Principles of Business Introduction to Finance –lecture 2

Learning outcomes

By the end of this session you should be able to:

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• Explain the key components of financial statements• Evaluate the role of the financial statements for

different stakeholders• Understand the accounting equation• Calculate profit and understand how it can be

manipulated

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Financial statements

• Legally required for all companies in most jurisdictions around the world• Used by a variety of different stakeholders• Measure Performance (Income statement)• Measure Position (Balance sheet) • Measure Cashflows (cashflow statement)

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Users of financial statements

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Income statement

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Income Statement

• Measures financial performance (profit)

Elements of an income statement:

• Revenue (price x quantity)• Cost of sales (Direct costs)• Gross profit = revenue less cost of sales• Operating expenses (administrative and distribution costs)• Finance expenses • Income tax expense

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• Revenue = The gross inflow of economic benefit from the ordinary course of trading.

• Expense = cost incurred in acquiring a product or service

Cash versus Profit

Profit = Revenue - Expenses

Cash = Money or legal tender

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Balance sheet/Statement Financial Position

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Balance sheet / Statement of Financial Position

• Measures financial position • Comprises of three elements:

- Assets- Liabilities- Equity

• The accounting equation will always hold true on a balance sheet:

ASSETS = LIABILITIES + EQUITY

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Assets

A resource that is controlled by a business as a result of past events, is expected to generate an inflow of future economic benefit.

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Liabilities

A present obligation arising from past events, which is expected to result in the outflow of economic benefits

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Equity

Owner’s capital in the business ie, the residue of assets less all liabilities.

In everyday terms, this means:

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Cash flow statements

• Show actual cash going in and out of the business• Internal and external cashflows are very different!• External cash flow statements reconcile to the balance sheet and

income statement and show cash movements in the business in three sections:

• Cashflow from operations• Cashflows from investing activities • Cashflows from financing activities

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What are they?

• A set of principles and standards that are used by organisations to prepare financial statements.

Commonly used sets of standards:

- International Financial Reporting Standards (IFRSs)- UK Generally Accepted Accounting Practice (UK GAAP)

Which standards should an organisation use?

• The appropriate framework to use generally depends on the location, type and nature of the organisation concerned.

• E.g. All companies listed in EU markets must report under IFRSs.

Financial statements

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Principles for preparing financial statements

Seminar 1: Evaluating sources of financing

- Read chapter 1 and 15 of core text book (Atrill & McClaney). Attempt the questions at the end of these chapters. - Research realistic sources of finance, and costs, for a brand new start up business

Seminar 2: Working capital management

- Read Chapter 16 of core text book (Atrill & McClaney)- Consider the following question:

“Suggest practical ways for a business to keep cash in it’s buisness for as long as possible”

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Seminar 3: What do financial statements do?

- Read chapters 2,3,6 of the core textbook (Atrill & McClaney) - Review Pearson Plc’s 2013 annual report(https://www.pearson.com/content/dam/corporate/global/pearson-dot-com/files/annual-reports/ar2013/2013--annual-report-accounts.pdf)

Seminar 4: Managing costs in a business

- Read chapter 8 of core textbook and attempt questions at back of chapter

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