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© 2014 Pacific Crest
393
8.5
Corporate Finance
P
urpose
The role this topic plays in quantitative reasoning
Why do people choose to invest in one company instead of another? How do banks decide whether or
not to loan money to a business? The decision for both investors and banks is made on the basis of a
company’s financial statements—the income statement and balance sheet. These financial statements
contain analytical information that, among other things, allows investors to determine if they will
invest, explain the financial health of a company to possible creditors, and assist company owners with
evaluating the performance of their company. The income statement, showing the revenues earned and
expenditures over a certain period of time, and the balance sheet which provides a snapshot of the
company’s assets and liabilities at a particular point in time, are the two most widely used financial
statements. While these two are separate financial statements, they do influence one another. When you
see changes in a company’s assets and liabilities on the balance sheet they will appear on the income
statement in the company’s revenues and expenses, which result in the company’s gains or losses.
The use of financial jargon can make reading and understanding financial statements difficult. Addition-
ally, there is a lack of standardization in the terminology used. For instance, the income statement itself
can also be referred to as
a profit and loss statement
or
a P&L
or
a statement of earnings
. While this
activity offers the most commonly used names for entries appearing in these financial statements, the
lack of standardization makes it impossible for the
The Language of Math
section to be truly compre-
hensive. It’s also important to understand that the story told by the analytical information presented in
financial statements paints only part of the picture—to really understand a company, you need to un-
derstand its core mission, its products, and the economic conditions of the industry in which it operates.
L
earning Goals
What you should learn while completing this activity
1. Understand the components of both an income statement and a balance sheet
2. Use an income statement and a balance sheet as tools to help you examine the health of a company
3. Create an income statement and budget sheet, given financial information
D
iscovery
Finding out for yourself
Go to the link available on the companion website to examine the financial information for Starbucks.
Examine the components and layout of the income statement and the balance sheet.
W
hat Do You Already Know?
Tapping into your existing knowledge
1.
What do parentheses mean in an income statement or balance sheet?
2.
What does it mean when a number is measured in thousands?
3.
What are the major categories on the income statement?
4.
What are the major categories on the balance sheet?
5.
What are the time frames for each financial tool?