Lesson 2:

Overview of the Financial Statements

People think I left basketball for 18 months to play baseball,

but I used the time to study for the CPA exam.

- Michael Jordan
 Today’s Topics
The 3 Types of Business - Financing activities
- Investing activities
Activities - Operating activities

The Fundamental - The fundamental accounting

equation
Accounting Equation - Relationship to the 3 business
activities

The 4 Financial - Overview of the financial

statements
Statements - Description of accounts
 Today’s Topics
The 3 Types of Business - Financing activities
- Investing activities
Activities - Operating activities

The Fundamental - The fundamental accounting

equation
Accounting Equation - Relationship to the 3 business
activities

The 4 Financial - Overview of the financial

statements
Statements - Description of accounts
 All businesses are involved in 3 types of activity

3 Types of Business
Activities
Financing • Borrowing
• Issuing stock
Activities

Investing • Purchasing property, plant, and equipment

Activities • Making investments

• Selling goods you manufactured (manufacturer)

Operating • Selling goods you purchased (retailer)
Activities • Providing services (service provider)
 Financing Activities
• Companies initially raise money by borrowing
or issuing stock
– After a company is up and running, it can also raise
money by selling goods and services
 Borrowing
• Creditors lend money to a company for a
specific length of time
– Creditors benefit by charging interest on the
money loaned

Loan

Interest and
Principal
Example: Amazon’s acquisition of
Whole Foods
Amazon issued $13.7 billion of bonds
(debt) to acquire Whole Foods in 2017
 Issuing Stock
• Companies can also get money from investors
– Investors receive shares of stock in exchange
• Investors hope the value of the stock increases
• Investors might also expect to receive dividends

Capital

Shares of stock
 Example
• In 2019 Uber raised money through an IPO
(initial public offering)
– This means the general public could buy shares of
Uber for the first time
If Uber raises money by issuing additional
shares at a later point in time, this would be
called a seasoned offering (because Uber
already had its initial public offering)
 Investing Activities
• Once a company has raised money, it can
invest the money in:
– Factories
– Equipment/machinery
– Trademarks, copyrights, patents
– An ecommerce platform
– Other companies
 Operating Activities
• After raising money and investing that
money, the company will conduct
operations and (hopefully) generate a
profit
Raise money Invest the Generate
through money in profits from
financing the business operations

Profits can be reinvested in

the business to finance
further growth
 Quiz A
1. What are the 3 types of business activities?

2. What are 2 ways a startup can raise money?

3. What are the differences between debt and equity?

 Today’s Topics
The 3 Types of Business - Financing activities
- Investing activities
Activities - Operating activities

The Fundamental - The fundamental accounting

equation
Accounting Equation - Relationship to the 3 business
activities

The 4 Financial - Overview of the financial

statements
Statements - Description of accounts
Next, we’ll discuss the most important equation in accounting and
how it pertains to the 3 types of business activities we just
discussed
 The Fundamental Accounting
Equation

Assets = Liabilities + Stockholders’ Equity

Sources of Financing
Liabilities are financing from
Economic
creditors
Resources
Equity is financing from
stockholders
 How are assets, liabilities, and
equity
related to the 3 types of business
activity?

Raise money Invest the Generate

through money in profits from
financing the business operations

The company obtains financing from liabilities and equity, uses the money
to acquire productive assets, and uses those assets to earn a profit.

Profits increase the company’s equity and can be used to finance

additional investment.
 Definitions
• An asset is something owned or controlled by
the company that provides future economic
benefit

• A liability is a probable future sacrifice of

economic resources arising from a present
obligation to transfer assets or provide services

• Equity is commonly referred to as the

“residual.” It is the amount left over after the
liabilities have been subtracted from the assets
 Quiz B
1. What is an asset?

2. What is a liability?

3. If a company has $30 million of stockholders’ equity

and $50 million of assets, what is its total liabilities?
 Today’s Topics
The 3 Types of Business - Financing activities
- Investing activities
Activities - Operating activities

The Fundamental - The fundamental accounting

equation
Accounting Equation - Relationship to the 3 business
activities

The 4 Financial - Overview of the financial

statements
Statements - Description of accounts
 The Financial Statements
12/31/2010 1/1/2011 to 12/31/2011 12/31/2011
Income Statement
Revenue – Expenses = Net
Income

Balance Statement of Stockholders’ Balance

Sheet Equity Sheet
Change in Stockholders’ Equity
Accounts
A = L + SE A = L + SE

Statement of Cash Flows

Change in Cash

Point in time Period of time Point in time

Notes to the financial statements

 The Balance Sheet
12/31/2010 12/31/2011

Balance Balance
Sheet Sheet

A = L + SE A = L + SE

Point in time Point in time

 The Financial Statements
• Let’s look at a company that’s bucking
the trend toward fuel-efficient vehicles
– Rubber Monster
– The world leader in oversize tires
Under IFRS, the balance sheet is called the “statement of financial position”

Balance Sheet
1. Name of Entity
2. Title of Statement
3. Specific Date
4. Unit measure
 Balance Sheet

Assets are
listed by
liquidity
Cash – bank
account balances,
Balance Sheet
coins, currency,
checks
Accounts
receivable -
amounts owed by
customers from
prior sales
Inventories –
products to be
sold
Plant and
equipment –
factories,
machinery
Land - property
held for investment
 Balance Sheet

Liabilities
are listed by
maturity
dates
 Balance Sheet

Accounts
payable -
amounts owed
to suppliers for
prior purchases
Notes payable -
amounts owed
on written debt
contracts
 Balance Sheet

Common stock -
investments in the
business by the
stockholders

Retained earnings -
the accumulation
of past profits
minus dividends
 Balance Sheet

A = L + SE
 Example
• Let’s look at Apple’s balance sheet
– Apple plans to announce some new products
 Quiz A
Below is a list of accounts for the
The Treeminator. Prepare a simple
balance sheet as of 12/31/2021.
 Financial Statements
12/31/2010 1/1/2011 to 12/31/2011 12/31/2011
Income Statement
Revenue – Expenses = Net
Income

Balance Balance
Sheet Sheet

A = L + SE A = L + SE

Point in time Period of time Point in time

 Next, we’ll look at Rubber Monster’s income statement

The income statement is also known as the

statement of operations or the P&L (profit and
loss) statement

The income statement tells you a company’s

sales and profit (or loss) for a particular time
period
 Income Statement
1. Name of Entity
2. Title of
Statement
3. Specific Date
4. Unit measure
Income Statement

③
 Income Statement

Sales revenue is
from goods the sale
of goods or services
to a customer
Definition of Revenues
Revenues are inflows or enhancements of assets or settlements of liabilities
from delivering or producing goods or rendering services related to activities
that constitute the company’s core business operations
 Income Statement

Here are some

common
expenses
Definition of Expenses
Expenses occur when assets are used up or liabilities are incurred
from delivering or producing goods or rendering services related to
activities that constitute the company’s core business operations
 Income
COGS - the cost
Statement
of the products
sold this period

SG&A – selling,
general, and
administrative
costs

Depreciation –
reflects wear
and tear on
equipment
Interest expense
- cost of using
borrowed funds

Income tax
expense
 Income Statement

if revenues >
expenses, the
company reports
net income

If revenues <
expenses, the
company reports a
net loss
Let’s look at Apple’s income statement
 Quiz B
Below is a list of accounts for
Goin’ Postal. Prepare an income
statement for the year ended
12/31/2021.
 The Financial
12/31/2010 Statements
1/1/2011 to 12/31/2011 12/31/2011
Income Statement
Revenue – Expenses = Net
Income

Balance Statement of Stockholders’ Balance

Sheet Equity Sheet
Change in Stockholders’ Equity
Accounts
A = L + SE A = L + SE

Point in time Period of time Point in time

 Statement of Stockholder’s
Equity
This statement tells you how stockholders’ equity
accounts changed over the prior period

1. Name of Entity
2. Title of
Statement
3. Specific Date
4. Unit measure
 Statement of Stockholder’s
Equity
You can see how each equity
account changed during 2021

Net income
increased retained
earnings

Dividends decreased
retained earnings

The ending balance

of retained earnings beginning balance + net income -
is calculated as
dividends
If the retained earnings account becomes negative,
we refer to the account as accumulated deficit
(instead of retained earnings)
 Dividends
• When a company
issues dividends to
its shareholders,
this reduces total
stockholders’
equity

• But dividends are

not an expense
Let’s look at Apple’s statement of
stockholders’ equity
 Financial Statements
12/31/2010 1/1/2011 to 12/31/2011 12/31/2011
Income Statement
Revenue – Expenses = Net
Income

Balance Statement of Stockholders’ Balance

Sheet Equity Sheet
Change in Stockholders’ Equity
Accounts
A = L + SE A = L + SE

Statement of Cash Flows

Change in Cash

Point in time Period of time Point in time

 We could find the cash balance simply by looking at the balance sheet.
We make the statement of cash flows to determine WHY the cash balance changed.

Statement of Cash Flows

Operating section
includes cash flows
related to earning
income
Investing section
includes cash flows
related to the
acquisition or sale
of productive
assets
Financing section
includes cash flows
to/from investors
and creditors
The statement
ends with a
reconciliation of
cash
 Statement of Cash Flows
• A mature firm that is doing well would be expected to
have:
– Positive cash flow from operating activities
– Negative cash flow from investing activities
• A start-up would be expected to have:
– Negative cash flow from operating activities
– Positive cash flow from financing activities
Negative cash flow from
investing activities is good – it
means the company is investing
in its operations (e.g., Walmart
updating its stores)

Positive cash flow from operating

activities is crucial to the long-
term success of the firm
Let’s look at Apple’s statement of cash flows
 Financial Statements
12/31/2010 1/1/2011 to 12/31/2011 12/31/2011
Income Statement
Revenue – Expenses = Net
Income

Balance Statement of Stockholders’ Balance

Sheet Equity Sheet
Change in Stockholders’ Equity
Accounts
A = L + SE A = L + SE

Statement of Cash Flows

Change in Cash

Point in time Period of time Point in time

Notes to the financial statements

Notes to the Financial Statements

Notes provide supplemental information about the

financial condition and performance of the company

• A note may:
1. Describe the accounting rules applied
2. Present additional detail about an item
on the financial statements
3. Provide additional information about
items not in the financial statements
Relationship between the
Financial Statements
 Quiz C
1. Which statement is a snapshot of a single point in time?

2. Which statement shows the company’s sales revenue?

3. Which statement shows the company’s assets?

4. Would issuing dividends decrease a company’s net income?

5. What is the primary purpose of the statement of cash flows?

6. How are the income statement and balance sheet connected?

7. If a company with beginning retained earnings of $10 million posts a net income of $25
million and declares and issues a $5 million dividend, what is the company’s ending
balance of retained earnings?

8. If a company with beginning retained earnings of $10 million posts a net loss of $40
million, what is the company’s ending balance of retained earnings?