Some fundamentals for people in engineering field who want to get started with business

1. ENGINEERING ECONOMICS
KUK2142
Chapter 2
Financial Statements

2. Topic Outcomes
● Apply company’s financial statement (balance sheet) and related
financial ratios to evaluate company’s performance.
● Apply company’s financial statement (income statement) and related
financial ratios to evaluate company’s performance.

3. Financial Statements
 Balance Sheet
 Income Statements
 Cash Flow Statements
 Financial Ratios

4. Financial Statements
 Financial statements are the written reports that provide the detail of the
company’s financial information during the period of time.
 Describing the financial health of a company.
 There are 3 financial statement of a company: balance sheet, income
statement and cash flow statement.
 The primary accounting statements are the balance sheet and the income
statement. They are linked to each other.
 Financial statements are usually compiled on a quarterly and annual basis.

6. Balance sheet
 The balance sheet lists the company’s assets, liabilities, and equity on a
specified date.
 A balance sheet is also called a 'statement of financial position' because it
provides a snapshot of company’s assets and liabilities — and therefore net
worth of the company.
 It pictures the organization’s financial health and usually, balance sheets are
taken at the end of the quarter and fiscal year.
 The following formula summarizes what a balance sheet shows:
 A company's assets have to equal, or "balance," the sum of its liabilities and
shareholders' equity.
Assets = Equities + Liabilities

7. Assets, liabilities, equities
 Assets: Economic resources of company which expected to benefit future
operations. Assets are owned by the company and have monetary value "How
much do the company have?"
 Liabilities: Amount the company owes, the dollar which against the asset of
company. "How much do the company owe?"
 Equities: Funding from the company and its owner or shareholder. The
remaining value of an owner's interest in a company, after all liabilities have
been deducted. "How much is left over?"

8. The accounting equation
The equity equation
Equity is the company's assets minus its liabilities.
The accounting equation
Accountants call this the “accounting formula,” or the “balance sheet equation”).
Accountants use this equation in Balance Sheet: In order for the accounting
equation to stay in balance, every increase in assets has to be matched by an
increase in liabilities or equity (or both).
Equities = Assets - Liabilities
Assets = Equities + Liabilities

9. Balance Sheet
8,770,000 + 4,485,000 +
560,000 =
2,180,000 + 1,200,000 +
10,435,000
$13,815,000 = $13,815,000
Assets = Liabilities+ Equity
Assets (current, fixed, other) =
Liabilities (current and long-
term)+ Equity

10. Features in Balance Sheet (Assets)
 Assets are listed on the left-hand side and liabilities and equity are on the
right-hand side.
 On a balance sheet, assets are listed in order of decreasing liquidity (how
quickly each one can be converted to cash). Thus current assets are listed
first, in the order of decreasing liquidity are cash, account receivables,
securities, and inventories. Receivables, referred as accounts receivable, are
debts owed to a company by its customers for goods or services that have
been delivered or used but not yet paid for.
 Fixed assets such as land, plant and equipment, are used to produce and
deliver goods and/or services, and they are not intended for sale.
 Other assets such as prepayments and intangibles such as patents are listed
last.

11. Features in Balance Sheet (Liabilities)
 Liabilities are divided into two major classifications—current liabilities and long-
term liabilities.
 Current liabilities are notes, and payable accounts that are due within one year
from the balance sheet date.
 Long-term liabilities include mortgages, bonds, and loans with later due dates.
 In performing engineering economic analyses, working capital for project is
estimated. Working capital is calculated as the difference between current
assets and current liabilities.
Working capital = Current assets - Current liabilities

12. Features in Balance Sheet (Equity)
 Equity is also called owner’s equity or net worth. It includes owners’
stockholdings and the capital surplus.
 Retained earnings are dollars a company chooses to retain rather than
paying out as dividends to stockholders.

13. Income Statements
 The first place an investor or analyst will look is the income statement. It shows
the performance of the business of a company.
 An income statement is a report that shows how much net income a company
earned over a period of business activity.
 A income statement is also called profit and loss statement that
summarizes company’s revenues and expenses over a month, quarter, or
year.
 The income statement reports the firm’s net income (profit) or loss by
subtracting expenses from revenues. If revenues minus expenses is positive
there has been a profit, if negative a loss has occurred.
Revenues (sales) − Expenses = Net profit (Loss)

14. Features in Income Statement
 Income statement can be separated into operating and nonoperating
activities and each revenues and expenses.
 Operating revenues are made up of sales revenues (minus returns and
allowances).
 Operating expenses includes cost of goods sold, selling and promotion costs,
depreciation, general and administrative costs, and lease payments.
 Nonoperating revenues come from rents and interest receipts.
 Nonoperating expenses such as interest payments on debt in the form of loans
or bonds.

15. Income Statements
Net profits (Loss) = Revenues − Expenses
$730,000 = 1,120,000 − 390,000 (after taxes)
$1,120,000 = 18,350,000 − 17,230,000 (before taxes

16. Cash Flow Statements
 Cash flow statements report a company’s movement of cash.
 Cash flow statements is important because a company needs to have enough
cash on hand to pay its expenses and purchase assets.
 A cash flow statement shows how much cash the company brought in and paid
out over a period of time, an accounting period.
 Cash flow statements have 3 sections:
 Cash from operation
 Cash from investing
 Cash from financing

17. Cash Flow Statements

18. Financial Ratios
 Financial ratios are created with the use of numerical values taken
from financial statements to gain meaningful information about a company.
 The numbers found on a company’s financial statements – balance
sheet, income statement, and cash flow statement.
 Common ratios:
 Financial Ratios Derived from Balance Sheet Data
 Financial Ratios Derived from Income Statement Data

19. Financial Ratios Derived from Balance Sheet Data
 Two common ratios are the current ratio and the acid-test ratio (quick ratio).
Ratios Formula Range
Current ratio
(Indicating its
ability to cover
current liabilities)
Company aim to
be at or above a
ratio of 2.0
Acid-test ratio
or quick ratio
Higher ratio
show higher
ability to pay
debt “instantly.”
*Current inventories are excluded from quick assets
 Working capital, current ratio, and acid-test ratio are all indications of the
company’s financial health (status).

20. Financial Ratios Derived from Income Statement Data
• Two common ratios are the net profit ratio and the interest coverage.
Ratios Formula Range
Net profit ratio
(Cost efficiency of
operations and
company’s
ability to convert
sales into profits)
Net profit
ratio is best
evaluated by
comparisons with
other time periods
and industry
benchmarks
Interest
coverage
For industrial
firms should be at
least 3.0.
The larger the
interest coverage
ratio the better.
*Net sales revenue = sales minus returns and allowances
*Total income is total revenues (operating and nonoperating) minus
all expenses except interest payments.