- Managing and Dealing with People
- Accounting Principles
- Supply Chain Mangement I
- Supply Chain Management II

The accounting report used to describe the performance of a business during a specific period, is the Income Statement.
On the simple example shown at right, it is reported that during the mentioned period, the sales amounted to $1,000, the cost of goods sold was $600, expenses were $100; as result, the Net Income of the period amounted to $300.

John Smith Inc.
Income Statement
for the Year Ending 12/31/1998

The Balance Sheet describes the exact status of a business at a given moment. A Balance Sheet has two sides: The Assets side and the Liabilities and Equity side. The Assets side reports the monetary value of every property or right with a money value. Under Liabilities we see the amount owed to third parties. On the example, the total Assets amount to $10,000. The Liabilities are $6,000. By definition, the Equity (Owners Capital), equals the results of subtracting Liabilities from Total Assets. In this cases $10,000 less $6,000 = $4,000. This is why on any Balance Sheet the Total Assets always equals the Total Liabilities and Equity.

John Smith Inc.
Balance Sheet as of December 31, 1998

On the right we have the same Balance Sheet of the previous frame. Here we see that the Assets are: Cash, Buildings & Equipment, Inventory (goods for sale), Accounts Receivable, and Advance Payments made for goods and services not yet received.
The Liabilities are: Accounts Payable, Other Creditors and a Mortgage.
Under Equity we see the Shareholders capital plus the Undistributed Profit.
The Undistributed Profit is calculated by subtracting from the Total Assets ($10,000), the Liabilities ($6,000) and the Shareholders Capital ($3,700). The resultant number is $300, shown as Undistributed Profit.

John Smith Inc.
Balance Sheet as of December 31, 1998

We said that the Balance Sheet is like a still picture, showing the position (in money terms) of a business at a given moment. If after making a Balance Sheet a transaction takes place, a new Balance sheet made after the transaction would be different from the previous one. Let's look at the example:
The company takes receipt of a merchandise to be sold later for a total value of $1,000, and pays cash.
The new balance sheet would show the following changes:
> Cash is diminished by $1,000, now being $520.
> The value of the Inventory (Goods to be sold) goes up by $1,000, now being $2,100. In this case the Total Assets do not change, but the composition does.

The amounts that changed are shown in blue

John Smith Inc.
Balance Sheet as of December 31, 1998
Plus 1 transaction

We'll now make a cash sale, and immediately afterwards draw a new Balance Sheet including this last transaction.
The company sells the merchandise bought by $1,000 in the previous transaction. The price it charges is $1,500 and this amount is received in cash.
> Cash now goes up by $1,500, to a new value of $2,020.
> The value of the Inventory goes down by $1,000, to $1,100.
> The Total Assets are now $10,500.
> We recalculate the Undistributed Profit:
* Total Assets: $10,500
- less Shareholders Capital $3,700
- less Liabilities $6,000
= equals $800, the new Undistributed Profit..
> Obviously, because of the way this calculation is made, Total Assets must be equal to Liabilities and Equity: $10,500.

The amounts that changed are shown in blue

John Smith Inc.
Balance Sheet as of December 31, 1998
Plus 2 transactions

Now let's make an Income Statement for the period during which the two transactions took place.
Sales were $1,500, Cost of Goods sold $1,000, and as a result the Net Income (profit) of the period was $500. Notice how the different reports check: in the first Balance Sheet we had an Undistributed Profit of $300. In the subsequent period (of two transactions) the company made a profit of $500 as shown in the Income Statement; in the new Balance Sheet the Undistributed Profit is $800.

John Smith Inc.
Income Statement
For the period x

In our example we reported Buildings and Equipment as a single number ($4,600) under Assets.
With a little more refinement, we could report both concepts separately: say Buildings $4,000 and Equipment $600.
Obviously no material goods last forever. Some may last more than others, but all eventually deteriorate or become obsolete (with the only possible exception of land).
Depreciation is a method for reporting the change in value of assets over time.
Let's use the $600 of Equipment as example, and assume that
this particular equipment is brand new; we just paid $600 for it.
this equipment has a useful life of 10 years.
What we will do in the following 10 yearly income statements, is
to include 10% of the original value as an expense; and
to diminish the residual value of the asset by the same amount.

In More Detail,

Depreciation is reported as an Expense in the Income Statement

In the Balance Sheet, the value of the depreciated Asset is diminished by he same amount.

The statement that "Cash is more important than Profit" may be somewhat shocking. But there is a lot of truth in it. Of course, no business can survive over the long run without profits. But a profitable business which does not generate sufficient cash may be forced into bankruptcy.
All well-run business prepare Cash Budgets (Cash Flow estimates) to make sure that:
The Cash Receipts allow for the Cash disbursements necessary for continuing operations, or
Preparations are made to cover the deficit (through loans, increase of capital, sale of assets, etc.)
The cash budget at right does not foresee a deficit, but if in the following month a sudden increase in sales (or the need to build up inventory) would require more funds for operation producing a Cash deficiency, the company would have to take a loan or find other ways to compensate the deficit.

John Smith Inc.
Cash Budget

For the Month of January

Assets = Liabilities + Owner's Equities. A "still Picture" of the situation of a business at a given moment.
Only elements that can be assigned monetary value can be included.
Assets cost money. Where does this money come from? Obviously, either from the owners (capital) or from creditors (liabilities).
It follows that the Liabilities side must equal the Assets side; the Liabilities side explains how the Assets are financed. On the example at right, the Assets (an investment of $10,500) are financed by: the Owners (Equity, Capital) to the extent of $4,500, and the rest ($6,000) by Creditors.
Every transaction changes the Balance Sheet and is reflected twice. We saw that a cash sale increased the cash position and diminished the value of the inventory of goods to be sold.
Profits in our example increased Owners Equity; this is always the case. By the same token, withdrawals by the owners, whether they come from Undistributed Profits or from Capital, diminish Owners Equity.

John Smith Inc.
Balance Sheet as of December 31, 1998
Plus 2 transactions

Reflects the performance of a business during a specific period.
Revenues (sales) less Expenses = Net Income (Profit).
Expenses can be in the form of an actual cash flow, but also non-cash, as Depreciation.
Cost of Goods sold, as other items, is always included in full; regardless of whether this cost has been paid in cash or not, totally or partially.

John Smith Inc.
Income Statement For the period y

See Model Answer A2

See Model Answer A3

See Model Answer A4

See Model Answer A5

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