Financial information is the HEART OF BUSINESS MANAGEMENT.
Most of us know almost nothing about accounting from experience.
However, you have to know something about accounting if you want to understand business.
It is almost impossible to run a business effectively without being able to read, understand, and analyze accounting reports and financial statements.
Accounting reports and financial statements are as revealing of the HEALTH OF A BUSINESS as pulse rate and blood pressure reports are in revealing the health of a person.
WHAT IS ACCOUNTING?
ACCOUNTING is the recording, classifying, summarizing, and interpreting of financial events and transactions to provide management and other interested parties with the information they need to make good decisions.
FINANCIAL TRANSACTIONS include buying and selling goods and services, acquiring insurance, using supplies, and paying taxes.
An ACCOUNTING SYSTEM is the methods used to record and summarize accounting data into reports.
PURPOSES OF ACCOUNTING:
To help managers evaluate the financial condition and the operating performance of the firm so they may make better decisions.
To report financial information to people outside the firm such as owners, suppliers, and the government.
Accounting is the measurement and reporting of financial information to various users regarding the economic activities of the firm.
AREAS OF ACCOUNTING.
Accounting has been called the LANGUAGE OF BUSINESS, but it also is the language used to report financial information about nonprofit organizations.
MANAGERIAL ACCOUNTING.
MANAGERIAL ACCOUNTING is used to provide information and analyses to managers within the organization to assist them in decision making.
Managerial accountants:
MEASURING AND REPORT COSTS of production, marketing, and other functions.
PREPARING BUDGETS .
Checking whether or not units are STAYING WITHIN THEIR BUDGETS.
DESIGNING STRATEGIES TO MINIMIZE TAXES.
A CERTIFIED MANAGEMENT ACCOUNTANT is a professional accountant who has met certain educational and experience requirements and been certified by the Institute of Certified Management Accountants.
FINANCIAL ACCOUNTING.
The information provided by FINANCIAL ACCOUNTING is used by people OUTSIDE of the organization (owners and prospective owners, creditors and lenders, employee unions, customers, governmental units, and the general public.)
These external users are interested in the organization’s profits and other financial information.
Much of this information is contained in the company’s ANNUAL REPORT, a yearly statement of the financial condition and progress of an organization covering a one-year period.
It is critical for firms to keep accurate financial information.
A PRIVATE ACCOUNTANT is one who works for a SINGLE COMPANY OR ORGANIZATION.
A PUBLIC ACCOUNTANT is one who provides services for a fee to a NUMBER OF COMPANIES.
PUBLIC ACCOUNTANTS help firms by:
Designing an accounting system for a firm.
Helping select the correct computer and software to run the system.
Analyzing the financial strength of an organization.
The accounting profession assures users of financial information that financial reports of organizations are accurate.
The independent Financial Accounting Standards Board (FASB) defines what are generally accepted accounting principles (GAAP) that accountants must follow.
If financial reports are prepared in accordance with GAAP, users know the information is reported professionally.
A CERTIFIED PUBLIC ACCOUNTANT (CPA) is an accountant who has passed a series of examinations established by the American Institute of Certified Public Accountant (AICPA) and met the state’s requirements for education and experience.
AUDITING.
AUDITING is the job of reviewing and evaluating the records used to prepare the company’s financial statements.
Internal accountants often perform INTERNAL AUDITS.
Public accountants also conduct INDEPENDENT AUDITS of accounting records.
An INDEPENDENT AUDIT is an evaluation and unbiased opinion about the accuracy of company financial statements.
An accountant who has a bachelor’s degree, experience in internal auditing, and has passed an exam can earn standing as a CERTIFIED INTERNAL AUDITOR.
TAX ACCOUNTING.
Federal, state, and local governments require submission of tax returns that must be filed at specific times and in a precise format.
TAX ACCOUNTANTS are accountants trained in tax law and are responsible for preparing tax returns and developing tax strategies.
As the burden of taxes grows, the role of the tax accountant becomes more important.
ACCOUNTING VERSUS BOOKKEEPING.
BOOKKEEPING is the recording of business transactions.
Bookkeeping is PART OF ACCOUNTING. but ACCOUNTING GOES FAR BEYOND the mere recording of data.
Accountants CLASSIFY, SUMMARIZE, INTERPRET, and REPORT DATA to managers.
They suggest strategies for improving the financial condition of the company.
WHAT BOOKKEEPERS DO.
The first task of bookkeepers is to DIVIDE ALL THE PAPERWORK INTO MEANINGFUL CATEGORIES.
Then they RECORD THE DATA from the original transaction documents (sales slips, etc.) into record books called JOURNALS.
A JOURNAL is the FIRST PLACE transactions are recorded.
DOUBLE-ENTRY BOOKKEEPING is the concept of writing each transaction in two places.
Bookkeepers can check one list against the other to make sure they add up to the same amount.
In double-entry bookkeeping, two entries in the journal are required for each company transaction.
A LEDGER is a specialized accounting book in which information from accounting journals is accumulated into specific categories and posted so that managers can find all the information about one account in the same place.
THE SIX-STEP ACCOUNTING CYCLE.
The ACCOUNTING CYCLE results in the preparation of the financial statements: the balance sheet and the income statement.
Step 1ANALYZING AND CATEGORIZING DOCUMENTS.
Step 2PUTTING THE INFORMATION INTO JOURNALS.
Step 3POSTING THAT INFORMATION INTO LEDGERS. (These first three steps are continuous.)
Step 4PREPARING A TRIAL BALANCE (summarizing all the data in the ledgers to see that the figures are correct and balanced.)
Step 5PREPARING AN INCOME STATEMENT AND BALANCE SHEET.
Step 6ANALYZE THE FINANCIAL STATEMENTS AND DETERMINE FINANCIAL HEALTH OF COMPANY.
UNDERSTANDING KEY FINANCIALSTATEMENTS.
A FINANCIAL STATEMENT is the summary of all transactions that have occurred over a particular period.
These indicate a firm’s financial health and stability.
Two key financial statements are:
The BALANCE SHEET. which reports the firm’s financial condition on a specific date.
The INCOME STATEMENT. which reports revenues, expenses, and profits (or losses) for a period of time.
The balance sheet is a snapshot. while the income statement is a motion picture.
BALANCE SHEET.
A BALANCE SHEET is the financial statement that reports a firm’s financial condition at a specific time.
The term balance sheet implies that the report shows a balance between two figures.
The balance sheet shows a balance between a company’s assets and its liabilities and owners equity; or: assets = liabilities + owners’ equity
THE FUNDAMENTAL ACCOUNTING EQUATION.
The FUNDAMENTAL ACCOUNTING EQUATION is: assets = liabilities + owners’ equity
The fundamental accounting equation is the BASIS FOR THE BALANCE SHEET.
The assets are equal to, or are balanced with, the liabilities and owners’ equity.
THE ACCOUNTS OF THE BALANCE SHEET.
ASSETS are economic resources owned by the company.
Assets include productive, tangible items that help generate income, as well as intangibles of value.
LIQUIDITY refers to how fast an assets can be converted into cash.
CURRENT ASSETS can be converted to cash within one year.
FIXED ASSETS (such as equipment, buildings, and land) are relatively permanent.
INTANGIBLE ASSETS (such as patents and copyrights) include items of value such as patents and copyrights that have no real physical form.
LIABILITIES AND OWNER’S EQUITY.
LIABILITIES are what the business owes to others.
CURRENT LIABILITIES are payments due in one year or less.
LONG-TERM LIABILITIES are payments not due for one year or longer.
ACCOUNTS PAYABLE are monies owed for merchandise and services purchased on credit but not paid for yet.
NOTES PAYABLE, are short-term or long-term promises for future payment.
BONDS PAYABLE are money loaned to the firm that it must pay back.
EQUITY.
The value of things you own (assets) minus the amount of money you owe others (liabilities) is called EQUITY.
The value of what stockholders own in a firm (minus liabilities) is called STOCKHOLDERS’ EQUITY (or SHAREHOLDERS’ EQUITY.)
The formula for OWNERS’ EQUITY is assets minus liabilities.
Businesses not incorporated identify this as a CAPITAL ACCOUNT.
For corporations, the OWNERS’ EQUITY account records the owners’ claims to funds they have invested in the firm plus earnings kept in the business and not paid out.
THE INCOME STATEMENT.
The INCOME STATEMENT is the financial statement that shows a firm’s profit after costs, expenses, and taxes.
It summarizes all of the resources that have come into the firm (revenue), all the resources that have left the firm, and the resulting net income or loss.
NET INCOME or NET LOSS are the revenues left over.
The income statement reports the results of operations over a particular period of time.
The INCOME STATEMENT’S FORMULA. revenue cost of goods sold = gross margin (gross profit) gross margin (gross profit) net income before taxes net income before taxes taxes = net income (or loss)
The income statement includes valuable financial information for stockholders and employees.
The income statement is arranged according to accepted accounting principles (GAAP)): revenue cost of goods sold gross margin operating expenses net income before taxes taxes net income (or loss)
REVENUE is the value of what is received for goods sold, services rendered, and other financial sources.
There is a difference between revenue and sales.
Most REVENUE comes from SALES, but OTHER SOURCES OF REVENUE include rents earned, interest earned, and so forth.
Net income can also be called NET EARNINGS, or NET PROFIT.
COST OF GOODS SOLD (COST OF GOODS MANUFACTURED.)
COST OF GOODS SOLD (COST OF GOODS MANUFACTURED) measures the cost of merchandise sold or cost of raw materials or parts and supplies used for producing items for resale.
The cost of goods sold includes the purchase price plus any costs associated with obtaining and storing the goods.
GROSS MARGIN (GROSS PROFIT) is how much the firm earned by buying and selling or making and selling merchandise.
In a service firm, there may be no cost of goods sold.
In either case, the gross margin doesn’t tell you everything—you must subtract expenses.
OPERATING EXPENSES.
EXPENSES are costs involved in operating a business, such as rent, utilities, and salaries.
OPERATING EXPENSES include rent, salaries, supplies, utilities, insurance, and depreciation of equipment.
After all expenses are deducted, the firm’s net income before taxes is determined.
After allocating for taxes, you get to the bottom line, the NET INCOME (or perhaps NET LOSS) the firm incurred from operations.
Businesses need to keep track of how much money they earn, spend, how much cash they have on hand, and so on.
The Importance of CASH FLOW ANALYSIS.
CASH FLOW is simply the difference between cash flowing in and cash flowing out of the business.
The number one financial cause of small-business failure today is INADEQUATE CASH FLOW.
Businesses often get into cash flow problems when they are growing quickly, borrowing heavily, and receiving payment from customers slowly.
They are selling their goods and services, but aren’t getting paid in time to turn around and pay their own bills.
In order to meet the demands of customers, more and more goods are bought on credit.
When the credit limit has been reached, the bank may refuse the loan.
Too often, the company goes into bankruptcy because there was no cash available when it was most needed.
By keeping a SKILLED BANKER informed about sales, profits, and cash flow, a small-business person makes sure of good financial advice and a more ready source of funds.
THE STATEMENT OF CASH FLOWS
In 1988, the Financial Accounting Standards Board required that the statement of cash flows replace the statement of changes in financial position.
The STATEMENT OF CASH FLOWS reports cash receipts and disbursement related to the firm’s major activities:
OPERATIONS — Cash transactions associated with running the business.
INVESTMENTS — Cash used in or provided by the firm’s investment activities.
FINANCING — Cash raised from the issuance of new debt or equity capital or cash used to pay business expenses, past debts, or company dividends.
Accountants analyze all of the cash changes that have occurred from operating, investing, and financing and determine the firm’s net cash position.
The CASH FLOW ANSWERS QUESTIONS such as:
How much cash came into the business from current operations?
Was cash used to buy stocks, bonds, or other investments?
Were some investments sold that brought in cash?
How much money came in from issues stock?
APPLYING ACCOUNTING KNOWLEDGE.
The major functions of recording transactions and preparing financial statements have largely been assigned to computers, but how you record and report data is also important.
DEPRECIATION .
Companies are permitted to write-off the cost of assets using DEPRECIATION as a business operation expense.
Companies may choose from a number of techniques for calculating DEPRECIATION .
Each technique results in a DIFFERENT NET INCOME.
Accountants can offer financial advice and recommend ways of legally handling investments, depreciation, and other accounts.
HANDLING INVENTORY.
INVENTORIES are a critical part of a company’s financial statements and important in determining a firm’s cost of goods sold.
FIFO is the accounting technique for calculating cost of inventory based on FIRST IN, FIRST OUT.
LIFO is the accounting technique for calculating cost of inventory based on LAST IN, FIRST OUT.
The American Institute of Certified Public Accountants (AICPA) insists that complete information about the firm’s financial operations be provided in financial statements. CONCEPT CHECK
ACCOUNTING AND BUDGETING PROCESS.
A BUDGET IS A FINANCIAL PLAN.
A BUDGET sets forth management’s expectations for revenues and, based on those financial expectations, allocates the use of specific resources.
Financial statements form the basis for the budgeting process because past financial information is what is used to project future financial needs and expectations.
Using accurate financial information to make strategic business decision is critical.
Accountants often assist the financial managers in determining the organization’s future financial needs.
The budget process is an opportunity to plan to improve the management of business.
Financial statements must be prepared according to legal and accepted accounting principles; this process cannot be compromised.
THE IMPACT OF COMPUTER TECHNOLOGY IN ACCOUNTING.
Financial information and transactions may be recorded by hand or in a computer system.
Most companies use computers since computers greatly simplify the task.
As a business grows, the number of accounts a firm must keep and the reports that must be generated expand in scope.
Many small-business accounting packages address the specific accounting needs of a small business.
Computers can record and analyze data and print out financial reports.
It is possible to have CONTINUOUS AUDITING. testing the accuracy and reliability of financial statements, because of computers.
Software programs allow even novices to do sophisticated financial analyses.
COMPUTERS DO NOT MAKE FINANCIAL DECISIONS BY THEMSELVES.
They are a TOOL to help accountants determine the best strategies.
Small-business owners should hire or consult with an accountant before they get started in business.
Computers help make accounting work less monotonous.
The work of an accountant requires training and very specific competencies.
Everyone needs to speak the language of accounting to succeed in business.
USING FINANCIAL RATIOS.
Accurate financial information forms the basis of the financial analysis performed by accountants.
FINANCIAL RATIOS are helpful in analyzing the actual performance of the company compared to its financial objectives.
They also provide insights into the firm’s performance compared to other firms in the industry.
LIQUIDITY RATIOS measure the company’s ability to pay its short term debts.
These short-term debts are expected to be repaid within one year.
The CURRENT RATIO is the ratio of a firm’s current assets to its current liabilities.
current ratio = current assets current liabilities
The ratio should be compared to competing firms within the industry.
The ACID-TEST RATIO (or QUICK RATIO ) measures the cash, marketable securities, and receivables of the firm, to its current liabilities.
acid-test ratio = cash + marketable securities + receivables current liabilities
This ratio is important to firms that have difficulty converting inventory into quick cash.
LEVERAGE (DEBT) RATIOS refer to the degree to which a firm relies on borrowed funds in its operations.
The DEBT TO OWNERS’ EQUITY RATIO measures the degree to which the company is financed by borrowed funds that must be repaid.
debt to owners’ equity ratio = total liabilities owners’ equity
A ratio above 1 (or 100%) would show that a firm actually has more debt than equity.
It is important to compare ratios to other firms in the same industry.
PROFITABILITY (PERFORMANCE) RATIOS measure how effectively the firm is using its various resources to achieve profits.
Management’s performance is often measured by using profitability ratios.
A new Accounting Standards Board rule went into effect at the end if 1997 requiring companies to report their quarterly earning per share two ways: basic and undiluted.
BASIC EARNINGS PER SHARE (BASIC EPS) measures the amount of profit earned by a company for each share of common stock it has outstanding.
Earnings help to stimulate growth and pay for stockholders’ dividends.
basic earnings per share = net income after taxes #shares common stock outstanding
DILUTED EARNINGS PER SHARE (DILUTED EPS) measures the amount of profit earned by a company for each share of outstanding common stock, but also takes into consideration stock options, warrants, preferred stock, and convertible debt securities which can be converted into common stock.
RETURN ON SALES is calculated by comparing a company’s net income with its total sales.
return on sales = net income net sales
Firms use this ratio to see if they are doing as well as other companies they compete against in generating income from sales.
RETURN ON EQUITY measures how much was earned for each dollar invested by owners.
It is calculated by comparing a company’s net income with its total owner’s equity.
return on equity = net income after taxes total owners’ equity
The higher the risk involved in an industry, the higher the return investors expect on their investment.
These and other profitability ratios are vital measurements of company growth and management performance.
ACTIVITY RATIOS measure the effectiveness of the firm’s management in using the assets that are available.
INVENTORY TURNOVER RATIO measures the speed of inventory moving through the firm and its conversion into sales.
inventory turnover ratio = cost of goods sold average inventory
The more efficiently a firm manages its inventory, the higher the return.
A lower than average inventory turnover ratio often indicates obsolete merchandise on hand or poor buying practices.
Inventory control is needed to ensure proper performance
Finance professionals use several other specific ratios to learn more about a firm’s financial condition.
