COMM 103 Chapter Notes - Chapter 14: Accounting Equation, Accounts Payable, Finished Good
26 Jun 2018
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(CHAPTER 14) FINANCIAL STATEMENTS: Structure and Implementation
TEXTBOOK SUMMATIVE
The chapter covers the following concepts:
●The roles of financial statements
○Two fundamental types of business transactions
●Liquidity, solvency, efficiency, and capacity
●Three primary financial statements:
○Statement of changes in comprehensive income
○Statement of changes in financial position
○Statement of cash flows
●Analyzing and interpreting financial information
○Ration analysis
○Leverage analysis
○Trend or comparative analysis
○Absolute analysis
○Forecasting and budgeting
●A note pertaining to NFPS
●Management Reflection: Keeping Your FInger on the Pulse of the Organization
●Appendix - Computation of Ratios
When purchasing a business, it is important that potential buyers understand FIVE KEY AREAS in
order to mitigate the risk of purchase:
1. Understand the legal obligations of owning a business, as well as, any obligations that are
transferred to them as a result of purchasing a business.
2. Conduct a full investigation of the competitive landscape the business operates in
○Includes assessing: competitors, internal strengths/weaknesses, market conditions,
consumer confidence, technology disruptions, etc.
3. Understand the terms of lease transfers, intellectual property transfer (patents, trandemarks,
licences), and other anticipated rights that could be passed on to you.
4. Ensure that the company is financially stable via financial statements
5. Analyze the current trends that the business is experiencing
○Important to look in at least three years of financial statements to analyze sales,
expense and profitability trends.
THE ROLE OF FINANCIAL STATEMENTS
The role of a senior management team is to determine an organization’s overall direction and
manage the execution of its tactics/strategic thrusts by effectively using its assets, employees,
capital, and management acumen so that it delivers a superior value proposition to its customers.
Analyzing and understanding financial statements allows the management team to “keep its fingers
on the pulse: of an organization; as it allows them to be up-to-date on the organization’s profitability
margin - is the portion of an organization’s revenue that is left after all operating expenses associated
with its products or services have been paid - and gross profit margin- the portion of an
organization’s revenue that is left over after the organization has paid the direct costs (wages,
components, materials, etc) associated with its products or services) - as it delivers its products
and/or services to its target market. Most managers usually rely on THREE PRIMARY FINANCIAL
STATEMENTS;
1. The statement of changes in financial position
2. Statement of cash flows
3. Statement of comprehensive income
**these documents help to provide vital information regarding the company’s liquidity and solvency,
as well as its overall financial capacity to respond to opportunities and challenges that the
organization may face in the near term.
●Over the long term, these statements also showcase information regarding the company’s
overall growth, profitability trends, and overall operating efficiency.
TWO FUNDAMENTAL TYPES OF BUSINESS TRANSACTIONS
The two fundamental business transactions managers review are:
1. OPERATIONAL TRANSACTIONS which refers to the flow of money within the organization
that is directly related to day-to-day business dealings.
○EXAMPLES INCLUDE: Revenue (generated as a result of selling goods and/or
services) and recurring expenses that are related to manufacturing, distribution, and
selling of such goods.
2. CAPITAL ASSET TRANSACTIONS are decisions that managers make with respect to
investment and divestment of capital assets (buildings, equipment, business subsidiaries) that
may be needed, are no longer needed, as part of the organization’s business system.
LIQUIDITY, SOLVENCY, EFFICIENCY, AND CAPACITY
An important responsibility or managers in conducting a financial analysis of their organization is to
draw conclusions about the current and future liquidity and solvency of the organization.
●LIQUIDITY refers to the ability of the company, on the basis of the cash it has on hand and
the cash it is generating within its operations, to meet its ongoing financial obligations.
●SOLVENCY refers to the ability of an organization to meet its long-term expense obligations
and profitability to grow the company.
○ It is a longer-term assessment of the financial stability of the organization
●EFFICIENCY refers to how effective the organization is in deploying its resources and
managing its operational processes in the delivery of goods/services to the marketplace.
●FINANCIAL CAPACITY is the general term that related to an organization’s cash reserves and
borrowing power
○This is an important factor in determining what level the organization feels it can
financially support its competitive position in the marketplace.
THE THREE PRIMARY FINANCIAL STATEMENTS
STATEMENT OF COMPREHENSIVE INCOME is the financial statement that responds to the question
of whether our business is earning a profit as a result of the sales we have made versus the expenses
that we have incurred in developing our goods and services and delivering to the marketplace.
●reflects the specific period of time (year, quarter, month), identifies the revenue we have
received, and then subtracts the expenses the business has incurred in generating such
revenue.
●Profit is the residual amount remaining after all operating expenses have been deducted
from an organization’s revenue
●If expenses incurred exceed the revenue, then the business would incur and operating loss
for the period of time specified.
Individual components of the statement of comprehensive income include:
1. SALES REVENUE reflects the dollar amount ($$$) that the organization has received as a
result of selling its products and/or services.
○Can be thought of as the sales that the company has made and can be further broken
down into the number of units that an organization has sold multiplied by its selling
price.
2. COSTS OF GOODS SOLD are the expenses that are directly incurred in the manufacturing of a
product and delivery of a service.
3. GROSS PROFIT MARGIN is the difference between the total revenue that an organization
receives and the direct expenses it incurs. The GPM represents the amount of money left
over from the sale and the organization’s products and/or services, which can then be used
to cover other business expenses and meet profit objectives.
