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COMM1140 Financial Management
Topic 2
Measuring Financial Performance and
Financial Position
Recap: what did we discuss last time?
▪ Balance sheet
• Financial position of an enterprise at a particular point in time.
– Sometimes referred to as the Statement of Financial Position
• Financial position: Enterprise’s set of financial resources and
obligations at a point in time
• Prepared under assumptions of the accounting equation
▪ Income statement
• Financial performance of an enterprise over a period of time.
• Financial performance: Generating new resources from operations
over a period of time
• Prepared using accrual accounting
▪ Cash flow statement:
• Cash inflows and outflows over a period of time.
• Prepared under cash accounting
Recap: what did we discuss last time?
Accrual accounting includes the impact of transactions on the
financial statements in the time periods where revenues and
expenses occur rather than when the cash is received or paid.
Accounting equation informs the preparation of the balance sheet
and how we record accounting transactions.
Assets = Liabilities + Equity
Cash accounting is where payment receipts are recorded during the
period in which they are received, and expenses are recorded in
the period in which they are actually paid.
For Support:
Deeper Understanding Video
Series
Today’s Learning Objectives
You should be able to:
1. Describe the relationship between the balance sheet and the
income statement (retained profits)
2. Identify the components of the Income Statement and Balance
Sheet statements (A, L, SE, R, E)
3. Prepare an income statement & balance sheet
Kahoot
A t-1
L t-1
SE t-1
A t
L t
SE t
RE
R – E = Profit during the period
Beginning period (t-1) Ending Period (t)
A t-1 = L t-1 + SE t-1 A t = L t + SE t
Question: How is the income statement and balance sheet connected?
The link between the income statement & balance sheet?
The link between the income statement & balance sheet?
The link between the income statement and the balance sheet occurs through
retained profits which are a part of shareholders equity
Shareholders’ equity is defined as the residual interest in the assets of the entity
after deducting all its liabilities
A = L + SE
A – L = SE
Also referred to as “net assets”
Common components:
• Retained profits – defined as the cumulative profits earned by the business
that have not been distributed to shareholders.
• Share capital – defined as the money invested in the business in return for
shares.
Retained profits
When a company earns a profit, that profit can be distributed to shareholders
as dividends or kept in the business to grow the business.
The profit that is kept is called ‘Retained Profits’.
The Retained Profits account is the link between the balance sheet and
income statement.
Opening retained profits
plus Net profit (Revenues – Expenses) for the period
less Distributions (Dividends declared)
= Closing retained profits
Remember: Dividends are NOT AN EXPENSE!
A t-1
L t-1
SE t-1
A t
L t
SE t
RE
R – E = Profit during the period
Beginning period (t-1) Ending Period (t)
A t-1 = L t-1 + SE t-1 A t = L t + SE t
Incorporated into the
Balance Sheet
Capture of income (profit)
Remember: Retained profits increase with all revenue transactions and
decrease with all expense transactions!
The link between the income statement & balance sheet?
= +
The Accounting Equation expanded even further!
= + { + (+ (R – E) – D)}
Where:
A = Assets
L = Liabilities
SE = Shareholders’ Equity
SC = Share Capital
RP = Retained Profits
R = Revenue during the period (t-1 to t)
E = Expenses during the period (t-1 to t)
D = Dividends (declared)
= + ( +)
The Accounting Equation expanded even further!
(Retained Profits)
Increasing shareholders’ equity: Owner driven
• Contributions by owners
• Issued Shares for $300,000 cash
A = L + SE
Share
Capital
Cash
Increasing shareholders’ equity: Activity driven
The company uses $100,000 of the cash received to purchase inventory.
How does this impact on the accounting equation?
A = L + SE
Inventory (+100,000) – Cash ($100,000) = 0
Inventory Cash
Asset Transaction
Increasing shareholders’ equity: Activity driven
The company sells $100,000 of worth of inventory for $200,000 for cash.
How does this impact on the accounting equation?
A = L + SE
How do we record profit in the accounting equation?
Inventory (-$100,000) + Cash ($200,000) = $100,000 (Retained Profits)
Inventory Cash Profit
Test Your Understanding…Retained Profit
Year Profit/Loss Dividend Retained Profit
2018 100 0 100
2019 200 50 250
2020 300 100 450
2021 (100) 0 350
Retained Profit = Opening Balance + Profit/(Loss) – Dividends
How do we calculate Profit?
Revenue – Expenses
This means…
Revenue increases retained profits and expenses reduce retained profits.
Today’s Learning Objectives
You should be able to:
1. Describe the relationship between the balance sheet and the
income statement (retained profits)
2. Identify the components of the Income Statement and Balance
Sheet statements (A, L, SE, R, E)
3. Prepare an income statement & balance sheet
The Balance Sheet
A statement that summarises the financial position of an enterprise at a particular
point in time
• What are the resources (Assets) of the enterprise?
• And what were the sources i.e., how were they financed? (Debt or Equity)
• Point in time - e.g., as at June 30, 2020
Provides information about:
• Financial structure (mix of debt/equity) – Debt to equity ratio
• Liquidity – ease of converting assets to cash in normal course of business
(short-term focus) – working capital, current ratio
• Solvency – ability to pay debts when they fall due (longer-term focus) –
Debt to equity ratio
Discussed in
Week 5
What is on a Balance Sheet?
A Balance Sheet will always have the following identifying information:
• Name of the reporting entity
• Type of financial statement – Balance Sheet
• Date – what point in time it refers to
• Currency used - $m, $AUD
Let’s look at Woolworths Balance Sheet in more detail…
Examples of assets
Assets are either
Current (expect to realise the benefits in the next 12 months from the
balance sheet date)
or
Non-current (realise benefits over a longer period)
Examples of assets (and lots of new terms)
Classify the following as current or non-current:
• Cash & cash equivalents
• Accounts receivable
• Machinery
• Inventory
• Prepayments (< 12 months)
• Motor vehicles
• Buildings
Example of Liabilities
Liabilities also have to be classified as current or non-current:
• Current liabilities are those that will be paid off within one year of the
balance sheet date.
• Non-current liabilities will remain liabilities for at least the next year.
Reason for this distinction (for both assets and liabilities):
To help the financial statement user assess short-term financial position.
Discussed in
Week 5
Examples of Liabilities
Classify the following as current or non-current:
• Accounts payable
• Overdrafts
• Loans
• Portion due within 12 months vs portion due after 12 months
• Taxes payable
• Dividends payable
• Wages payable
Income Statement
Shows the results of business operations over a specific time
period
• Reports revenues earned, less any expenses incurred
• Provides a measure of organisational efficiency
• Calculates the profit that may be available to shareholders
• If revenues are greater than expenses, there is a profit
• If revenues are less than expenses, there is a loss
Remember: Accrual profit is not the same as cash profit!
What’s on an Income Statement?