2L BA-1 (General)

A) Distributions

I) Owner can receive distribution payments of all or part of the company’s earnings

B) Sale

I) Owner can sell all or part of ownership in business for more than you paid for it

• (1) Income Statements -- show the net income of a business for a period of time
• Revenue-- Cost of Goods Sold = Profit before taxes

• (2) Cash Flow statements-- measures how much more or less CASH a company has from one period to the next; compares cash amount at the end of the period to the beginning
• Profit AFTER tax + Depreciation -- Investment = Cash Flow

(3) Balance Sheets-- shows a companies assets, liablities and equity

I) Matching: costs/expenses should be booked in the same period as the revenues those expenditures helped generate

• II) Conservatism: date should be conservative—should
• represent the firm’s financial date in an accurate way (but err on the side of understating revenue/value of assets and overestimating costs/liabilities)

• :( Off-balance sheet financing—financial irregularities… thought recourse loan was a non-recourse
• loan and showed no obligation on balance sheet (Enron)

I) Shows net income of a business for a period of time (quarterly/annual) >>>> (Revenue – Expenses -- Depreciation = Profit b4 taxes)

• (1) Computes profit of a business for a
• period of time based on data about revenues and costs

• (2) Learn about business performance
• in a particular year (and changes over several years) BUT…

(a) …Cannot see from an income statement how much cash a business may be generating or using up in a given year

(b) Depreciation – accounting tool for investments

• (i) Changes the relationship between the
• business’s income statement and real cash flow

1. Investments (value of item goes beyond 1 yr.)

a. $ Spent to purchase equipment used for more than 1 yr. is an investment and only the depreciation appears on the income statement

2. Expense

Equipment used within 1 yr. is considered an expense and the total amount appear on the incomes statement.

• I) measures how much more or less CASH a company has from one period to the
• next; compares cash amount at the end of the year to beginning of that year
• (Profit after tax + Depreciation – Investment= Cash Flow)

(1) CASH is separate from profit.

• (a) Undercapitalization: A co. might be
• profitable, but it doesn’t have enough cash to pay all of its bills; leading reason that companies shut down. Even if it doesn’t leave a co. insolvent, it leads to a weak growth

• (4) Increase in assets other than cash equals a decrease in cash flow.
• You spent money on the asset, you don’t have that money in your cash flow now

• (5) If you receive less money from accounts receivable then you thought your cash decreases and accounts
• receivable increases

(6) Investment v. expense

• (a) Investment: when a business buys something that will be used for more than one year. Depreciation
• appears on the income statement.

• (b) Expense: business buys something that will be used for only one year. Total amount of the item
• appears on the income statement.

I) shows the company’s assets, liabilities, and equity in a business during a particular moment

(1) Always balance: Equity=assets – liabilities & Assets= liabilities + equity

• (2) Income and cash flow statements
• illustrate activity “during a period” but a balance sheet illustrates a “particular moment”

(3) 3 Main Sections

• (a) ASSETS: Everything a company owns that has
• value

EX: Cash; land, buildings; accounts receivable; machinery and equipment

• (ii) Assets must always =
• liabilities + equity

(iii) Depreciation rules

1. Cash is not depreciated

• 2. Account receivable are not
• depreciated but may be written off

• 3. Assets must be depreciated on the
• balance sheet when they are depreciated on the income statement

(b) LIABILITIES: What the company owes

• Ex. Accounts payable,
• wages payable to employees, debts

• (c) EQUITY: Value of the company; difference
• between the assets and liability

• 1. Equity= Total assets – total
• liabilities

• (ii) Insolvency= Liabilities> assets
• (negative owner equity)

• (iii)
• AKA:
• net worth; shareholder’s equity; book value

• (1) Sole proprietorship
• (2) Partnership
• -general
• -Limited
• - LLP
• (3) Corporations
• -C
• -S
• - non-profit
• (4) LLC

• (1) Individual and the business are one
• and the same for tax and legal liability purposes

• (a) Individual reports all income and
• deductible expenses; does not pay taxes as a separate entity

• (b) Personally liable: claimants can
• pursue all assets of the owner

(1) General

• (a) 2+ owners, no filing with the state-
• default status

• (b) Treated like a sole proprietorship
• for tax and liability purposes

• (i) Earnings distributed according to
• agreement and taxes paid by each partner individually- the “business” itself is
• not taxed

• (ii) Each partner is jointly and severally
• liable

(2) Limited

(a) Partnership with both limited and general partners

(i) Limited partner: no say in management and NOT personally liable for co. debt

• (ii) General partner: management responsibility
• and UNLIMITED legal liability for the business

(b) Partnership for tax purposes

(c) Corporation for liability purposes

II) Limited liability company (LLC)

(1) Protection from liability and protection from double taxation

• (2) Owners of a limited liability are not
• individually liable for the company’s debts

• (3) LLC is not a tax paying entity, taxes
• are only paid once- by the owners when the earnings are distributed to them

(4) Based on state LLC law

• (1) Corporation’s owners (stockholders
• and shareholders) are protected from personal liability

(2) Corporation= tax-paying entity

• (a) Double taxation: Income of the
• corporation is taxed, then the owners of the corporation are taxed for their
• earnings (dividends paid)