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Understanding Accounting and

Financial Statements

Explain the functions and importance of accounting, and identify the three basic activities involving accounting.

Describe the roles of the financial players in an organization and what they do

Explain the functions and major components of the four principal financial statements: the balance sheet, the income statement, the statement of owner’s equity, and the statement of cash flows.

Discuss how financial ratios are used to analyze a company’s financial strengths and weaknesses.

Describe the role of budgets in a business.

Develop your financial intellgence and understand better the whole aspects of a business

Learning Goals

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Accounting

Accounting is the process of measuring, interpreting, and communicating financial information to support internal and

external business decision making.

Business & Accounting

•  Accounting is the universal language of Business and Finance.

•  More CEO’s from fortune 500 companies have come up through the ranks of accounting than from any other area in business. Currently: 54%

•  Small businesses usually fail because of poor accounting understanding.

•  Marriages usually fail because of poor financial management (80% of divorces are $$$$ related.)

•  If you want to get ahead in business & marriage determine that you are going to understand accounting basics.

•  Open book management - sharing sensitive financial information with employees and teaching them how to understand and use financial statements.

•  Viewing financial information may help them better understand how their work contributes to the company’s success.

•  Outsiders use financial data to evaluate investment opportunities.

Open Book Management

Business Activities

Involving Accounting

•  Financing activities provide necessary funds to start a business and expand it after it begins operating.

•  Investing activities provide valuable assets required to run a business.

•  Operating activities focus on selling goods and services, but they also consider expenses as important elements of sound financial management.

The Players

•  Chief Financial Officer (CFO) is involved in management and strategy of the organization from a financial perspective.

•  Treasurer is responsible for banking relationships, cash flow management, forecasting, investor relations, equity and capital structure decisions.

•  Controller has an internal focus- is responsible for providing reliable and accurate financial reports including general accounting, financial reporting, business analysis, financial planning, asset management and internal control.

The Accounting Cycle

Accounting process - set of activities involved in converting information about transactions

into financial statements.

Income Statement

ü  Income Statement (Profit & Loss Statement)- financial record of a company’s revenues and expenses, and profits over a period of time.

ü  Tries to measure whether the products or services that a company provides are profitable when everything is added up.

ü Reports profit or loss. ü  Focus on revenues and costs associated with

revenues.

Sample Income Statement

Income Statement – Example

Louise Jones’ Income Statement (Month of Sept. 2016)

Revenue: Income from Job $500 Income from Pell Grant 2000 Total Revenue: $2500 Expenses: Clothes Expense $300 Rent Expense 200 Food Expense 50 Tuition Expense 1200

Misc. Expense 250 Total Expenses: $2000 Net Income for September: $ 500

Profit

§  Gross Profit- total revenues from sales- cost of goods sold or services sold. It is what is left over after the company has paid direct costs incurred in making the product or delivering the service

§  Operating Profit (EBIT)- is gross profit minus operating expenses, inlcuding depreciation and amortization. It shows the profit made from running the business.

§  Net Profit- is the bottom line of income statement, what is left after all costs and expenses are substracted from revenue.

•  Assets - anything of value owned or leased by a business. •  Liability - claim against a firm’s assets by a creditor. •  Owner’s equity - all claims of the proprietor, partners, or

stockholders against the assets of a firm, equal to the excess of assets over liabilities.

•  Basic accounting equation - relationship that states that assets equal liabilities plus owners’ equity.

•  Double-entry bookkeeping - process by which accounting transactions are entered; each individual transaction always has an offsetting transaction.

The Accounting Equation

ü Balance sheet - statement of a firm’s financial position—what it owns and the claims against its assets (what is owns and what it ows)—at a particular point in time.

ü  Photograph of firm’s assets together with its liabilities and owner’s equity

ü  Follows the accounting equation: Assets- Liabilities= Owners Equity

Balance Sheet

Sample Balance Sheet

Example (Simplified)

Louise Jones’ Business or Personal Records

Balance Sheet

•  •  Assets:

–  Current: •  Cash at Home $100 •  Cash Deposits in Bank 500

–  Fixed: •  Wardrobe 2000 •  Equipment 1000 •  Car 5000

–  Total Assets: $8,600 •  Liabilities:

–  Current: •  Credit Card Payable $500

–  Long Term: •  Note Payable (on Car) $2000

–  Total Liabilities $2,500 •  Capital, Louise Jones: 6,100 •  Total Liabilities & Owners Equity: $8,600

Statement of Owner’s Equity

ü  Statement of Owner’s Equity - is designed to show the components of the change in equity from the end of one fiscal year to the end of the next.

ü  Begins with the amount of equity shown on the balance sheet.

ü Net income is added, and cash dividends paid to owners are subtracted.

Sample Statement of Owner’s Equity

Assessing Company’s Health

ü  Is the company solvent? - Do it’s assets outweigh its liabilities, so that owner’s equity is a positive number?

ü Can the company pay its bills? – comparing current

assets (particularly cash) with current liabilities. ü Has owner’s equity been growing over time? –

comparing owner’s equity in the balance sheets over a period of time.

The Statement of Cash Flows

ü  Statement of cash flows - a firm’s cash receipts and cash payments that presents information on its sources and uses of cash.

ü  3 categories of accounts- cash inflows and outflows

from: operating activities, investing activities and financing activities.

Cash is King

§  Turning profit into cash- Cash is a reality check for how the business is run.

§  Cash is different from Profit (and you need both) §  You will need real money to run a business, pay

people, pay your bills for electricity, phones, computers, suppliers, etc. You can’t pay for all this with profits.

Sample Statement of Cash Flows

Financial Ratios Analysis

Ratio analysis - tool for measuring a firm’s liquidity, profitability, and reliance on debt financing, as well as the effectiveness of

management’s resource utilization.

Liquidity Ratios

Acid-test (or quick) ratio measures the

ability of a firm to meet its debt payments on

short notice.

Cash and equivalents ���+ short-term investments ���+ accounts receivable

Total current liabilities

Current ratio compares current assets to current liabilities.

Total current assets

Total current liabilities

Activity Ratios

Inventory turnover ratio indicates the number of times

merchandise moves through a business.

Cogs

Average of inventory

Total asset turnover ratio indicates a business ability

to generate sales in reaction to its total assets

Net sales

Average of total assets

Profitability Ratios

Profitability ratios measure the organization’s overall financial performance by evaluating its ability to generate revenues in excess of

operating costs and other expenses.

•  Leverage ratios measure the extent to which a firm relies on debt financing.

•  Total liabilities to total assets ratio > 50 percent indicates that a firm is relying more on borrowed money than owners’ equity.

Leverage Ratios

•  Budget - planning and control tool that reflects a firm’s expected sales revenues, operating expenses, and cash receipts and outlays for un upcoming accounting period.

•  Management estimates of expected sales, cash inflows and outflows, and costs.

•  Budgets are a financial blueprint that serves as a financial plan.

•  Cash budget - tracks the firm’s cash inflows and outflows.

Budgets

•  Outlines a plan for managers and employees

•  Fortifies effective pricing and spending efforts

•  Benefits :

•  Requires planning

•  Enhaces communication

•  Reinforces accountability

•  Identifies problems

•  Motivates employees

Importance of Budgeting

Sample Budget

Quiz – Use a Pencil Today

•  Which financial report is a “snapshot” of the of the financial status of a business or a family…..and is given a specific date?

•  Which financial report is a “moving picture” of the business/enterprise for a period of time?

•  What does a balance sheet balance? •  What are the two kinds of accounts found on an Income Statement? •  On what financial report(s) is the “cash” account found? •  What are the three subtitles of a income statement. (name them in the order

they are given on the report) •  If the bank wanted to know your “Net Worth” what report would they ask

for? •  Capital in a corporation is entitled ?