Week 1 Discussion
Discussion Question 1:
There are several different groups that use financial ratio analysis. Who are these groups and what are the primary concerns of each? Justify your answer.
Financial Statements
All of the �nancial statements used have a different importance. Many people consider the income statement the
most important of the four �nancial reports, because it conveys whether a business achieved its pro�tability goal;
in other words, whether the company earned an acceptable level of income or beat the targeted goal. Sometimes,
this is referred to as “making your numbers.”
The balance sheet is frequently viewed as runner-up to the income statement in terms of importance. However,
this statement shows the company’s �nancial status at a speci�c date and indicates how effectively assets are
being managed to generate returns. This report is unique in that it presents a view of a business as a holder of
resources (assets) that are equal to the claims against those assets. The claims consist of the company’s liabilities
and the owner’s equity in the company.
The statement of cash �ows focuses mainly on a company’s liquidity versus a company’s pro�tability or �nancial
position. Cash �ows are nothing more than the in�ows and out�ows of cash in and out of a company. The
statement of cash �ows illustrates the cash produced by business operations during an accounting period, as well
as vital investing and �nancial activities that occurred during the same period. Keep in mind that this statement
uses the cash basis method of accounting. Most corporations use accrual based accounting, so the statement of
cash �ows may be the only place you can determine the current cash situation.
The statement of owners’ equity portrays the changes in owners’ equity over an accounting period. Typically, net
income/loss is added/subtracted from the beginning retained earnings balance. Any withdrawals or dividends
that were paid are deducted from this total to determine the ending capital balance.
Each type of �nancial statement is used in a different way, depending on the needs of the user.
Income statement: Used to determine a company’s pro�tability
Balance sheet: Assesses whether the company has enough assets to cover any outstanding liabilities
Statement of cash �ows: Used by creditors to determine whether a company is liquid or not, because the
statement tracks in�ows and out�ows for operating, investing, and �nancing activities
Statement of owners’ equity: Breaks down a company’s capital and ownership accounts
Three Capitals of Finance
The �eld of �nance contains four interrelated areas: �nancial management (corporate �nance), �nancial markets
and institutions, international �nancial management, and investments.
Within those four areas, we focus upon three elements of capital: working capital, capital budgeting, and capital
structure.
Capital management is also known as operations. The �nancial statements associated with it are the balance
sheet, income statement, and statement of cash �ows. All current assets and current liabilities from sales to EBIT
operating activities are associated with capital management.
Capital budgeting is also known as planning and investing. The balance sheet and the statement of cash �ows are
the �nancial statements associated with this type of capital management. Long-term or �xed assets and investing
activities are the accounts associated with capital budgeting.
Capital structure is also known as �nancing. The �nancial statements associated with it are the balance sheet,
income statement, statement of cash �ows, and retained earnings or equity. Long-term liabilities and equity from
EBIT to net income �nancing activities are associated with capital structure.
The �nancial statements show the company’s operations and results in �nancial terms. Accountants create these
�nancial statements each accounting period to present the current results of company operations. These �nancial
statements are used internally and externally.
These are the four primary �nancial statements:
Income statement: describes a company’s revenues and expenses along with the resulting net income or
loss over a period. (Net income occurs when revenues exceed expenses. Net loss occurs when expenses
exceed revenues.)
Balance sheet: describes a company’s �nancial position (types and amounts of assets, liabilities, and equity)
at a point in time.
Statement of cash �ows: identi�es cash in�ows (receipts) and cash out�ows (payments) over a de�ned
period of time.
Statement of stockholders’ equity: explains changes in equity from net income (or loss) and from owner
investment and withdrawals over a de�ned period of time.
Finance
Finance is the study of the allocation of scarce resources. It includes elements of economic costs and bene�ts. The
resources we study include �nancial capital and economic capital.
Finance is dynamic because time is an important element. Financial decision-making uses signi�cant
commitments of resources, since decisions are being made about the future. Finance involves management—
information, risk, and uncertainty vary to complicate decisions on adding value to the �rm. The planning,
organization, leading, and controlling results affect a �rm’s objective of maximizing shareholder wealth.
Finance starts with �nancial accounting—the system of �nancial accounting (accrual accounting) and scorecards
of �nancial statements (i.e., the balance sheet, the income statement, and the statement of cash �ows). Tracking
and timing of revenue, expenses, earnings, and cash �ow are essential in accounting.
The accounting equation is:
Total Assets (TA) = Total Liabilities (TL) plus Owner’s Equity (OE)
Assets are what we use to create value, and they are �nanced by liabilities and equity. In the balance sheet the
right-hand side balances with the left-hand side of the equation. The accounts (current assets, long-term assets,
current liabilities, long-term liabilities, and equity) are measured as stock variables—a measure of the amount of
each item at a point in time.
Two key aspect of a balance sheet are:
1. The balance sheet is a picture of the �rm as of one point in time. It does not provide information for any
period of time.
2. The ordering of the accounts is according to decreasing liquidity (ease of conversion to cash).
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include course/text
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