Foundations of Business

1
Foundations of Business

• Introduction to Financial ReportingThe Income
  Statement

2
6 Roles of Financial Management

• Recording transactions
• Budgeting
• Allocating capital to the best projects for the
  company
• Board decides
• Reinvest earnings
• Pay dividends
• Projecting
• Raising capital
• Issue stock
• Borrow (loans/bonds)
• Preparing financial reports

3
Financial Reporting

• Financial accounting for external users (e.g. the
  IRS SEC) through financial statements
• Generally Accepted Accounting Principles (GAAP,
  US-GAAP)
• 4 primary statements
• Income statement
• Balance Sheet
• Statement of Cash Flows
• Statement of Changes in Stockholders Equity

4
What are Earnings?
Sales Expenses Net Income (earnings, profit,
the bottom line)
INCOME STATEMENT EQUATION

• Sales (Revenue)
• Expenses
• Net Income
• (Net Loss)

• value of what customers have bought
• e.g. ice cream cones X price
• e.g. 3 cones X 2.50 7.50 total sales
• ? Recorded when transacted
• Costs used up in generating sales
• ? Recorded when incurred
• Whats left over from sales after accounting
  for all expenses in the period

5
EXPENSES

• Matching principle costs incurred (used up) must
  be matched with the sales that these costs helped
  generate in the same period
• 2 types of expenses
• Fixed do not fluctuate when sales change
• Variable fluctuate with sales

6
Champ Creemee CompanyIncome Statement (for the
Year ending 12/31/07)
Covers a period of time.

• Sales (Revenue)
• Expenses
• Cost of Goods sold (Cost of
  Revenue)
• Gross Profit
• Waste/Spoilage
• Wages
• Salaries
• Payroll Remittances
• Rent/Permits
• Advertising
• Maintenance and Repair
• Operating Expenses
• Operating Profit (EBIT)
• Interest
• Pre-Tax Profit
• Taxes (35)
• Net Income

• 3,000
• (1,000)
• 2,000
• 50
• 500
• 50
• 50
• 100
• 100
• 50
• (900)
• 1,100
• (500)
• 600
• (210)
• 390

7
Champ Creemee CompanyCost of Goods Sold
2 gallons of ice cream
cones
napkins
We sell 1 ice cream cone. What have we used
up? 1 cone 3 scoops 1
napkin
Direct product costs (COGS) VARIABLE costs
8
Unqualified ( clean) Opinion by the
Independent Auditors
Independent auditors Nothing is wrong with the
financial statements.
Report of Independent Registered Public
Accounting Firm (link from Yahoo.com to Form
10-K, SEC document, pp. 122-3 http//yahoo.brand.
edgar-online.com/EFX_dll/EDGARpro.dll?FetchFilingH
TML1?SessionID8PXgWQvURc7loAhID4997832Y30486E1
0VK_HTM_118)   To the Stockholders and the
Board of Directors of Merck  Co., Inc.   We
have completed integrated audits of Merck  Co.,
Inc.s consolidated financial statements and of
its internal control over financial reporting as
of December 31, 2006, in accordance with the
standards of the Public Company Accounting
Oversight Board (United States). Our opinions,
based on our audits, are presented below.  
Consolidated financial statements   In our
opinion, the accompanying consolidated balance
sheets and the related consolidated statements of
income, of retained earnings, of comprehensive
income and of cash flows present fairly, in all
material respects, the financial position of
Merck  Co., Inc. and its subsidiaries at
December 31, 2006 and December 31, 2005, and the
results of their operations and their cash flows
for each of the three years in the period ended
December 31, 2006 in conformity with accounting
principles generally accepted in the United
States of America. These financial statements are
the responsibility of the Companys management.
Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits of these statements in
accordance with the standards of the Public
Company Accounting Oversight Board (United
States). Those standards require that we plan and
perform the audit to obtain reasonable assurance
about whether the financial statements are free
of material misstatement. An audit of financial
statements includes examining, on a test basis,
evidence supporting the amounts and disclosures
in the financial statements, assessing the
accounting principles used and significant
estimates made by management, and evaluating the
overall financial statement presentation. We
believe that our audits provide a reasonable
basis for our opinion.    
    PricewaterhouseCoopers LLP Florham Park,
New Jersey February 27, 2007
PricewaterhouseCoopers LLP Florham Park, New
Jersey February 27, 2007
9

• Value Line
• Investment Survey
• sheet for Merck
• www.valueline.com
• SMC subscription to Value Line
• http//www.valueline.com/secure/vlispdf/stk1700/in
  dex.aspx

10
Homework Assignment to prepare for the Finance
Application Assignment

• You may work with a partner to prepare the
  research and financial analysis, but you must
  write the memo individually.
• Select two publicly traded U.S. companies in
  similar businesses, i.e. in the same industry. 
  Consult the major industries on Valueline
  (http//www.valueline.com/secure/vlispdf/stk1700/i
  ndustry.aspx or click on "Lookup Industry" in the
  left navigation bar). (NOTE Do not choose
  automobile manufacturers or banks and make sure
  the companies are profitable, produce a product,
  and are listed in Value Line.)  You may identify
  2 companies from this list and get information by
  clicking on its name.An alternate source for a
  list of major industries is Yahoo's Industry
  Index at http//biz.yahoo.com/ic/ind_index.html.
• Find your two comparable companies on Valueline
  (http//www.valueline.com/secure/vlispdf/stk1700/l
  ookup.aspx or click "Lookup Company" in the left
  navigation bar).  Click the radio button for
  Company and type in the name of your company. 
  Confirm that the companies are listed on a U.S.
  stock exchange (NYSE--New York Stock Exchange,
  NASDAQ, American) and note the "Ticker
  Symbol"--you will need this later.
• Download or copy the pages from Value Line for
  both companies..
• For each company, get the Balance Sheet and
  Income Statement for the latest year.  These can
  be found under Financials on the company's site
  in Yahoo!Finance (http//finance.yahoo.com/) or
  in the company's Annual Report (also called 10-K)
  on either the company's Web site or under the SEC
  filings on the Yahoo!Finance site, MSN-Money
  (http//moneycentral.msn.com/investor/research/pro
  file.asp), or another source.  Make sure you get
  the annual (not quarterly) financial statement.