Financial accounting, Sintesi del corso di Contabilità Finanziaria

Scarica Financial accounting e più Sintesi del corso in PDF di Contabilità Finanziaria solo su Docsity! CHAPTER 1: ACCOUNTING - THE LANGUAGE OF BUSINESS ACCOUNTING DEFINITIONS • AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS: ART (not science) OF RECORDING, CLASSIFYING AND SUMMARIZING IN A SIGNIFICANT (rigorous) WAY AND IN TERMS OF MONEY (monetary unit of measure) TRANSACTIONS AND EVENTS WHICH ARE IN PART AT LEAST OF A FINANCIAL CHARACTER AND INTERPRETING THE RESULTS THEREOF. • AMERICAN ACCOUNTANT ASSOCIATION (AAA): PROCESS OF IDENTIFYING, MEASURING AND COMMUNICATING ECONOMIC INFORMATION TO PERMIT INFORMED JUDGEMENTS AND DECISIONS BY THE USERS OF THIS INFORMATION. ACCOUNTING SYSTEM = SERIES OF STEPS THAT AN ORGANIZATION USES TO RECORD FINANCIAL DATA AND CONVERT THEM INTO INFORMATIVE FINANCIAL STATEMENTS. ACCOUNTING FOCUS ON RULES AND PROCEDURES TO FOLLOW. DOUBLE PURPOSE: 1. RECORD AND REPORT FINANCIAL INFORMATION. 2. MAKE COMPANIES’ NUMBERS SPEAK AND GUIDE COMPANIES’ DECISIONS. ACCOUNTANTS: - ANALYZE, RECORD, QUANTIFY, SUMMARIZE, REPORT AND INTERPRET ECONOMIC EVENTS AND FINANCIAL EFFECTS PRODUCING FINANCIAL STATEMENT USED BY DECISION MAKERS. - TRANSACTIONS = ANY EVENT THAT AFFECTS THE FINANCIAL POSITION OF A FIRM AND THAT CAN BE RECORDED IN MONETARY TERMS. MAIN DECISION MAKERS = STAKEHOLDERS OF ACCOUNTING: SUPPLIERS, COMMON PEOPLE, OWNERS, MANAGERS, INVESTORS, BANKS. (SCOMIB) - INTERNAL = OWNER, MANAGER. - EXTERNAL = GOVERNMENT AGENCIES, STOCKHOLDERS, SUPPLIERS, INVESTORS, BANKS. (GASSIB) TWO TYPES OF ACCOUNTING: 1. FINANCIAL ACCOUNTING = FIELD OF ACCOUNTING THAT SERVES EXTERNAL DECISION MAKERS. 2. MANAGEMENT ACCOUNTING = FIELD OF ACCOUNTING THAT SERVES INTERNAL DECISION MAKERS. ANNUAL REPORT = DOCUMENT PREPARED BY MANAGEMENT AND DISTRIBUTED TO CURRENT AND POTENTIAL INVESTORS TO INFORM THEM ABOUT THE COMPANY’S PAST PERFORMANCE AND FUTURE PROSPECTS. SOME DOCUMENT IN COMMON, FOR EXAMPLE FINANCIAL STATEMENTS: - BALANCE SHEET = FINANCIAL PICTURE AS OF A GIVEN DAY. - INCOME STATEMENT, STATEMENT OF CASH FLOWS, STATEMENT OF STAKEHOLDERS’ EQUITY = PERFORMANCE OVER A PERIOD OF TIME. USEFUL DEFINITIONS: • ACCOUNT = SUMMARY RECORD OF THE CHANGES IN ASSET, LIABILITY OR OWNERS’ EQUITY. • OPEN ACCOUNT = FIRM BUYS OR SELLS ON CREDIT = NOT PAY IMMEDIATELY. • ACCOUNT PAYABLE = LIABILITY THAT RESULTS FROM A PURCHASE ON OPEN ACCOUNT. DEBTS TOWARDS SUPPLIERS. • NOTES PAYABLE = DEBTS TOWARDS BANKS, INVESTORS. • COMPOUND ENTRY = TRANSACTION THAT AFFECTS MORE THAN 2 ACCOUNTS. • CREDITOR = PERSON TO WHOM THE FIRM HAS TO GIVE MONEY. • MERCHANDISE INVENTORY = FIRM STOCKS, SO GOODS THAT THE FIRM BUYS FROM SUPPLIERS TO BE SOLD TO CUSTOMERS. • STORE EQUIPMENT = MACHINERY THAT THE FIRM BUYS. • LONG-LIVE ASSET = ASSET THAT YOU EXPECT TO LIVE FOR MORE THAN 1 YEAR. • COST OF GOODS SOLD = ORIGINAL PURCHASE COST OF INVENTORY THAT THE FIRM SELLS TO CUSTOMERS. BALANCE SHEET • MAIN FINANCIAL STATEMENT, BUT IT NEEDS TO BE READ TOGETHER WITH THE OTHERS = “PLACE THE BIGGER PART, BUT NOT ALONE”. • FINANCIAL SITUATION OF AN ORGANIZATION AT A PARTICULAR POINT IN TIME. • USUALLY IT IS WRITTEN AT THE END OF THE YEAR = IT COVERS 1 YEAR. • INTERNALLY IT SHOULD BE WRITTEN AT LEAST EVERY 3 MONTHS. • DOUBLE-ENTRY ACCOUNTING SYSTEM = AT LEAST 2 ENTRIES FOR EVERY TRANSACTION. SINGLE ENTRIES CANNOT MAINTAIN THE BALANCE! COMPOSITION OF BALANCE SHEET • ASSETS = ECONOMIC AND FINANCIAL RESOURCES: CASH, BUILDINGS, INVENTORIES, EQUIPMENT. • LIABILITIES = CLAIMS AGAINST THESE RESOURCES / ECONOMIC OBLIGATIONS TO THIRD PARTIES, SO DEBTS. • OWNERS’ EQUITY = OWNERS’ CLAIM ON FIRM’S ASSETS. OWNERS’ EQUITY = OWNERS’ INVESTMENT IN THE FIRM - OWNERS’ WITHDRAWALS FROM THE BUSINESS + NET INCOME ON BUSINESS ASSETS OR - NET LOSS ON BUSINESS ASSETS. BALANCE SHEET EQUATION: ASSETS = LIABILITIES + OWNERS’ EQUITY ( A = L + OE ) TYPES OF OWNERSHIP ACCOUNTING PRACTICES CHANGE ACCORDING TO THE LEGAL STATUS OF THE COMPANY. 1. SOLE PROPRIETORSHIP • SIMPLE AND MOST COMMON TYPE OF BUSINESS OWNERSHIP. • SINGLE OWNER (OFTEN MANAGER) = SINGLE INDIVIDUAL ENGAGES IN A BUSINESS ACTIVITY WITHOUT NECESSITY OF FORMAL ORGANIZATION. • NOT ENTITY SEPARATE FROM THE OWNER. • OFTEN PERSONALLY LIABLE. • SMALL BUSINESSES. 2. PARTNERSHIP = GENERAL PARTNERSHIP • CO-OWNERS = JOINTLY RAN BY 2 OR MORE PEOPLE (OFTEN MANAGERS) WHO ASSOCIATE TO CARRY ON A BUSINESS FOR PROFIT. THEY SHARE RISKS AND PROFITS. • PARTNERSHIP AGREEMENT. • TERMINABLE AT WILL OR DEATH OF THE PARTNERS. • PARTNERSHIP INTERESTS CANNOT BE SOLD OR TRANSFERRED WITHOUT CONSENT OF OTHER PARTNERS. • IN MOST STATES, PARTNERSHIPS ARE CONSIDERED TO BE AN ENTITY SEPARATE FROM THE PARTNERS, SO THAT A PARTNERSHIP CAN OWN PROPERTY AND SUE AND BE SUED IN ITS OWN NAME. • THE PARTNERSHIP PROVIDES NO LIABILITY PROTECTION TO ITS OWNERS. PARTNERS ARE ALL LIABLE FOR THE DEBTS OF THE PARTNERSHIP ACCORDING TO THEIR PROPERTY PERCENTAGES. • BIG BUSINESSES. 3. LIMITED LIABILITY COMPANY (LLC) • COMPANY IN-BETWEEN A PARTNERSHIP AND A CORPORATION. • DISTINCT TYPE OF ENTITY. • MEMBERS = OWNERS. MEMBER = INDIVIDUAL, PARTNERSHIP, CORPORATION, TRUST, LEGAL OR COMMERCIAL ENTITY. • MEMBERS HAVE LIMITED LIABILITY TO THEIR INVESTMENT. • MANAGEMENT STRUCTURE MUST BE STATED IN THE CERTIFICATE OF FORMATION MADE BY LLC AND ITS MEMBERS. LLC CAN BE MANAGED BY MANAGERS OR BY ITS MEMBERS. THE VISION OF GLOBAL ACCOUNTING STANDARDS HAS BEEN SUPPORTED BY MANY INTERNATIONAL ORGANIZATIONS. THESE STANDARDS ARE CAPABLE OF BEING APPLIED ON A GLOBALLY CONSISTENT BASIS IN ORDER TO COMPARE THE FINANCIAL PERFORMANCE. IFRS STANDARDS ARE NOW MANDATED FOR USE BY MORE THAN 100 COUNTRIES, INCLUDING EU AND BY MORE THAN 2/3 OF THE G20. BECAUSE OF GLOBALIZATION, INTERNATIONAL TRADE AND INVESTMENT, THERE IS AN INCREASING NEED TO CONVERGE. COMPANIES LISTED ON PUBLIC STOCK EXCHANGES ARE LEGALLY REQUIRED TO PUBLISH FINANCIAL STATEMENTS IN ACCORDANCE WITH THE RELEVANT ACCOUNTING STANDARDS. SOME DIFFERENCES BETWEEN US GAAP AND IFRS: • DEFINITION DIFFERENCES. • RECOGNITION DIFFERENCES. • MEASUREMENT DIFFERENCES. • ALTERNATIVES. • LACK OF REQUIREMENTS OR GUIDANCE. • PRESENTATION DIFFERENCES. • DISCLOSURE DIFFERENCES. • US GAAP = RULES-BASED SYSTEM. • IFRS = PRINCIPLES-BASED SYSTEM : BROAD PRINCIPLES BUT WITH LIMITED DETAILED RULES. • THE IFRS IS MORE FLEXIBLE THAN THE US GAAP! US GAAP = 10 PRINCIPLES: 1. REGULARITY: ACCOUNTANTS MUST RESPECT GAAP STANDARDS REGULARLY. 2. CONSISTENCY: GAAP STANDARDS MUST BE APPLIED THROUGH THE ALL ACCOUNTING PROCESS. 3. SINCERITY: ACCOUNTANTS MUST BE COMMITTED TO ACCURACY AND IMPARTIALITY. 4. PERMANENCE OF METHODS: CONSISTENT PROCEDURES MUST BE USED IN THE PREPARATION OF ACCOUNTING DOCUMENTS TO COMPARE THEM IN DIFFERENT YEARS. 5. NON-COMPENSATION: ALL ASPECTS OF A FIRM’S PERFORMANCE, POSITIVE OR NEGATIVE, MUST BE FULLY REPORTED WITH NO PROSPECT OF DEBT COMPENSATION. 6. PRUDENCE: NO SPECULATION WHEN YOU REPORT FINANCIAL DATA. 7. CONTINUITY: ACCOUNTING OPERATIONS MUST ASSUMED THAT THE COMPANY’S LIFE WILL CONTINUE. 8. PERIODICITY: ACCOUNTING ACTIVITIES MUST FOLLOW PRECISE PERIODS (FISCAL YEAR). 9. MATERIALITY: AN ACCOUNTANT MUST HIGHLIGHT THE ORGANIZATION’S MONETARY SITUATION. 10. UTMOST GOOD FAITH: ALL PARTIES INVOLVED IN ACCOUNTING ACTIVITIES ARE ASSUMED TO BE ACTING HONESTLY. THIS PRINCIPLES ARE FOLLOWED ALSO BY THE IFRS, BUT THEY ARE NOT EXPLICITLY LISTED. CHAPTER 2: MEASURING INCOME TO ASSESS PERFORMANCE MEASURES OF PROFITABILITY = ABILITY OF A COMPANY TO PROVIDE INVESTORS WITH A RATE OF RETURN ON THEIR INVESTMENT. • USEFUL DECISION-MAKING TOOLS. • INVESTORS USE THEM TO DISTINGUISH AMONG DIFFERENT INVESTMENT OPPORTUNITIES. • MANAGERS KNOW THAT THEIR COMPANY’S PROFITABILITY MEASURES WILL AFFECT THE INVESTMENT DECISIONS OF INVESTORS. • HOW THE BUSINESS IS GOING. NET INCOME = SALES - EXPENSES —> INCOME IS ONE METRIC TO EVALUATE ECONOMIC PERFORMANCE. 1. PERIOD REPEATING OPERATING CYCLE / CASH CYCLE = TIME BETWEEN THE ACQUISITION OF PRODUCTS IN EXCHANGE FOR CASH AND THE SUBSEQUENT SALE OF PRODUCTS TO CUSTOMERS WHO PAY FOR THEIR PURCHASES WITH CASH = TIME FROM PURCHASING TO SELL. 2. ACCOUNTING TIME PERIOD CALENDAR YEAR = JANUARY 1 - DECEMBER 31. FISCAL YEAR = YEAR ESTABLISHED FOR ACCOUNTING PURPOSES, WHICH MAY DIFFER FROM THE CALENDAR YEAR. FISCAL YEAR DOES NOT NECESSARILY END ON DECEMBER 31. 3. INTERIM PERIODS = TIME ESTABLISHED FOR ACCOUNTING PURPOSES THAT IS LESS THAN A YEAR (special BS, income). INCOME: • REVENUES = INFLOWS (SALES or SALE REVENUES) —> INCREASING ASSETS + INCREASING OE • EXPENSES = OUTFLOWS —> DECREASING ASSETS + DECREASING OE - REV > EXP —> (NET) INCOME, PROFITS, EARNINGS - EXP > REV —> (NET) LOSS RETAINED EARNINGS / RETAINED INCOME = TOT CUMULATIVE OWNERS’ EQUITY GENERATED BY INCOME OR PROFITS. • COMPUTED AT THE END OF ACCOUNTING PERIOD. • PART OF EARNINGS NOT PAID OUT AS DIVIDENDS, BUT RETAINED IN THE COMPANY TO BE REINVESTED IN ITS BUSINESS OR TO PAY DEBT (CORPORATION). RETAINED EARNINGS FORMULA: RE = BEGINNING RE + NET INCOME (REV - EXP) OR NET LOSS - DIVIDENDS DIVIDENDS THEY CAN BE IN MONEY/CASH OR STOCKS. CASH DIVIDENDS = DISTRIBUTIONS OF CASH TO STOCKHOLDERS THAT REDUCE RETAINED EARNINGS. CASH DIVIDENDS ARE PAID FROM COMPANY’S EARNINGS OR NET INCOME. • DIVIDENDS USUALLY PAID AT THE END OF ACCOUNTING PERIOD. • DIVIDENDS USUALLY ANNOUNCED IN ADVANCE TO CREATE EXPECTATIONS IN INVESTORS. • IF THERE IS NO BEGINNING RE AND NO DIVIDENDS PAID, THEN: RE = REV - EXP = NET INCOME. DISTRIBUTION OF DIVIDENDS STEPS: 1. DECLARATION DATE = BOARD OF DIRECTORS ANNOUNCES THE INTENTION TO PAY DIVIDENDS ON A DATE. 2. RECORD DATE = DIVIDEND IS DECLARED PAYABLE TO STOCKHOLDERS BY AN EXTERNAL BODY. 3. PAYMENT DATE = DIVIDEND IS PAID. HOW IS INCOME MEASURED IN ACCOUNTING 1. THE ACCRUAL BASIS = ACCOUNTING METHOD IN WHICH ACCOUNTANTS RECORD REVENUES AND EXPENSES EXACTLY WHEN THEY OCCUR, REGARDLESS OF WHEN CASH CHANGES HANDS. - MOST USED AND RECOMMENDED BY US GAAP AND IFRS. - COMPLETELY SUMMARY OF THE FIRM’S ACTIVITY. 2. THE CASH BASIS = ACCOUNTING METHOD THAT RECOGNIZES AND RECORDS REVENUES AND EXPENSES ONLY WHEN THE PAYMENT OCCURS. BOTH US GAAP AND IFRS : CHOOSE THE METHOD YOU PREFER, BUT BE CONSISTENT BECAUSE FINANCIAL STATEMENTS MUST BE COMPARED OVERTIME. REVENUE RECOGNITION IN ACCRUAL BASIS US GAAP + IFRS —> CRITERIA TO RECOGNIZE REVENUE. REVENUE SHOULD: - BE EARNED = GOOOD/SERVICE MUST BE DELIVERED. - BE REALIZED OR REALIZABLE = FIRM RECEIVES CASH OR CLAIMS CASH. EXPENSES IN ACCRUAL BASIS - PRODUCT COSTS = COSTS THAT ARE LINKED WITH REVENUES AND ARE CHARGED AS EXPENSES WHEN THE RELATED REVENUE IS RECOGNIZED. - MATCHING = RECORDING OF EXPENSES IN THE SAME TIME PERIOD THAT WE RECOGNIZE THE RELATED REVENUES. - PERIOD COSTS = EXPENSES SUPPORTING A COMPANY’S OPERATIONS FOR A GIVEN PERIOD. WE RECORD THESE EXPENSES IN THE TIME PERIOD IN WHICH THE COMPANY INCURS THEM. 1. COSTS OF THE GOOD SOLD (MOST IMPORTANT EXPENSE FOR MOST FIRMS) = ORIGINAL ACQUISITION COST OF THE INVENTORY THAT A COMPANY SELLS TO COSTUMERS DURING THE REPORTING PERIOD. 2. RENT PAID IN ADVANCE = EXPENSE THAT HAS NOT BEEN REALIZED YET. 3. DEPRECIATION = SYSTEMATIC ALLOCATION OF THE ACQUISITION COST OF LONG-LIVED ASSETS TO THE EXPENSE ACCOUNTS OF THE PARTICULAR ACCOUNTING PERIODS THAT BENEFIT FROM THE USE OF THE ASSETS. • IT IS THE LOSS IN VALUE OF THE ASSET OVERTIME. • IT CONCERNS PHYSICAL ASSETS THAT COVER MULTIPLE PERIODS. LAND: NO DEPRECIATION! • ACCOUNTANT MUST KNOW THE PURCHASE COST AND HOW LONG THE ASSET IS SUPPOSED TO LAST. IF IT IS NOT KNOWN, ESTIMATE DEPRECIATION USING PRUDENCE. DEPRECIATION = PURCHASE COST / HOW LONG THE ASSET IS SUPPOSED TO LAST. SHORTER AMOUNT OF PERIODS —> HIGHER DEPRECIATION! SECOND FORMAT: MULTIPLE-STEP INCOME STATEMENT = CONTAINS ONE OR MORE SUBTOTALS THAT HIGHLIGHT SIGNIFICANT RELATIONSHIPS. MOST USED, COMMON AND REQUIRED FORMAT. MORE INFORMATION. WRITTEN AT LEAST TWICE A YEAR. MULTIPLE-STEP IS 3 STEPS: STEP 1: GROSS PROFIT = NET SALES - COST OF GOODS SOLD STEP 2: OPERATING INCOME = GROSS PROFIT - OPERATING EXPENSES STEP 3: NET INCOME OR NET LOSS = OPERATING INCOME + NON-OPERATING ITEMS (REVENUES, GAINS, EXPENSES, LOSSES) XXX FIRM INCOME STATEMENT Jan 1 , 2020 - Dec 31 , 2020 —> same heading as the single-step IS 
 Sales $ 100,000 Cost of goods sold 75,000 ____________ Gross profit 25,000 Operating expenses Selling expenses Advertising 7,000 7,000 Administrative expenses Office supplies expenses 3,500 Office equipment expenses 2,500 6,000 _________ _________ Total operating expenses 13,000 _________ Operating income 12,000 = (gross profit - operating expenses) Non-operating/other expenses Interest revenues 5,000 Gains on sale of equipment 3,000 Interest expenses (500) = (brackets —> negative amount) Loss from lawsuit (1,500) __________ Total non-operating 6,000 __________ Net income $18,000 = operating income + total non-operating __________ __________ BENEFITS MULTIPLE-STEP IS WITH RESPECT TO THE SINGLE-STEP IS: 1. GROSS PROFIT AMOUNT = EXCESS OF SALES REVENUE OVER THE COST OF THE INVENTORY THAT WAS SOLD. 2. OPERATING EXPENSES = RECURRING EXPENSES THAT PERTAIN TO FIRM’S ROUTINE, ONGOING OPERATIONS. 3. OPERATING INCOME = IT INDICATES THE PROFIT EARNED BY THE COMPANY FROM ITS PRIMARY ACTIVITIES OF BUYING AND SELLING GOODS. 4. NON-OPERATING REVENUES AND EXPENSES = REVENUES AND EXPENSES THAT ARE NOT DIRECTLY RELATED TO THE MAINSTREAM OF A FIRM’S OPERATIONS. 5. NET INCOME OR NET LOSS AS A FINAL FIGURE, BUT BY PROVIDING INFO ON ITS COMPOSITION IT ALLOWS DECISION-MAKERS TO INVESTIGATE IT IN A DEEP AND SIGNIFICANT WAY. ETHICS, DEPRECIATION AND NET INCOME MEASURING NET INCOME CAN CAUSE ETHICAL DILEMMAS FOR ACCOUNTANTS. ETHICAL STANDARDS AND ACCOUNTING STANDARDS OFTEN LEAVE SPACE FOR: INDIVIDUAL INTERPRETATION AND JUDGEMENT. NET INCOME IS SO IMPORTANT IN MEASURING MANAGERIAL PERFORMANCE, SOMETIMES MANAGERS PUT PRESSURE ON ACCOUNTANTS TO REPORT HIGHER REVENUES AND LOWER EXPENSES THAN IS APPROPRIATE. AUTHORITIES ACCUSED MANY COMPANIES OF MANIPULATING THEIR INCOME TO MAKE RESULTS LOOK BETTER THAN THEY ACTUALLY WERE. “Materially falsified financial statements…to paint a falsely rosy picture of the company’s financial results to analysts and investors”. THE LARGEST BANKRUPTCY IN US HISTORY FOLLOWED THE COLLAPSE OF LEHAM BROTHERS IN 2008. MANY BELIEVE THAT THIS BROUGHT TO THE US FINANCIAL AND ECONOMIC CRISIS. DEPRECIATION REQUIRES JUDGEMENT AND LEAVES SPACE FOR ETHICAL CONFLICTS. IMPORTANT: RECOGNIZE THE ETHICAL DIMENSION OF THIS PROBLEM AND WEIGH THEM WHEN FORMING YOUR OPINION / JUDGEMENTS. ETHICAL BEHAVIOR = CRITICALLY IMPORTANT IN ALL AREAS OF ACCOUNTING! IF USERS CANNOT TRUST ACCOUNTING NUMBERS, FINANCIAL STATEMENTS WILL HAVE LITTLE VALUE. STATEMENT OF STOCKHOLDERS’ EQUITY BIG COMPANIES WRITE A FINANCIAL STATEMENT DEVOTED EXCLUSIVELY TO STOCKHOLDERS’ EQUITY. • IT SHOWS ALL THE CHANGES IN EACH STOCKHOLDERS’ EQUITY ACCOUNT IN A YEAR. • STATEMENT OF SE HIGHLIGHTS BUSINESS ACTIVITIES THAT CONTRIBUTE TO THE VALUE OF SE. • STATEMENT OF SE CONTAINS ABOUT SHARES OF THE COMPANY AND DIVIDENDS DISTRIBUTED (RELEVANT FOR INVESTORS). • IT IS A FINANCIAL DOCUMENT THAT A COMPANY ISSUES AS PART OF BALANCE SHEET. - BEGINNING BALANCE - ALL CHANGES ARE LISTED - FINAL BALANCE STOCKHOLDERS’ EQUITY CHANGES BECAUSE OF RETAINED EARNINGS = IMPORTANT PART OF SE: - NET INCOME INCREASE —> RE INCREASE - NET LOSS INCREASE —> RE DECREASE - TRANSACTIONS INVOLVING SHAREHOLDERS (DIVIDENDS’ PAYMENTS, ISSUING STOCKS) INCREASE —> RE DECREASE SE = TOTAL ASSETS - TOTAL LIABILITIES (FROM BS EQUATION) SUM OF ALL BALANCES OF SE MUST BE EQUAL TO THE DIFFERENCE BETWEEN ASSETS AND LIABILITIES. ELEMENTS IN THE STATEMENT OF SE: - RE = TOTAL EARNINGS OF A COMPANY - AMOUNT PAID OUT IN SHAREHOLDER DIVIDENDS. - TRANSACTIONS ON STOCKS - PAID-IN CAPITAL - ADDITIONAL PAID-IN CAPITAL = EXCESS AMOUNT INVESTORS PAY OVER THE PAR VALUE OF A COMPANY’S STOCK. COMPANY CAN ISSUE DIFFERENT KINDS OF STOCKS IF THE COMPANY NEEDS MONEY TO INVEST AND GROW AND IT PREFERS TO DIVERSIFY RISK BY NOT ASKING BANKS FOR MONEY, THE COMPANY COULD IMPLEMENT ANOTHER SOURCE OF BORROWING. 1. PREFERRED STOCK = SPECIAL KIND OF STOCK. - IT OFFERS HOLDERS A HIGHER CLAIM ON A COMPANY’S EARNINGS AND ASSETS THAN THOSE WHO OWN COMMON STOCK. - THE COMPANY IS ENTITLED TO RECEIVE DIVIDENDS BEFORE PEOPLE HOLDING COMMON STOCKS. - IT COSTS MORE THAN THE COMMON STOCK. 2. COMMON STOCK = MOST COMMON TYPE OF STOCK. - IF COMPANY NEEDS TO LIQUIDATE, THEN COMMON STOCKHOLDERS WILL BE PAID AFTER BONDHOLDERS AND PREFERRED STOCKHOLDERS. 3. TREASURY STOCK = STOCK THAT THE ISSUING COMPANY REPURCHASES. - USED TO AVOID A HOSTILE TAKEOVER OR BOOST ITS STOCK PRICE. - SE IS REDUCED BY THE AMOUNT OF MONEY SPENT TO REPURCHASE THE SHARES IN QUESTION. THE PROCESS OF RECORDING ACCOUNTANTS SHOULD KNOW THE COMPANY. 1. SOURCE DOCUMENTS = ORIGINAL RECORDS (RELEVANT SOURCE DOCUMENTS) SUPPORTING ANY TRANSACTION. COMPANIES USE THEM TO VERIFY THE DETAILS OF A TRANSACTION AND THE ACCURACY, IF NECESSARY. 2. JOURNALIZING = PROCESS OF ENTERING TRANSACTIONS IN CHRONOLOGICAL ORDER IN THE GENERAL JOURNAL. 3. POSTING = RECORD TRANSACTIONS INTO LEDGER ACCOUNTS (T-ACCOUNTS). 4. TRIAL BALANCE = LIST OF ALL LEDGER ACCOUNTS’ BALANCES USED TO CHECK IF ACCOUNTING INFO IS CORRECT BEFORE PREPARING FINANCIAL STATEMENTS (BS, IS…). NOT MANDATORY BUT HIGHLY RECOMMENDED. ALWAYS SPECIFY THE TIME PERIOD IT REFERS TO. INTERMEDIATE STEP: “CLOSING THE BOOKS”! - TRANSFER BALANCES OF REVENUES AND EXPENSES TO RE AND THEY BECOME EQUAL TO ZERO. - IN ORDER TO DO THIS TRANSFER, OPEN A SPECIAL ACCOUNT = INCOME SUMMARY. 5. FINANCIAL STATEMENTS (BS, IS…). CHART OF ACCOUNTS = NUMBERED OR CODED LIST OF ALL ACCOUNT TITLES. ACCOUNTANTS OFTEN USE THESE ACCOUNT NUMBERS TO IDENTIFY THE ACCOUNTS. CROSS REFERENCING = PROCESS OF USING NUMBERING, DATING AND/OR SOME OTHER FORM OF IDENTIFICATION TO RELATE EACH GENERAL LEDGER POSTING TO THE APPROPRIATE JOURNAL ENTRY. JOURNALIZING • DATE. • IDENTIFICATION NUMBER OF THE ENTRY. • ACCOUNTS AND EXPLANATION SHOWS THE NAMES OF THE ACCOUNTS AFFECTED. • POSTING REFERENCE COLUMN CONTAINS BAN IDENTIFYING NUMBER FROM THE CHART OF ACCOUNTS. • DEBITS (LEFT-ENTRY) AND CREDITS (RIGHT-ENTRY): TELL THE WHOLE STORY IN THE RECORDING PROCESS. EXAMPLE: 1) Peter invests $200,000. 2) He takes a loan of $50,000. 3) He buys equipment in cash for $5,000. MOST COMMON WAY OF JOURNALIZING! • NO CURRENCY SIMBOLS • NO NEGATIVE NUMBERS • EXPLANATION IS NOT MANDATORY DATE ENTRY NO ACCOUNTS AND EXPLANATION POST REFERENCE DEBIT CREDIT JAN 2, 2020 1 CASH PAID-IN CAPITAL 01 20 200,000 200,000 JAN 2, 2020 2 CASH NOTES PAYABLE 01 21 50,000 50,000 JAN 2, 2020 3 EQUIPMENT CASH 06 01 5,000 5,000 POSTING ASSETS LIABILITIES + SE XXX DEPRECIATION —> ACCUMULATED DEPRECIATION / ALLOWANCE FOR DEPRECIATION = CUMULATIVE SUM OF ALL DEPRECIATION OF A FIRM’S EQUIPMENT RECOGNIZED SINCE THE DATE OF ACQUISITION OF AN ASSET. IT IS A CONTRA ASSET ACCOUNT: 1. IT HAS A COMPANION ACCOUNT (EQUIPMENT) = ASSET. 2. IT HAS A BALANCE ON THE OPPOSITE SIDE FROM THE COMPANION ACCOUNT. NORMAL BALANCE OF ACCUMULATED DEPRECIATION = CREDIT. BOOK VALUE / NET BOOK VALUE / CARRYING AMOUNT / CARRYING VALUE = BALANCE BETWEEN AN ACCOUNT AND ITS CONTRA ACCOUNT. FOR EQUIPMENT: BOOK VALUE = ACQUISITION COST - ACCUMULATED DEPRECIATION. IT TELLS THE VALUE OF EQUIPMENT LEFT AFTER TAKING DEPRECIATION INTO ACCOUNT. ERRORS IF THE ACCOUNTANT DISCOVER AN ERROR LATER ON, THE ACCOUNTANT MAKES A CORRECTING ENTRY = JOURNAL ENTRY THAT CANCELS THE PREVIOUS MISTAKES AND GIVES A CORRECT RECORDING OF THE TRANSACTIONS. ACCRUAL ACCOUNTING AND FINANCIAL STATEMENT 2 KINDS OF TRANSACTIONS: • EXPLICIT = OBSERVABLE ECONOMIC EVENTS (purchases, sales). • IMPLICIT = NOT GENERATE DOCUMENTS / VISIBLE EVIDENCE THAT ECONOMIC EVENT ACTUALLY OCCURRED. RECORDED AT THE END OF THE ACCOUNTING PERIOD —> END-OF-PERIOD ENTRIES. IN ORDER TO RECORD IMPLICIT TRANSACTIONS, DO ADJUSTMENT ENTRIES OR ADJUSTMENTS. ADJUSTMENTS / ADJUSTMENT ENTRIES = RECORDING OF IMPLICIT TRANSACTIONS THAT ALLOWS THE ACCOUNTANT TO LINK THE IMPLICIT TRANSACTIONS WITH THE APPROPRIATE TIME PERIODS. THEY NEVER AFFECT CASH. EACH ADJUSTMENT AFFECTS BOTH IS AND BS. Example: wages earned by workers but not paid yet. You will pay the work they did in December on Jan 10, but the cost of this work must be included in this accounting year, ending on December 31. Example: interest owed on borrowed money but not paid yet. You do adjustment entries to accrue revenues and expenses to their true accounting time period. ACCRUE = ACCUMULATE A RECEIVABLE (ASSET) OR PAYABLE (LIABILITY) DURING A GIVEN PERIOD, EVEN THOUGH NO EXPLICIT TRANSACTION OCCURS, AND TO RECORD A CORRESPONDING REVENUE OR EXPENSE. Example: for 2020 I have to pay wages for $25,000. I pay in cash (explicit transaction) 20,000 in 2020. For the remaining $5,000 there is no explicit transaction, but it’s a liability and it is an expense for 2020 —> At the end of 2020 the accountant makes an ADJUSTMENT ENTRY TO RECORD THE DEFERRED $5,000 AS AN EXPENSE AND A LIABILITY. 4 KINDS OF ADJUSTMENT ENTRIES: 1. EXPIRATION OR CONSUMPTION OF UNEXPIRED COSTS EXAMPLE 1: PREPAID RENT —> You pay $4,500 (explicit transaction) in Jan for Jan, Febr, March. Then at the end of January you record the adjustment entry to reduce the asset “prepaid-rent” and increase the account “rent expense”. Then Feb the same. Then March the same. EXAMPLE 2: OFFICE SUPPLIES INVENTORY —> The firm buys $5,000 of office supplies. Before buying, I have this situation: Office supplies inventory 10,000 Cash 10,000 Now I pay it: Office supplies inventory 5,000 Cash 5,000 At the end of the month, you see that you have used $500: Office supplies expense 500 Office supplies inventory 500 Now the balance of your office supplies inventory will be: $15,000 - 500 —> very often this amount is estimated! _________ 14,500 EXAMPLE 3: DEPRECIATION = LOSS IN VALUE OF EQUIPMENT. It is an implicit transaction, usually recorded at the end of the year. It is often estimated. 2. EARNINGS OF UNEARNED REVENUES (MOST USED) IT IS CASH RECEIVED BY CUSTOMERS WHEN THEY PAY IN ADVANCE FOR GOODS OR SERVICES, SO CUSTOMERS PAY BEFORE RECEIVING GOODS OR SERVICES THAT WILL BE DELIVERED IN THE FUTURE. EXAMPLE: PRE-PAID RENT of $4,500. PRE-PAID RENT CAN BE AN UNEARNED REVENUE FROM THE POINT OF VIEW OF THE OWNER OF THE BUILDING. • POV OF THE CUSTOMER COMPANY WHO PAYS —> TYPE 1 OF ADJUSTMENT ENTRIES ASSETS LIABILITIES + SE CASH PRE-PAID RENT RENT EXPENSE ADVANCE PAYMENT -4,500 4,500 JANUARY ADJSUTMENT -1,500 -1,500 FEBRUARY ADJUSTMENT -1,500 -1,500 MARCH ADJUSTMENT -1,500 -1,500 ETHICS, UNEARNED REVENUE AND REVENUE RECOGNITION DECIDING WHEN UNEARNED REVENUE BECOMES EARNED CAN POSE ETHICAL DILEMMAS FOR ACCOUNTANTS. SUPPOSE YOU ARE THE ACCOUNTANT FOR A COMPANY THAT RECEIVES CASH PAYMENT IN EXCHANGE FOR A COMMITMENT TO PROVIDE VARIOUS SERVICES AT A LATER DATE. AT THE TIME THE COMPANY RECEIVES THE CASH, YOU APPROPRIATELY RECORD AN INCREASE IN CASH AND AN INCREASE IN THE LIABILITY ACCOUNT = UNEARNED REVENUE. AS THE COMPANY PROVIDES THE SERVICES, THE APPROPRIATE ACCOUNTING TREATMENT IS TO DECREASE THE UNEARNED REVENUE ACCOUNT AND RECOGNIZE REVENUE ON THE IS. ACCOUNTANTS SHOULD BE CONSERVATIVE CONSERVATISM = SELECTING METHODS OF MEASUREMENT THAT ANTICIPATE EXPENSES AND LIABILITIES AND DEFER RECOGNITION OF REVENUES AND ASSETS, YIELDING LOWER NET INCOME, LOWER ASSETS, AND LOWER SE. THE BOSS OF THE FIRM ARGUES THAT FINANCIAL STATEMENTS ARE LESS LIKELY TO MISLEAD USERS IF BALANCE SHEETS REPORT ASSETS AT LOWER RATHER THAN HIGHER AMOUNTS, REPORTS LIABILITIES AT HIGHER RATHER THAN LOWER AMOUNTS, AND IF INCOME STATEMENTS REPORT LOWER RATHER THAN HIGHER NET INCOME. THE BOSS CLAIMS THAT IT IS UNETHICAL TO OVERSTATE REVENUE AND NET INCOME AND UNDERSTATE LIABILITIES. PROCESS OF RECORDING WITH ADJUSTMENTS 1. COLLECTION OF DOCUMENTS 2. GENERAL JOURNAL 3. GENERAL LEDGER 4. TRIAL BALANCE - UNADJUSTED TRIAL BALANCE: to check that everything is fine before adjustments. - JOURNALIZE AND POST ADJUSTMENTS - ADJUSTED TRIAL BALANCE 5. FINANCIAL STATEMENTS BALANCE SHEET IT INFORMS ABOUT ASSETS, LIABILITIES AND EQUITY ATA CERTAIN POINT IN TIME. THE BALANCE SHEET HAS DIFFERENT FORMATS: 1. CLASSIFIED BS 2. COMMON-SIZE BS 8. COMPARATIVE BS 1) CLASSIFIED BS * ASSETS, LIABILITIES, EQUITY AGGREGATED OR CLASSIFIED INTO SUB CATEGORIES OF ACCOUNTS. * MOST COMMON FORMAT: INFO IN THE BS MORE READABLE AND USABLE. * SAME CLASSES OVERTIME, OTHERWISE BS WILL NOT BE COMPARABLE OVERTIME!!! ALWAYS: TOT ASSETS = TOT LIABILITIES + TOTAL SE! - CURRENT ASSETS = CASH AND PTHER ASSETS THAT A COMPANY EXPECTS TO CONVERT TO CASH, SELL, CONSUME WITHIN 1 YEAR OR THE NORMAL OPERATING CYCLE. - CURRENT LIABILITIES = LIABILITIES THAT COME DUE WITHIN 1 YEAR OR THE NORMAL OPERATING CYCLE. TYPICALLY WE EXPECT CURRENT LIABILITIES TO BE PAID USING CURRENT ASSETS. MOST COMMON CLASSES IN A CLASSIFIED BD AND ACCOUNTS IN EACH SUB-CATEGORY: alniA IT DOES NOT NEED TO BE ALL CLASSIFIED! THE CLASSIFIED BS ALLOWS THE IMMEDIATE COMPARISON BETWEEN: CURRENT ASSETS AND CURRENT LIABILITIES = MOST IMPORTANT COMPONENTS OF CLASSIFIED BS. COMPARISON ALLOW TO SEE THE FIRM’S ABILITY TO MEET ITS OBLIGATIONS. CURRENT ASSETS: US GAAP AND IFRS SUGGEST TO LIST ACCOUNTS IN THE ORDER IN WHICH THEY ARE LIKELY TO BE CONVERTED INTO CASH = DECREASING ORDER OF LIQUIDITY = MOST LIQUID —> LEAST LIQUID. LIQUIDITY = ENTITY’S ABILITY TO MEET ITS NEAR-TERM FINANCIAL OBLIGATIONS WITH CASH AND NEAR- CASH ASSETS AS THOSE OBLIGATIONS BECOME DUE. 1. Cash and cash equivalents 2. Accounts receivable 3. Notes receivable 4. Accrued interest receivable (3 / 4 RELATED TOGETHER) 5. Merchandise inventory 6. Prepaid rent and prepaid assets in general = asset because it decreases the obligation to pay in the future. (5 / 6 = NON-MONETARY ASSETS) CURRENT LIABILITIES: LIST IN THE ORDER IN WHICH THEY NEED OR REQUIRE THE USE OF CASH. 1. Accounts payable 2. Unearned rent revenue (someone has paid rent in advance to you) 3. Accrued wages payable 4. Accrued interest payable 5. Note payable / Accrued tax income payable WORKING CAPITAL / NET WORKING CAPITAL / NET CURRENT ASSETS = CURRENT ASSETS - CURRENT LIABILITIES • IT RELATES CURRENT ASSETS AND CURRENT LIABILITIES. • THE LARGE IS THE DIFFERENCE, THE BETTER! • COMPANY’S EFFICIENCY AND ITS SHORT-TERM FINANCIAL HEALTH AND ITS LIQUIDITY. • RESULTS OF THE COMPANY’S SHORT-TERM DEBT MANAGEMENT. WORKING CAPITAL RATIO = CURRENT ASSETS / CURRENT LIABILITIES • IF THE COMPANY HAS ENOUGH SHORT-TERM ASSETS TO COVER ITS SHORT-TERM LIABILITIES. • DIFFICULT TO INTERPRET: SOME CURRENT ASSETS ARE LESS LIQUID THAN OTHERS AND MAY TAKE LONGER TO CONVERT TO CASH. • DISTINGUISH AMONG ASSETS BASED ON THEIR RELATIVE LEVEL OF LIQUIDITY. QUICK RATIO (ACID TEST RATIO): ONE COMMON VARIATION OF THE CURRENT RATIO. IT REMOVES INVENTORY AND POTENTIALLY OTHER LESS LIQUID ASSETS FROM THE NUMERATOR OF THE CALCULATION. THIS RATIO PROVIDES A MORE RESTRICTIVE VIEW OF THE COMPANY’S LIQUIDITY. - LOWER THAN 1: CURRENT LIABILITIES > CURRENT ASSETS —> WC NEGATIVE. - EQUAL TO 1: CURRENT LIABILITIES = CURRENT ASSETS —> WC = 0. - EQUAL TO 2: CURRENT ASSETS = 2 CURRENT LIABILITIES —> CA = 2 CL. - GREATER OR EQUAL THAN 2 —> COMPANY IS NOT INVESTING EXCESS ASSETS. RULE OF THUMB: BEST VALUE BETWEEN 1.3 AND 1.9 FINANCIAL STATEMENTS: 1. BALANCE SHEET 2. INCOME STATEMENT 3. STATEMENT OF RETAINED EARNINGS STATEMENT OF RETAINED EARNINGS • FINANCIAL STATEMENT THAT SUMMARIZES THE CHANGES IN THE AMOUNT OF RE DURING A PARTICULAR PERIOD OF TIME. • RE = COMPONENT OF STOCKHOLDERS’ EQUITY IN THE BALANCE SHEET. • RE = PORTION OF NET INCOME NOT DISTRIBUTED AS DIVIDENDS AMONG SHAREHOLDERS, BUT IT IS RETAINED IN THE BUSINESS FOR VARIOUS REASONS, LIKE FUTURE GROWTH AND TO PAY DEBTS. - NET INCOME —> RE INCREASE. - NET LOSS —> RE DECREASE. - DIVIDENDS ARE DISTRIBUTED —> RE DECREASE. USUALLY A COMPANY PREPARES: 1. INCOME STATEMENT (IS). 2. STATEMENT OF RE: AMOUNT OF RE AT THE END OF THE PERIOD TO BE SHOWN IN THE BS. 3. BALANCE SHEET (BS). - IS, BS = COMPULSORY. - STATEMENT OF RE = COMPULSORY FOR LISTED COMPANIES: FINANCIAL STATEMENTS HAVE THE AIM OF REDUCING INFORMATION ASYMMETRY BETWEEN COMPANIES AND INVESTORS. RE AT THE END = BEGINNING RE + NET INCOME - DIVIDENDS - NET LOSS FORMAT OF THE STATEMENT OF RETAINED EARNINGS COMPANY XXX STATEMENT OF RETAINED EARNINGS FOR THE YEAR ENDED DECEMBER 31, 2020 Beginning Retained Earnings XXX (Retained Earnings at the beginning of the period) Add: Net Income XXX (Subtract: Net Loss) _____________ Subtotal XXX Less: Dividends XXX _____________ Retained Earnings at the end of the period XXX _____________ _____________ • STATEMENT OF RE STARTS WITH BEGINNING BALANCE OF RE. • NET INCOME IS ADDED OR NET LOSS IS SUBTRACTED. • ANY DIVIDENDS DECLARED DURING THE PERIOD (whether paid or not) ARE SUBTRACTED. • RE AT THE END OF THE PERIOD (SE SECTION OF THE BS). MORE COMPLEX SE —> DETAILS OF NET INCOME OR NET LOSS. FINANCIAL RATIO ANALYSIS AFTER COMPUTING THE FINANCIAL RATIOS AND COMMENTING ON EACH OF THEM, IT IS IMPORTANT TO PROVIDE A GENERAL PICTURE OF THE COMPANY, HENCE TO READ THE RATIOS TOGETHER BY CONNECTING THEM. THIS IS ONE OF THE HARD PARTS OF THE FINANCIAL ANALYST’S JOB! TWO TOOLS THAT CAN HELP THE FINANCIAL ANALYST: 1. THE CASH CONVERSION CYCLE AND THE OPERATING CYCLE 2. THE DU PONT ANALYSIS CASH CONVERSION CYCLE (CCC) OR CASH CYCLE • LENGTH OF TIME TO CONVERT RESOURCES INPUTS INTO CASH FLOWS. • TIME SPAN BETWEEN A FIRM’S DISBURSING AND COLLECTING CASH. • AMOUNT OF TIME NEEDED TO SELL INVENTORY, TO COLLECT RECEIVABLES AND THE TIME THAT COMPANY IS AFFORDED TO PAY ITS BILLS. • USEFUL TO EVALUATE THE EFFICIENCY AND OVERALL HEALTH OF THE COMPANY. CCC = DIO + DSO - DPO - DIO = DAYS INVENTORY OUTSTANDING = DAYS TO SELL INVENTORY —> SMALLER IS PREFERRED! - DSO = DAYS SALES OUTSTANDING = DAYS TO COLLECT ON SALES —> SMALLER IS PREFERRED! - DPO = DAYS PAYABLE OUTSTANDING = COMPANY’S PAYMENT OF BILLS, ITS ACCOUNTS PAYABLE —> THE LONGER DPO, THE BETTER —> THE COMPANY HOLDS ONTO CASH LONGER, INCREASING ITS INVESTMENT POTENTIAL. THIS CYCLE MEASURES THE EFFECTIVENESS OF A COMPANY’S MANAGEMENT: HOW FAST A COMPANY IS IN CONVERTING CASH ON HAND INTO INVENTORY AND ACCOUNTS PAYABLE THROUGH SALES. —> INVENTORY —> PAYING —> SELLING —> THE SHORTER THE CCC, THE BETTER-MANAGED THE COMPANY. THE CYCLE CAN BE APPLIED TO FIRMS THAT BUY AND SELL ON ACCOUNT, NOT CASH-ONLY FIRMS. THE CCC SHOULD BE COMBINED WITH OTHER METRICS: ROE AND ROA. THE DU PONT ANALYSIS / RATIO / IDENTITY • METHOD OF PERFORMANCE MEASUREMENT STARTED BY DUPONT CORPORATION IN 1920s. • METHOD FREQUENTLY USED BY ANALYSTS. • SNAPSHOT VIEW OF THE OVERALL PERFORMANCE (WEAKNESSES AND STRENGTHS) OF A FIRM IN 3 OF THE CRITICAL AREA OF RATIO ANALYSIS: PROFITABILITY, EFFICIENCY, LEVERAGE. IT FOCUSES ON RETURN ON EQUITY (ROE) = (NET INCOME / AVERAGE SE) X 100 —> AMOUNT OF NET INCOME RETURNED AS A PERCENTAGE OF SE. ROE = (NET INCOME/SALES) X (SALES/AVERAGE TOTAL ASSETS) X (AVERAGE TOTAL ASSETS/AVERAGE SE) - NET INCOME / SALES = PROFITABILITY. - SALES / AVERAGE TOTAL ASSETS = ASSET USE EFFICIENCY TO GENERATE SALES. - AVERAGE TOTAL ASSETS / AVERAGE SE = LEVERAGE —> HIGH LEVERAGE MEANS THAT A LARGE PORTION OF ASSET FINANCING IS ATTRIBUTED TO DEBT. THE STATEMENT OF CASH FLOW / CASH FLOW STATEMENT • ANOTHER IMPORTANT FINANCIAL STATEMENT. • FOCUS ON CASH THAT IS ESSENTIAL AND REFLECTS A FIRM’S LIQUIDITY. • HOW THE COMPANY GENERATE THE AMOUNT OF CASH OF THE BALANCE SHEET. • IT IS A SNAPSHOT AT A SINGLE POINT IN TIME AND CONTAINS INFLOWS AND OUTFLOWS OF CASH. • IN 1987 IN THE US: IT BECAME A REQUIREMENT FOR PUBLICLY TRADED COMPANIES. • IT EXPLAINS THE CHANGES THAT OCCUR IN A FIRM’S CASH BALANCE IN A YEAR: • FIRMS PREFER TO HOLD LARGE AMOUNTS OF CASH —> UNFORESEEN NEEDS (ECONOMIC CRISIS). • FIRMS NOT HOLD AMONTS OF CASH —> CASH NOT PROVIDE ANY OR SMALL RETURN. • FIRM WHICH LOSE TOO MUCH CASH: - BANKRUPT. - EVEN IF THE FIRM IS LOSING MONEY, IF IT HAS FUTURE PROSPECTS AND IT SEEKS COURT AND LAW PROTECTION FROM CREDITORS. SO DOING, THE FIRM MAY NEGOTIATE ITS DEBT AND REORGANIZE ITS BUSINESS. STATEMENT OF CASH FLOW (SCF): - FINANCING CASH FLOW - INVESTING CASH FLOW - OPERATING CASH FLOW SCF USEFUL TO: 1) ANALYZE RELATIONSHIP BETWEEN NET INCOME AND CASH. 2) PREDICT FUTURE CASH FLOWS. 3) SEE IF THE GENERATION AND USE OF CASH IS EFFICIENT. 4) SEE IF THE COMPANY IS ABLE TO PAY INTERESTS, DEBTS, DIVIDENDS. CASH: 1. CURRENCY 2. BANK ACCOUNTS 3. CASH EQUIVALENTS = short-term investments that you can easily and quickly convert into cash. THE SCF SUMMARIZE THE CASH FLOWS USED BY EACH OF THE 3 TYPES OF ACTIVITIES, WHICH AFFECT CASH: OPERATING, FINANCING AND INVESTING. 1. OPERATING ACTIVITIES = DAY-TO-DAY ACTIVITIES THAT GENERATE REVENUES AND EXPENSES. 2. FINANCING ACTIVITIES = ACTIVITIES IMPLEMENTED TO OBTAIN RESOURCES BY BORROWING OR SELLING SHARES AND USE THEM TO REPAY CREDITORS OR GIVE A RETURN TO SHAREHOLDERS. 3. INVESTING DECISIONS = CONCERN LONG-LIVE ASSETS. INTERNATIONAL COMPANY —> SCF SHOWS THE EFFECT OF THE EXCHANGE RATE ON CASH. US GAAP: - Interest payments = OPERATING - Dividend payment = FINANCING IFRS: - Interest payments can also be financing, if and only if borrowing is not a common activity for the company. THE INDIRECT METHOD • IT SHOWS HOW NET CASH FLOW FROM OPERATING INCOME DIFFERS FROM NET INCOME. • IF CASH FROM OPERATING ACTIVITIES > NET INCOME —> NET INCOME IS OF HIGH QUALITY, BECAUSE IT IS ACTUALLY TURNING INTO CASH. • POPULAR METHOD: INFORMATION IS RELATIVELY EASY TO ASSEMBLE. • HOWEVER, IT IS LESS FAVORED BY THE STANDARD-SETTING BODIES: NOT GIVE A CLEAR VIEW OF CASH FLOWS THROUGH A BUSINESS THAT IS SHOWN UNDER DIRECT METHOD WHICH PROVIDES MORE INFO FOR EXTERNAL USERS. 1. START WITH: NET INCOME OR NET LOSS FROM INCOME STATEMENT. 2. ADD OR SUBTRACT: ADJUSTMENTS FOR NON-CASH ITEMS SINCE ARE CALCULATED INTO NET INCOME. 3. FIND: NET INCOME PROVIDED BY AND USED FOR OPERATING ACTIVITIES. 4. FROM NET INCOME, MAKE: ADJUSTMENTS IN ORDER TO ARRIVE TO CASH AMOUNTS. 5. EACH SALE WILL RESULT IN CASH INFLOWS AND EACH EXPENSE IN CASH OUTFLOWS. 6. IF, ON THE CONTRARY, ALL REVENUES AND EXPENSES WERE PAID IN CASH, CASH FLOW FROM OPERATING ACTIVITIES = NET INCOME. NET INCOME = CASH FLOW FROM OPERATING ACTIVITIES IF ALL REVENUES ARE EQUAL TO CASH INFLOWS AND ALL EXPENSES ARE EQUAL TO CASH OUTFLOWS. 7. AS A RESULT: ADJUSTMENTS FOR THE TIME DIFFERENCE BETWEEN REVENUES AND CASH INFLOWS AND BETWEEN EXPENSES AND CASH OUTFLOWS. 8. NON OPERATING LOSSES ARE ADDED BACK TO NET INCOME, WHILE NON OPERATING GAINS ARE SUBTRACTED. INDIRECT METHOD CONVERTS NET INCOME FROM THE ACCRUAL BASIS INTO THE CASH BASIS BY MAKING ADJUSTMENTS. GENERAL RULE OF THUMB USED TO PREPARE AN INDIRECT CASH FLOW STATEMENT: - ↑ ASSET: ↓ CASH. - ↓ ASSET: ↑ CASH. - ↑ LIABILITY: ↑ CASH. - ↓LIABILITY: ↓ CASH. - ↑ EXPENSE: ↑ CASH (ex. depreciation). - ↑ REVENUE: ↓ CASH (ex. accounts receivable). —> LIABILITIES WORKS IN THE OPPOSITE WAY OF THE ASSETS HOW CHANGES IN THESE ACCOUNTS AFFECT CASH IN ORDER TO IDENTIFY WHAT WAY INCOME NEEDS TO BE ADJUSTED. DEPRECIATION: - IT DOES NOT INVOLVE A CASH OUTFLOW PER SE. - IT IS A NON-CASH ITEM IN ACCOUNTING, BUT IT IS SPECIAL BECAUSE RELATED TO AN INVESTING ACTIVITY. THE CASH FLOW FROM OPERATING ACTIVITIES TELLS IF THE COMPANY HAS GENERATED CASH OR IF IT NEEDS A CASH INFUSION: - A FEW PERIODS OF NEGATIVE CASH FROM OPERATING ACTIVITIES IS NOT A REASON OF ALARM IF IT IS BASED ON PLANS FOR COMPANY GROWTH OR DUE TO A PLANNED INCREASE IN RECEIVABLES OR INVENTORIES. - IF NEGATIVE CASH FLOW FROM OPERATING ACTIVITIES IS A SURPRISE TO MANAGERS AND OWNERS, IT MAY BE UNDESIRABLE. - IF UNCORRECTED OVERTIME —> BUSINESS FAILURE. - PAY ATTENTION TO INCREASES IN ACCOUNTS RECEIVABLE. BOTH USING THE INDIRECT AND DIRECT METHOD, WE END UP WITH NET CASH FLOW FROM OPERATING ACTIVITIES! INVESTING ACTIVITIES • LIST CASH FLOWS FROM THE PURCHASE OR SALE OF PLANT, PROPERTY, EQUIPMENT AND OTHER LONG-LIVE ASSETS. • INVESTING ACTIVITIES ARE USED TO GENERATE REVENUES OVER A LONG PERIOD OF TIME. • CASH FLOW FROM INVESTING ACTIVITIES IS IMPORTANT IN CAPITAL-HEAVY INDUSTRIES THAT REQUIRE LARGE INVESTMENTS. RULE OF THUMB: • SALE —> INCREASES IN CASH. NO PARENTHESIS ( ). • PURCHASE —> DECREASES IN CASH. YES PARENTHESES ( ). CAPITAL EXPENDITURE / CAPEX! FINANCING ACTIVITIES • CASH FLOWS FROM AND TO PROVIDERS OF CAPITAL. • FINANCING ACTIVITIES: - BORROWING (MAINLY) - REPAYING MONEY - ISSUING STOCK - PAYING DIVIDENDS • THE SECTION OF FINANCING ACTIVITIES OF THE SCF MEASURES THE FLOW OF CASH BETWEEN A FIRM AND ITS OWNERS AND CREDITORS: - POSITIVE —> CASH INFLOW. - NEGATIVE —> CASH OUTFLOW. RULE OF THUMB: • INCREASE IN LIABILITIES AND PAID-IN CAPITAL (SALE) → INCREASE IN CASH • DECREASE IN LIABILITIES AND PAID-IN CAPITAL (REPURCHASE, PAYMENT) → DECREASE IN CASH US-BASED COMPANIES —> GAAP. OVERSEAS COMPANIES —> IFRS. NET CASH PROVIDED BY / USED BY FINANCING ACTIVITIES BEFORE THE LAST STEP, ANOTHER ONE THAT RARELY OCCURS: COMPANIES REPORT NON-CASH INVESTING AND FINANCING ACTIVITIES, SO INVESTING AND FINANCING ACTIVITIES WHICH NOT AFFECT CASH. NEVERTHELESS, THEY ARE IMPORTANT INVESTING AND FINANCING DECISIONS, IN FACT STAKEHOLDERS WANT TO BE INFORMED ABOUT THEM. COMPANIES LIST THEM IN A SEPARATE SCHEDULE: SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES. ENDING CASH BALANCE COINCIDE WITH THE CONTROL FIGURE. TO EVALUATE AND COMMENT ON A SCF, ANALYZE THE SCF OF DIFFERENT YEARS. ANALYSTS PAY ATTENTION TO THE ENDING CASH BALANCE, BUT ABOVE ALL TO THE RELATIVE WEIGHTS OF OPERATING, INVESTING AND FINANCING ACTIVITIES. LIMITS OF THE SCF: - COMPLEX ACCOUNTING STATEMENT (especially when the indirect method is used). - SNAPSHOT AT A CERTAIN POINT IN TIME, BUT CASH CHANGES EXTREMELY QUICKLY! - IT NEEDS TO BE WRITTEN AT LEAST EVERY 3 MONTHS. - WHEN CASH MANAGEMENT DELEGATED BY OWNER TO SOMEONE ELSE, THIS STATEMENT IS ALSO USED FOR MONITORING AND SUPERVISING. - A FIRM CANNOT SURVIVE: WITHOUT PROPER CASH MANAGEMENT AND WITHOUT KNOWING HOW FAST THE FIRM IS GROWING. - IMPORTANT TO CONSIDER SECTIONS THAT CONTRIBUTE TO THE OVERALL CHANGE IN CASH POSITION (NEGATIVE OR POSITIVE). - ANALYZING CASH FLOW STATEMENT = EXTREMELY VALUABLE, BECAUSE IT PROVIDES A RECONCILIATION OF THE BEGINNING AND ENDING CASH ON THE BS. THE STATEMENT OF CASH FLOWS AND THE BALANCE SHEET EQUATION
 THE BALANCE SHEET EQUATION IS THE BASIS OF ALL FINANCIAL STATEMENTS: ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY
 (CASH + NON-CASH ASSETS) = Liabilities + Stockholders’ Equity CASH = Liabilities + Stockholders’ Equity ̶Non cash Assets ANY CHANGE IN CASH MUST BE ACCOMPANIED BY A CHANGE IN ONE OR MORE ITEMS ON THE RIGHT SIDE, IN ORDER TO KEEP THE EQUATION BALANCED: ΔCash = ΔLiabilities + ΔStockholders’ Equity ̶ΔNon-cash Assets CHANGE IN CAHS = CHANGE IN ALL NON-CASH ACCOUNTS THE SCF EXPLAINS THE CHANGES IN NON-CASH ACCOUNTS. DIRECT METHOD = INDIRECT METHOD - DIRECT METHOD = LISTING OF ALL CHANGES IN CASH. - INDIRECT METHOD = SHOWS THE REASONS BEHIND THOSE CHANGES. THE STATEMENT OF CASH FLOWS AND THE INCOME STATEMENT PROVIDE IMPORTANT AND DIFFERENT INFORMATION: • BOTH EVALUATE THE COMPANY’S PERFORMANCE. • INCOME STATEMENT: MATCHES REVENUES AND EXPENSES USING THE ACCRUAL BASIS + SHOWS THE CHANGES IN SE. • SCF: EXPLAINS THE CHANGES IN THE CASH ACCOUNT + ALLOWS TO COMPARE THE CASH FLOW FROM OPERATING, INVESTING AND FINANCING ACTIVITIES. FREE CASH FLOW FREE CASH FLOW = NET CASH FLOW FROM OPERATIONS - CAPITAL EXPENDITURE • IT CAN BE DEFINED AS THE CASH FLOW REMAINING AFTER UNDERTAKING THE FIRM’S OPERATIONS AND THE INVESTMENTS NECESSARY TO CONTINUE ITS OPERATIONS. • IF THE CASH FLOW IS NOT ENOUGH TO COVER ITS INVESTMENT, THE COMPANY SHOULD INCREASE CAPITAL. • IF INVESTMENT IS PART OF A SPECIFIC GROWTH PLAN —> NEGATIVE FREE CASH FLOWS MAY BE ACCEPTABLE. • ON THE CONTRARY, IF INVESTMENTS ARE NEEDED TO MAINTAIN THE STATUS QUO —> NEGATIVE FREE CASH FLOWS REQUIRE ACTION. • DURING THE RECENT ECONOMIC CRISIS, MANY COMPANIES HAVE HAD NEGATIVE FREE CASH FLOWS AND HAVE SOLD ASSETS TO INCREASE THEIR CASH FLOWS.