Week 5 Writing Assignment:
In 600-750 content words, respond to the following:
Managers within the firm, as well as the firm’s owners and lenders, keep track of the firm’s performance by reviewing its financial statements – income statement, balance sheet, and statement of cash flows.
• What is the purpose of the income statement? Identify the major types of expenses that are shown on the typical income statement.
• What is the purpose of the balance sheet? Identify the major types of assets and the claims of creditors and owners shown on the typical balance sheet.
• What are the three different accounts that comprise the owners’ equity section on a typical corporate balance sheet?
• What is a statement of cash flows? Describe the three standard sections contained in a statement of cash flows.
• Identify the three categories of ratios that a business may use in an analysis of its financial statements. Describe the benefits of calculating these ratios.
Use the template provided. Follow APA format, including a title page, introduction, conclusion, citations, and two references. See the attached PPT file. Turnitin is required.
The income statement reports the revenues generated and expenses incurred by a firm over an accounting period, such as a quarter or year. The accrual concept is used to construct the income statement. Table 13.4 presents income statements for the Walgreens for 2012 and 2011. In 2012, Walgreens had net revenues of $71.6 billion compared with $72.2 billion for 2011, which reflects a decrease of less than 1 percent. After deducting production costs and other expenses incurred in running the business, Walgreens’ net income was $2127 million in 2012, almost a 22 percent decrease over 2011’s net income of $2714 million.
reports the revenues generated and expenses incurred by the firm over an accounting period, such as a quarter or a year
Let’s look at some of the major income statement accounts in greater detail. The starting point of the income statement reflects the revenues or sales generated from the operations of the business. Often, gross revenues are larger than net revenues. This is due to sales returns and allowances that may occur over the time period reflected in the income statement. Sometimes when customers make early payment on their bills, cash discounts are given by the firm. If customers buy in large quantities, trade discounts may be given. Thus, discounts will reduce gross revenues.
The costs of producing or manufacturing the products sold to earn revenues are grouped under cost of goods sold (COGS). These expenses reflect costs directly involved in production, such as raw materials, labor, and overhead and, thus, vary with the level of production output.
Selling, general, and marketing expenses tend to be stable or fixed in nature and cover requirements such as recordkeeping and preparing financial and accounting statements. These expenses reflect the costs associated with selling the firm’s products. This includes salaries and/or commissions generated by the sales force as well as promotional and advertising expenditures.
TABLE 13.4: Income Statements for Walgreens ($ millions)
Cost of Goods Sold
Selling, General & Administrative Expense
Other Expenses (Income)
INCOME BEFORE TAXES
Earnings per share (as reported)
Weighted Avg. Shares Outstanding (’000)
Depreciation is an estimate of the reduction in the economic value of the firm’s plant and equipment caused by manufacturing the firm’s products. It is for the time period covered by the income statement. This one-time period depreciation is accumulated over time, and the accumulated depreciation appears in the balance sheet. No cash outflow is associated with depreciation, so depreciation is considered to be a noncash expense.
Operating income is a firm’s income before interest and income taxes and is sometimes referred to as earnings before interest and taxes (EBIT).
Interest expense is subtracted from operating income. When a portion of a firm’s assets are financed with liabilities, interest charges usually result. This is true for bank loans and long-term corporate bonds. Operating income less interest expense gives the firm’s pretax earnings, or earnings before taxes.
Businesses are required to pay federal income taxes on any profits. Most states tax business profits. Taxable earnings or profit are defined as income remaining after all other expenses have been deducted from revenues except income taxes. Effective income tax rates can vary substantially depending on whether the firm is organized as a proprietorship, partnership, or corporation. More information on taxes appears in this chapter’s Learning Extension.
The net income or profits remaining after income taxes are paid reflects the earnings available to the owners of the business. This income may be retained in the business to reduce existing liabilities, increase current assets, and/or acquire additional fixed assets. On the other hand, some or all of the income may be distributed to the owners of the business.
Because of accrual accounting, a firm’s net income over some period may not be the same as its cash flow. The amount of cash flowing into the firm can be higher or lower than the net income figure.
For a corporation, a firm commonly shows its net income on a per-share basis. This is referred to as the earnings per share (EPS) and is calculated by dividing the net income by the number of shares of common stock that are outstanding. For Walgreens, EPS decreased from $2.94 in 2011 to $2.42 in 2012. This is an 18 percent decrease, less than the percentage decrease in net income, as the number of shares outstanding fell by about 5 percent during the year.
In some instances, corporations have preferred and common stockholders. Dividends are paid to these “preferred” stockholders out of net income; the remaining earnings are called income available to common stockholders. For example, if Walgreens had paid $200 million in preferred stock dividends in 2012, the remaining earnings available for common stockholders would have been $1,927 million and the EPS to common stockholders would have been $2.19 ($1,927 million/880,100,000 shares).
What does the income statement measure for a firm?
Describe the items found in a typical firm’s income statement.
Corporations frequently pay cash dividends to their common stockholders. The percentage of net income or earnings paid out as dividends is referred to as the dividend payout ratio. For example, in 2012, Walgreens paid common stock dividends of $787 million (this figure is given in Table 13.6); this represents a dividend payout ratio of 37.0 percent. The remaining earnings are retained in the business. On a per-share basis, the dividends per share (DPS) in 2012 would be about $0.89 ($787 million/880,100,000 shares).
THE BALANCE SHEET
The balance sheet is a statement of a company’s financial position as of a particular date, usually at the end of a quarter or year. Whereas the income statement reflects the firm’s operations over time, the balance sheet is a snapshot at a point in time. It reveals two broad categories of information: (1) the assets or the financial and physical items owned by a business and (2) the claims of creditors and owners in the business assets. The creditors’ claims, which are the financial obligations of the business, are referred to as liabilities. The company’s equity is the funds supplied by the owners and represents their residual claim on the firm.
statement of a company’s financial position as of a particular date, usually at the end of a quarter or year
financial and physical items owned by a business
creditors’ claims on a firm, which are the financial obligations of the business
funds supplied by the owners and represents their residual claim on the firm
In addition to providing a snapshot of a firm’s financial condition, the balance sheet reveals much of the inner workings of the company’s financial structure. The various types of assets indicate the results of recent business operations and the capacity for future operations. The creditors’ claims and the owners’ equity in the assets reveal the sources from which these assets have been derived. The term balance sheet indicates a relationship of equality between the assets of the business and the sources of funds used to obtain them that may be expressed as follows:
Assets = Liabilities + Owners equity
This “balance sheet equation” or “accounting identity” shows that every dollar of a firm’s assets must be financed by a dollar of liabilities (typically some type of credit or borrowing), a dollar of owner’s equity, or some combination of the two. The firm’s asset total shows what the firm owns; the total of liabilities and equity shows what the firm owes to its creditors and owners.
The balance sheet for the Walgreens shown in Table 13.5 reveals this equality of assets and the financial interests in the assets. Total assets were $33,462 million in 2012, a 22 percent increase over 2011’s asset level of $27,454 million.
Total liabilities increased from $12,607 million to $15,226 million, which is a 21 percent increase. Owner’s equity, which for Walgreens is stockholders’ equity, provided the balancing figure with $18,236 in 2012 and $14,847 in 2011. This was an increase of about 23 percent.
Assets that are most liquid are typically listed first. By liquidity, we mean the time it usually takes to convert the assets into cash. Two broad groups are identified on the balance sheet: current assets and fixed assets.
TABLE 13.5: Balance Sheets for Walgreens ($ millions)
Cash & Cash Equivalents
Other Current Assets
Total Current Assets
Net Fixed Assets
Other Long-Term Assets, Goodwill
Other Current Liabilities
Total Current Liabilities
Common Equity and Retained Earnings
TOTAL LIABILITIES & EQUITY
The current assets of a business include cash and other assets that are expected to be converted into cash within one year. Current assets, thus, represent the working capital needed to carry out the normal operations of the business. The principal current assets of a business are typically its cash and marketable securities, accounts receivable, and inventories.
Melicher, Ronald W., Edgar Norton. Introduction to Finance: Markets, Investments, and Financial Management, 15th Edition. Wiley, 2013-10-21. VitalBook file.