CHAPTER
CHAPTER
2
An Introduction to Financial Statements
I
n this chapter, we introduce the reader to the balance sheet, income state-and Sources and Uses of Funds The Operating Statements: The Income Statement
statement. We illustrate the financial statement analysis using a health care,
R&D-intensive firm in New Jersey, Johnson & Johnson. Financial data can
be used to value the firm’s equity, deriving the fair market value of the com-
pany stock, or accessing its financial health in terms of potential bank-
ruptcy. We show financial Johnson & Johnson balance sheets, income
statements, and sources and uses of funds for the 1999–2003 period using
AOL Personal Finance data and calculate ratios concerning balance sheet
and income statement data for the 1970–2003 period using the Wharton
Research Data Services (WRDS) data. This chapter is designed to serve two
modest purposes: to acquaint the student with accounting and financial ter-
minology and concepts used throughout the book, and to explain the three
important accounting statements on an introductory level: balance sheet,
income statement, and statement of cash flows.
The Balance Sheet
The balance sheet is the financial picture of the firm at a point of time. The
assets of the firm are its resources. Assets include cash, receivables, inventory,
and plant and equipment. Assets are used to produce goods and services, and
generate profits and cash flow. The liabilities of the firm represent what the
firm owes its creditors and its stockholders’ claims. The difference between
the liabilities and the assets is the net worth, stockholders’ equity which rep-
resents the owners’ investment in the firm. The liabilities plus the net worth
of the firm must equal the sum of the firm’s assets. The balance sheet presents
the equation that the sum of the assets equals the sum of liabilities and equity.