefully you'll note that the revenues minus expenses gave rise to a net income a $115,000 that flow through into the statement of retained earnings (the green arrow showing the flow-through) adding that to the beginning retained earnings and subtracting the dividends gave us ending retained earnings - the $480,000 dollars - which is also the amount that appeared on the balance sheet and allowed the balance to balance. Total assets now equal total liabilities plus equity. It might be a mystery as to why that occurs so let's think about adding one more transaction to this particular company. If we added one more dollar of revenue here - uh - let's suppose services to customers $750,001 dollar and no additional expenses were incurred then income would be $115,001. And then retained earnings would be $480,001 dollar and total liabilities and equity would be $975,001 dollar. But remember we got an extra dollar of cash so cash would be a $192,001 dollar. The balance sheet would be preserved. It's really a brilliant system, it's a simple system, but it's a brilliant system in terms of capturing all transactions and events into a set of articulating, or self balancing, financial statements. And these are the key financial statements that investors look at when they make decisions about business enterprises. Silence

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Duration: 5 minutes and 45 seconds
Country: Andorra
Language: English
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Posted by: christineward on Feb 28, 2016

1 - The Four Core Financial Statements

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