CHAPTER 1 – FINANCIAL STATEMENTS AND BUSINESS DECISIONS

Understanding The Business

THE PLAYERS * When starting new businesses, founder can also be manager, called owner-manager * Starting off requires loaning money from banks and others, called creditors, and off of investors who buy small percentages of large corporations * Investors hope to receive a portion of company earnings in cash called dividends * Also hope to sell share for more than bought * Creditors lend money for a certain amount of time and get paid interest. * When org exchanges money w/creditor or investor is called financing activities. When org buys property (like equipment) is called investing activities

THE BUSINESS OPERATIONS * Purchase ingredients from suppliers produce product sell product to customers collect cash and pay suppliers

THE ACCOUNTING SYSTEM * Managerial or management accounting is used by internal decision makers (like managers) b/c needs more continuous detailed financial info * Financial accounting is used by external decision makers (like investors), which is less detailed but captures overall org financial info. Will study this in course.

The Four Basic Financial Statements: An Overview

- Usually orgs prepare financial statements at end of each quarter (quarterly reports) and end of year (annual reports)

THE STATEMENT OF FINANCIAL POSITION * Purpose of the statement of financial position is to report financial position (assets, liabilities, and shareholder’s equity) of accounting entity at a particular point in time * Structure: * The heading of the statement identifies: * Name of entity * Title of statement * Specific date of the statement * Unit of measure * Basic accounting equation: Assets = Liabilities + Shareholder’s Equity * Assets = economic resources controlled legally by entity * Liabilities and shareholder’s equity = claims against company’s economic resources. Financing by creditors is liability, and financing by owners is owners’ equity * Thus the basic equation show financial position, how much company owns and sources of financing resources * Elements: * Assets are economic resources controlled by entity and which future benefits can be obtained * In Nestle example, had 8 items under assets: * Cash, land, plant and equipment, prepayments (i.e. insurance protection), inventories, trade receivables (sells on credit and gets cash later), investments, intangible assets (like other brands), and other assets * Every asset is initially measured at cost incurred to acquire it, once after acquisition, are reported at values that reflect benefits company expects to get * Liabilities are the entity’s legal obligations resulted from past business events * In Nestles example had 7 liabilities: * Trade payables (purchase of goods from suppliers on credit w/o formal contract), short-term borrowings, income tax payable (to gov’t tax), accrued liabilities (owed to suppliers for rent, utilities etc.), long-term borrowings, provisions (estimated amounts payable in future but exact amount depends), and other liabilities * Shareholder’s equity 1. Share capital – investment of cash/assets in biz by owners for shares 2. Retained earnings – earnings in biz not for dividends 3. Other components * A Note On Format: * Assets may be listed in decreasing or increasing order based on liquidity (cash most liquid) * Liabilities can too, based on date of maturity * Assets are important to creditors b/c a basis for judging whether the company has sufficient resources available to operate the business. Creditors interested in debts shows whether or not the company has sufficient sources of cash to pay its debt obligations. Shareholders' equity important to creditors because, legally,