LO1-3 Communicating through Financial Statements Part 2

What question does the Zoom analysis answer?

Are a company’s net resources increasing from internal or external sources?

What accounting information is used to answer this question? (Are a company’s net resources increasing from internal or external sources?)

Common stock vs. retained earnings on the balance sheet.

What increases common stock?

Selling stock to investors (external financing).

What increases retained earnings?

Profits (net income) minus dividends (internal financing).

What did Zoom’s 2020 equity increase show?

Most of the increase came from issuing stock, not profits

They only had $672 profits

What is another name for the balance sheet?

The statement of financial position.

What does the balance sheet report?

Assets, liabilities, and stockholders’ equity at a point in time.

Accounting Equation

Assets = Liabilities + Stockholders’ Equity

What are assets?

Resources owned by the company

What are liabilites?

Amount owed to creditors

What is stockholders’ equity?

Owners’ claims to the company’s assets

What were Eagle’s total assets?

$350,000

What were Eagle’s total liabilites?

$140,000

What was Eagle’s stockholders’ equity?

$210,000

Why does the balance sheet “balance”?

Because assets always equal liabilities + equity.

What question does this analysis answer?

How much does a company rely on creditors vs. investors?

What accounting information is used? (How much does a company rely on creditors vs. investors?)

Total liabilities vs. total equity.

What does a high proportion of liabilities mean?

The company relies more on creditors (debt financing).

What percentage of Pepsi’s assets are liabilities?

81.3% (heavily debt‑financed)

What percentage of Monster’s assets are liabilities?

15.3% (heavily equity‑financed)

Which type of company usually relies more on equity?

Younger companies.

What does the statement of cash flows report?

Cash receipts and cash payments over a period.

What are the three categories of cash flows?

1. Operating

2. Investing

3. Financing

What are operating cash flows?

Cash from revenue and expense activities.

Cash from day‑to‑day business operations.

For Eagle:

• Cash received from customers: +49,000

• Cash paid for salaries: –28,000

• Cash paid for rent: –60,000

Total operating cash flow:

👉 Operating cash flow = –$39,000

They spent more cash than they collected.

This is normal for a brand‑new business.

What are investing cash flows?

Cash from buying or selling long‑term assets.

Cash spent on long‑term assets.

Eagle bought equipment:

• Equipment purchase: –120,000

👉 Investing cash flow = –$120,000

What are financing cash flows?

Cash from borrowing, repaying debt, issuing stock, and paying dividends.

Cash from owners and lenders.

Eagle:

• Issued stock: +200,000

• Borrowed from bank: +100,000

• Paid dividends: –4,000

Total financing cash flow:

👉 Financing cash flow = +$296,000

What was Eagle’s operating cash flow?

–$39,000

What was Eagle’s investing cash flow?

–$120,000 (equipment purchase)

What was Eagle’s financing cash flow?

+ $296,000

Formula for change in cash?

Change in cash = Operating + Investing + Financing

What was Eagle’s change in cash?

+ $137,000

What was Eagle’s beginning cash balance?

$0 (first month of operations)

What was Eagle’s ending cash balance?

$137,000 (matches the balance sheet)

What question does the Shake Shack analysis answer?

How does cash flow information reveal a company’s ability to sustain operations?

What accounting information is used? (How does cash flow information reveal a company’s ability to sustain operations?)

Trends in net income and types of cash flows (operating, investing, financing).

What is a good sign for long‑term sustainability?

Operating cash flows greater than net income.

What does it mean if operating cash flows follow the same trend as net income?

The company’s core operations are healthy and consistent.

What do increasingly negative investing cash flows indicate?

The company is investing more in long‑term productive assets (growth).

Why did Shake Shack have large financing cash inflows in 2020–2021?

Issuing stock and debt to survive falling profits during COVID‑19 and to fund expansion.

Why are the four financial statements linked?

Because one business transaction affects multiple statements.

What statement records revenues and expenses?

The income statement.

Where does net income go after the income statement?

Into retained earnings on the statement of stockholders’ equity.

How does retained earnings connect to the balance sheet?

Ending retained earnings becomes part of stockholders’ equity on the balance sheet.

How does the statement of cash flows connect to the balance sheet?

Ending cash from the cash flow statement = cash on the balance sheet.

What does Link [1] in Illustration 1–9 show?

Net income → retained earnings

What does Link [2] show?

Retained earnings → total stockholders’ equity on the balance sheet.

What does Link [3] show?

Ending cash on the cash flow statement = cash on the balance sheet.

What are the Computer Shop’s revenues?

$65,000

What are the Computer Shop’s total expenses?

Rent 6,000 + Supplies 14,000 + Salaries 40,000 = $60,000.

What is the Computer Shop’s net income?

65,000 - 60,000 = 5,000

What is beginning retained earnings?

$7,000

How do you calculate ending retained earnings?

7,000 + 5,000 - 1,000 = 11,000

How much common stock was issued during the year?

$4,000

What is ending common stock?

15,000 + 4,000 = 19,000

What is total stockholders’ equity?

19,000 + 11,000 = 30,000

What are total assets?

Cash 10,000 + Supplies 8,000 + Equipment 26,000 = 44,000

What are total liabilities?

Accounts payable 4,000 + Notes payable 10,000 = 14,000

Does the balance sheet balance?

44,000 = 14,000 + 30,000

What is the key takeaway from this review problem?

Every revenue or expense affects retained earnings, which affects equity, which affects the balance sheet