Foundations of Finance and Accounting

So this then brings us to the 4 Financial Statements. Okay? The 4 Financial Statements that we use in accounting, and of course we also use in finance. Now, what’s often considered the first of these statements, although they really aren’t in any particular order, is the balance sheet. Okay, the balance sheet, as I mentioned, is Assets equals Liabilities plus Equity. The balance sheet, and the balance sheet is a snapshot of a company at any given moment in time. So right now you could go to any company, anywhere on Earth, assuming they have their books up to date, and just print up a balance sheet. Right? Or bring it up on the computer screen, and it tells you where that company is at that particular moment. Now, if it’s a global company and constantly doing business, the very next moment it’s already changed. Okay, but that’s where that business was at that moment. So balance sheets usually say, okay, as of, you know, year ending December 31st, 2014. Right? So they’ll say, as of a specific date, that’s where the balance sheet is. And so, of course, quarterly statements that are published, it’s at the end of every quarter we’re gonna see the balance sheet of that business. And the balance sheet is the, the personification as it were, the manifestation of accounting. Okay? Well if the balance sheets shows us the accounting equation, then no sheet out there better shows us the financial equation than the Income Statement.

Okay. The Income Statement is different than the balance sheet in a couple of ways, well, in every way really. But primarily the balance sheet, remember it’s a snapshot? The Income Statement takes place over a period of time. And that period of time depends on you. What do you want? You can run an Income Statement from the very first transaction that was ever conducted in the business. It’s not often you do that, but you can do it. More often what we do is, we do Income Statements for quarters and Income Statements for a year. So for the year ending, so what was the income generated by that business that year. What were all the revenues minus all the expenses generating the income. Okay, so we do that quarterly. What’s the income for the quarter? What’s the income for the year? We specify the duration, the time frame that we’re gonna look at. And then during that time frame, the Income Statement, it lists all of the different sources of revenues, all of the different sources of costs and subtracts the costs from the revenues, arrives at the income. How much money did we make? Now these are really the two principal financial statements. Okay? Balance Sheet, Income Statement. Now I’ve got another one. My personal favorite the cash flow statement.

Cash Flow Statement tracks our cash.

The actual, as it says, the Cash Flow Statement, the flows of cash. You see, because as we’re gonna learn a little bit later, the reporting of income. Okay when income is generated, when costs are occurred. Things like that, don’t necessarily match the flow of cash. I could just take my own business for an example. I have a retail business, and so I sell things to the public. As such, I have to charge a tax, or a, or a VAT, right? Now, I have to pay that tax to my local government on a quarterly basis. So, every three months, I have to send a decent size check over to the state of California and send them all of the income, I’m sorry, all of the sales tax that I have collected during that period. So, the, the sales tax that I collect is not income. It doesn’t belong to me. I collect it, but it belongs to the state. I collect it, nonetheless, and it goes into my accounts, nonetheless. On my cash flow statement, we are going to see this. We are going to see the cash coming in. It’s, you are going to see it accrue, accrue, accrue for three months. Then every three months, I pretty much empty that account out and it goes off to the state, pay off what I owe the state. We see that in the cash flow statement. We’re not going to see that in the income statement. Right? Because tax is not an income to me. It doesn’t go anywhere on my income statement. The tax that I pay is a cost on my income statement. so you’ll see that down below. But you’ll never see on my income statement, the inflow of cash of, of, of tax into my business. Okay? So, another thing that we often do in business is we depreciate things that we buy. So if I buy a truck for my business and I expect to use that truck for five years, I’m gonna depreciate that truck over five years.

And I’m gonna speak about this a little bit more when we talk about the, the the rules and the guidelines of accounting.

But just as the basic example, I have to pay for that truck either up front if I buy it all cash or I pay for it during the time that I finance it for. And you’re gonna see the outflow of cash as I pay for it. And maybe I finance it, so I finance it for three years. But I put, maybe the truck, the truck is $30,000. I put $10,000 in cash down. The cash goes out. And then I pay for that truck over three years. So over three years, the cash goes out. But on my income statement, I’m equally going to divide the cost of that truck over five years.

So, you’re not gonna see that big $10,000 deposit, that outlay of cash. You’re not gonna see that on the income statement. You are gonna see it in the statement of cash flows. So although income is a driver of cash the income statement and the cash flow statement can differ and sometimes significantly. This is the reason we have the cash flow statement. One is to show us the income our business is doing, that’s the income statement. The income that we’re getting, or the loss that we’re getting. The other one is showing us the cash that we have, and the cash that we have on hand, and that’s very important. Because I need that cash for certain things. I’ve got to pay creditors. I’ve got to pay salaries. I’ve got to make sure I have the cash. When salaries are due, my employees don’t care that I was profitable last month. Where’s the cash, where’s their paycheck? Okay, that’s what they’re interested in. The final financial statement actually goes by many different names. It’s kind of funny. I call it Shareholder’s Equity. It can be called the statement of retained earnings. It’s got a lot of different names out there, depending on on where you go. But basically, this is the statement that shows us the nature of the equity that we have in the company. So, assets equal liabilities plus equity. [SOUND] So what is that equity? And what form is that equity in? And what were the changes in that equity? The equity is the ownership of the company. So if it’s a publicly traded company, how many shares were bought, or sold, or, or issued?

How much money has been paid into the company? How much money, how much of the ownership has been taken out of the company? In a typically traded company on the stock market, the payment of dividends

is the returning of equity to the owners.

Right? So the company has generated an ownership value of a certain amount and they want to pay that back to the owners, or pay a portion back to the owners. So that’s gonna come out of the equity of the company.

So the the statement of retained earnings or the statement of shareholder’s equity basically shows us the nature, that the amount and the nature of the equity. So is it owned by one person, by many people?

Is it in common stock? Preferred stock, etc., etc.? The different kinds of ownership that can occur within a company, it shows us that and it shows us how it’s changing from period to period. So those are the 4 Financial Statements. The the Balance Sheet, the Income Statement, the Cash Flow Statement and the Statement of Shareholder’s Equity or the statement of returned, retained earnings. And these are the statements that we use in analyzing, evaluating companies and doing our, our accounting. Accounting is the department that puts those statements together. And then finance often uses those statements to evaluate the business to see how the business is doing, to run the different ratios. And and investors use those statements to make their investment decisions.