$$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 3-1 Chapter 3

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Entrepreneurial Finance, 4th EditionBy Adelman and Marks

PRENTICE HALL©2007 by Pearson Education, Inc.Upper Saddle River, NJ 07458

3-1

Chapter 3

Financial Statements

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3-2

Understand how financial statements are used by businesses.

Understand the differences and similarities that exist between a personal cash flow statement and a business income statement.

Distinguish between fixed and variable expenses. Understand the changes in income statements that exist

with different forms of business.

Learning Objectives

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3-3

Understand the differences and similarities that exist between a personal statement of financial position and a business balance sheet.

Analyze the components of the basic accounting equation. Distinguish between assets and liabilities. Understand the relationship between fixed assets and

depreciation.

Learning Objectives (continued)

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3-4

Understand the significance of the statement of cash flows. Given the basic data for a company, be able to construct a

financial statement. Understand the problems that may exist with financial

statements.

Learning Objectives (continued)

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3-5

Financial Statement (Personal Form)

Single bank loan application form which incorporates two individual financial forms:› Statement of financial position

– Cash– Cash equivalents– Invested assets– Use assets – Liabilities– Net worth

› Personal cash flow statement– Income– Fixed expenses– Variable expenses

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3-6

NAME: SOCIAL SECURITY NO:

ADDRESS: BUSINESS PHONE: CITY, STATE, ZIP HOME PHONE:

SPOUSE NAME: SOCIAL SECURITY NO:ASSETS IN DOLLARS LIABILITIES: IN DOLLARS

CASH IN THIS BANK: CHECKING LOANS PAYABLE THIS BANK:

SAVINGS:

LOANS PAYABLE OTHER FINANCIAL

INSTITUTIONS: (SCHEDULE 6)

CASH IN OTHER FINANCIAL INSTITUTIONS:

ACCOUNTS PAYABLE OTHER FIRMS &

INDIVIDUALS: (SCHEDULE 6)CREDIT CARDS:

MARKETABLE STOCKS AND BONDS; (SCHEDULE 1) INCOME & OTHER TAXES PAYABLE:ACCOUNTS RECEIVABLE: (SCHEDULE 2) REAL ESTATE TAXES:

TOTAL CURRENT ASSETS TOTAL CURRENT LIABILITIES:NOTES OR MORTGAGES RECEIVABLE:

(SCHEDULE 3)

OTHER REAL ESTATE INDEBTEDNESS

(SCHEDULE 5):CASH SURRENDER VALUE LIFE INSURANCE:

(SCHEDULE 4)

LIFE INSURANCE LOANS:

(SCHEDULE 4)VEHICLES (YEAR & MAKE): OTHER LONG-TERM DEBTS: (DESCRIBE)

REAL ESTATE: (SCHEDULE 5)OTHER PERSONAL PROPERTY: TOTAL LIABILITIES:

TOTAL ASSETS:TOTAL ASSETS - TOTAL LIABILITIES = NET WORTH

ANNUAL INCOME: ANNUAL FIXED EXPENSES:GROSS SALARY: REAL ESTATE PAYMENTS: (SCHEDULE 3)

SPOUSE'S GROSS SALARY: RENTBONUSES & COMMISSIONS: INCOME TAXES:

INCOME FROM SECURITIES: (SCHEDULE 1) PROPERTY TAXES:RENTAL OR LEASE INCOME (SCHEDULE 3) ALIMONY, CHILD SUPPORT:

MORTGAGES OR CONTRACT INCOME (SCHEDULE 3) INSURANCE PREMIUMS:OTHER INCOME (DESCRIBE): OTHER (DESCRIBE):

TOTAL GROSS INCOME: TOTAL ANNUAL EXPENSES:LESS - TOTAL EXPENSES:

NET CASH INCOME:

Table 3 -1, Financial Statement, Personal Form

FINANCIAL STATEMENT Personal FormFIRST ANY KIND OF BANK: OFFICE:

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3-7

Personal Income Statement (Cash Flow Statement)

Income—Include all sources› Wages, tips, overtime› Interest on savings, stock dividends, etc.

Fixed expenses› Contractual, must be paid› Rent, insurance, utilities, car payments, etc.

Variable expenses› You control level of expenses (food, clothing)

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3-8

INCOME Salaries 60,000$

Interest Income 740 TOTAL INCOME $60,740

FIXED EXPENSESMortgage Payment 9,600$ Automobile Payment 5,040 Property Taxes 1,235 Insurance 4,500 Income Taxes 5,032 Savings & Investment 1,200 Personal Loan Payment 900 TOTAL FIXED EXPENSES 27,507$

VARIABLE EXPENSESFood 5,485$ Transportation 2,500 Utilities 1,800 Clothes & Personal 2,700 Recreation & Vacation 2,780 TOTAL VARIABLE EXPENSES 15,265$ TOTAL EXPENSES 42,772$

(Cash Balance at the end of the year) 17,968$

January 1, 2006 to December 31, 2006.

Table 3-2 Jones Family, Personal Income StatementThe Tom Jones Family

Personal Income Statement(Cash Flow Statement)

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3-9

Income Statement Business

Basic Format› Sales, revenues, income from doing business› Less cost of goods sold› Gross profit› Less operating expenses› Operating income› Less interest› Net income (explain)

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3-10

Gross Sales 350,642$ Less: Returns and Allowances 2,366

Net Sales 348,276$

Cost of Goods Sold 124,276

Gross Profit 224,000$

Operating Expenses:Salaries Expense 95,000$ Rent Expense 24,000Property Taxes Expense 2,500Depreciation Expense 6,000Utilities Expense 10,250Advertising Expense 9,250Insurance Expense 3,000

Total Operating Expenses 150,000

Operating Income 74,000$

Other Expenses:Interest Expense 10,000

Net Income* 64,000$

*This line on an Income Statement for a Corporation appears as Net Income before Income Taxes see Table 3-3a

The Tom Jones Company

Table 3-3 Income Statement for a Sole Proprietorship, Partnership, Limited

Income StatementJanuary 1, 2006, through December 31, 2006

Liability Company, or Subchapter S-Corporation

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3-11

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3-12

Balance Sheet (Statement of Financial

Position) Basic Accounting Equation

Individual

Sole Proprietorship

Partnership

Corporation

EquitysOwnersLiabilitieTotalssetsTotal ' A +=

EquitysPartnersLiabilitieTotalAssetsTotal '+=

EquitysrStockholdesLiabilitieTotalAssetsTotal '+=

Net Worth A += sLiabilitieTotalssetsTotal

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3-13

Balance Sheet (Statement of Financial Position) (continued)

Total assets› Current assets

– Cash, accounts receivable, inventory› Fixed assets

– Land

– Building & equipment (less accumulated depreciation)

– Net building & equipment

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3-14

Balance Sheet (Statement of Financial Position) (continued)

Total liabilities› Current liabilities

– Accounts payable, notes payable, taxes payable› Long-term liabilities (debt)

Total equity› Preferred stock› Common stock par value › Paid-in capital in excess of par (common)› Retained earnings

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3-15

AssetsCash and Cash Equivalents

Cash and Checking Account 1,900$ Savings Account 4,000

Total Cash and Cash Equivalents 5,900$

Invested AssetsStocks and Bonds 38,000 Life Insurance Cash Value 5,500

Total Invested Assets 43,500$

Use AssetsResidence 310,000 Automobiles 45,000 Furniture, clothing, jewelry, etc. 52,000

Total Use Assets 407,000$

Total Assets 456,400$

Liabilities and Net WorthLiabilities

Homeowner's Insurance 975 Credit Card Balance 4,500 Automobile Note Balance 22,400 Home Mortgage Balance 138,000

Total Liabilities 165,875$ Net Worth 290,525 Total Liabilities and Net Worth 456,400$

Table 3-4 Statement of Financial Position (Balance Sheet)

The Tom Jones FamilyStatement of Financial Position

As of December 31, 2006

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3-16

Current AssetsChecking Account 2,000$

Certificates of Deposit 50,000 Accounts Receivable 40,000

Inventory 35,000 Total Current Assets 127,000$

Fixed Assets

Land 50,000$ Buildings 250,000$

Less: Accumulated Depreciation 50,000 200,000 Equipment 50,000$

Less: Accumulated Depreciation 6,000 44,000 Total Fixed Assets 294,000$


Current LiabilitiesAccounts Payable--Trade 10,000$

Notes Payable--Bank 5,000 Taxes Payable 3,000

Total Current Liabilities 18,000$

Long-Term LiabilitiesBuilding Mortgage 180,000$

Equipment Loan 30,000

Total Long-Term Liabilities 210,000$

Total Liabilities 228,000$ Owner's Equity 193,000$

Total Liabilities and Owner's Equity 421,000$

Assets

Liabilities and Owner's Equity

Table 3-5 Balance Sheet (Statement of Financial Position), Sole Proprietorship

The Tom Jones CompanyBalance Sheet

As of December 31, 2006

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3-17

Partners' Equity

Tom Jones 18,650$ Larry Smith 83,925 Kathy Moore 83,925

Total Partner's Equity 186,500$

Total Liabilities and Partners' Equity 421,000$

Table 3-6 Balance Sheet, Partnership

Tom Jones and Partners

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3-18

Current AssetsChecking Account 2,000$ Certificates of Deposit 50,000 Accounts Receivable 40,000 Inventory 35,000

Total Current Assets 127,000$

Fixes AssetsLand 50,000$ Buildings 250,000$ Less: Accumulated Depreciation 50,000 200,000 Equipment 50,000$ Less: Accumulated Depreciation 6,000 44,000

Total Fixed Assets 294,000$


Current LiabilitiesAccounts Payable--Trade 16,500$ Notes Payable--Bank 5,000 Taxes Payable 14,000

Total Current Liabilities 35,500$ Long-Term Liabilities

Building Mortgage 180,000$ Equipment Loan 30,000


Total Liabilities 245,500$

Stockholders' EquityPreferred Stock, $5 par (10,000 Shares) 50,000$ Common Stock, $0.10 par (100,000 Shares) 10,000 Paid-in Capital in Excess of Par--Common 50,000

Total Paid-in Capital 110,000$ Retained Earnings 65,500

Total Stockholders' Equity 175,500$

Total Liabilities and Stockholder's Equity 421,000$

Assets

Liabilities and Stockholder's Equity

Table 3-7 Balance Sheet (Statement of Financial Position), CorporationThe Tom Jones Corporation

Balance SheetAs of December 31, 2006

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3-19

Current AssetsChecking Account 3,000$ Certificates of DepositAccounts Receivable 23,000 Inventory 18,000

Total Current Assets 44,000$

Fixes AssetsLand 50,000$ Buildings 100,000$ Less: Accumulated Depreciation 45,000 55,000 Equipment 50,000$ Less: Accumulated Depreciation 5,000 45,000

Total Fixed Assets 150,000$


Current LiabilitiesAccounts Payable--Trade 8,000$ Notes Payable--Bank 3,500 Taxes Payable -

Total Current Liabilities 11,500$ Long-Term Liabilities

Building Mortgage 135,000$ Equipment Loan 35,000


Total Liabilities 181,500$

Owner's Equity 12,500$ 12,500

Total Liabilities and Stockholder's Equity 194,000$

Assets

Liabilities and Owner's Equity

Table 3-7a Balance Sheet (Statement of Financial Position), CorporationThe Tom Jones Corporation

Balance SheetAs of December 31, 2005

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3-20

Statement of Cash Flows

Statement of cash flows shows how the company’s working capital flows into and out of the business during the year.

Statement of cash flows includes:› Cash flows from operating activities is the difference between all

of the cash received by the business and all of the cash paid out by the business in conducting its day-to-day operations.

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3-21

Statement of Cash Flows (continued)

– Receipts: All cash received from sales, changes in accounts receivable, changes in inventory.

• NOTE: An increase in accounts receivable or inventory represents a negative cash flow. A reduction in receivables or inventory is a positive cash flow.

– Payments: All payments made by the company to all accounts (suppliers, employees, rent, utilities, etc.).

› Cash Flows from Investing Activities:

– Acquisition or sale of Plant Assets › Cash Flows from Financing Activities:

– Proceeds from issuance or sale of stock (preferred & common), bonds. Purchase of stock or the payment of long-term debt.

› Net increase (decrease) in cash plus the cash balance, previous year equals cash balance, current year.

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3-22

Cash flows from operating activities Net Income 53,000$

Adjustments to reconcile net income to net cash

provided by operating activies Depreciation Expense 6,000

Increase in Accounts Receivable (17,000) Increase in Inventory (17,000)

Increase in Accounts Payable 8,500 Increase in Notes Payable 1,500

Increase in Taxes Payable 14,000 (4,000)

Net Cash provided by Operating Activities 49,000$

Cash flows from investing activities: Acquisition of plant assets (150,000)

Net cash outflow from investing activities (150,000)

Cash flows from financing activities: Proceeds from issuance of preferred stock 50,000

Proceeds from issuance of common stock 60,000 Proceeds from Mortgage Payable 45,000

Payment of long-term debt (5,000) Net cash inflow from financing activities 150,000$

Net increase in cash 49,000$

Cash balance, December 31, 2005 3,000 Cash balance, December 31, 2006 52,000$

Table 3-8 Statement of Cash Flows

The Tom Jones Corporation

Statement of Cash Flows For the Year Ended December 31, 2006

Increase (Decrease) in Cash and Cash Equivalents (Amounts in thousands)

Documents

$$ Entrepreneurial Finance, 4th Edition By Adelman and Marks PRENTICE HALL ©2007 by Pearson Education, Inc. Upper Saddle River, NJ 07458 3-1 Chapter 3