Finance And Accounting—Decision-Making Tools (Lecture 25)

I. Definitions

A. Accounting is the means by which organizations communicate to key constituents how they are performing through accounting data.

• Internal users include managers, executives and owners that need to plan and control operations, manage resources, evaluate capital needs, and make strategic decision.
• External users, including investors, lenders, and suppliers, must evaluate the company's financial strength and performance to know whether to lend or invest capital in the organization.

B. Finance focuses on how accounting information is used to make certain decision such as evaluating investment opportunities, how to best raise capital to run or expand operations, how to value stocks, bonds, etc.

II. Standard Accounting Disclosures
Publicly traded companies are required to file an annual report to shareholders and in the United States, they file the equivalent, the form 10-K, with with SEC, generally within 60-75 days after the end of their fiscal year.

The annual report includes an overview of the companies business and operations, discussion and analysis of financial results, financial statements and related footnotes, an independent audit report and several other disclosures. The four financial statements included in the annual report are the balance sheet, income statement, statement of cash flows, and statement of shareholder equity.

A. Balance Sheet
A balance sheet is a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. The balance sheets gets its name from the fact that the two sides of the equation above – assets on the one side and liabilities plus shareholders' equity on the other – must balance out.

B. Income Statement

Unlike the balance sheet which is prepared as of a particular point in time, the income statement reflects operations as of a particular period of time, typically a quarter or year. It starts with revenues, subtracts costs and expenses and end with net income or loss.

C. Statement of Cash Flows

Since large companies use the accrual method of accounting, the income statement generally will not tell us about the companies actual cash flows. As a result, the statement of cash flows is also provided. This statement reports, for a certain period of time, the actual cash either generated or consumed by the company. The statement of cash flows provides two key pieces of data"

1) It lays out the difference between reported profit and loss under accrual accounting and the actual cash inflows and outflows.  

2) It segments the cash flows into three distinct categories: operating activities, investing activities and financing activities.
-Operating are supposed to reflect cash inflows and outflows from normal and recurring operations.
-Investing activities reflect the cash inflows and outflows from nonrecurring investment decisions including the purchase of property, plant, and equipment; mergers and acquisitions; or even the investment of access cash into stocks and bonds.
-Financing activities reflect cash inflows and outflows from transactions involving the company's lenders and shareholders, such as the issuance of stock or bonds, the payment of dividends or the repurchase of company stock.

III. Accounting Myths
-Accounting uses estimates and judgement and subjectivity may be involved in applying accounting rules.
-There is no single measure or metric that allows an overall assessment of financial performance.
-Most (large) companies keep at least two sets of books; one for creditors, lenders and shareholders and the other for tax authorities. This is because the financial accounting standards board and the IRS have different standards.