Ch 17 Business Dynamics

understanding accounting and financial information

Is accounting only for profit-seeking businesses?

No, it’s used to report financial information in general and is needed to understand any business

What is accounting

The recording, classifying, summarizing, and interpreting of financial events and transactions.

• Done to provide management and others (i.e. investors) financial information needed to make good decisions.

What counts as financial transactions?

1. buying and selling g/s

2. insurance

3. paying employees

4. using supplies

What is the accounting system?

Taking inputs (accounting documents) and processing them into accounts, journals and ledgers to create outputs (financial statements)

Who uses accounting statements/information

1. government taxing authorities

2. gov. regulatory agencies

3. investors

4. firm managers

What does FASB stand for and what do they do?

FASB is the Financial Accounting Standards Board.

• They define the generally accepted accounting principles (GAAP) accountants must follow

What is the accounting cycle

for the preparation and analysis of financial statements

1. analyze source documents

2. record transactions in journals

3. posting entries into the ledger

4. trial balance

5. prepare financial statements

6. analyze financial statements

What is bookkeeping, how does it differ from accounting?

It is the recording of business transactions.

— Difference: Accountants classify and summarize financial data provided by bookkeepers, interpret it, suggest strategies, and prepare financial statements

What are the 3 types of financial statements?

1. Balance sheet

2. Income statement

3. Statement of cash flows

What is the journal for?

It serves as a record book or computer program where accounting data is first entered

What is double-entry bookkeeping and what is its purpose?

The recording of financial transactions in two places(two entries), so that they can be cross checked for errors.

— two entries in journal and ledger

What is a ledger?

An accounting book in which information from journals are posted into their specific categories to isolate information.

What is a trial balance?

A summary of all financial data in ledgers to ensure debits and credits are balanced.

What is a financial statement, what does it indicate?

A summary of all the financial transactions that have occurred over a particular period.

• indicates a firm’s financial health and stability

balance sheet

reports the firm’s financial condition on a specific date

— owns and owes on a certain day

income statement

• summarizes revenues

• cost of goods sold

• expenses (+taxes)

• — resulting net income or loss

— highlights the total profit or loss the firm experiences during a specific period

— profit vs. loss over period of time

statement of cash flows

summary of money coming into and going out of the firm.

— tracks cash receipts and payments

related to 3 major activities

• operations — running the business

• investments — used in or provided by investment activities

• financing — cash raised through debt, equity, or cash to pay expenses, debts and dividends

— difference between cash coming in and out of the business

What is the fundamental accounting equation?

A = L + OE

What are assets?

economic resources (things of value) owned by a firm

• listed in order of liquidity

what is liquidity

the ease at which you can convert an asset to cash

What are current, fixed, and intangible assets

1. Current Assets — can be converted into cash within one year

   • cash, AR, inventory

2. Fixed Assets — long-term assets that are pretty much permanent

   • land, buildings, equipment

3. Intangible Assets — long-term assets that have no physical form

   • patents, trademarks, copyrights, and goodwill

Types of liabilities

Liabilities — essentially debt, it’s what the business owes to others

• current is 1 yr or less, the rest is long-term

1. Accounts payable — current liabilities or bills for merchandise or services purchased on credit

2. Notes payable — short or long-term promised to be repaid by a certain date

   • loans

3. Bonds payable — long-term liabilities; bonds

what is owner’s equity?

amount of the business that belongs to owners minus any liabilities held

retained earnings

accumulated earnings (profits) from the firms operations that are reinvested into the business

• NOT paid out to stockholders

What are the two different inventory valuation methods (cost of goods sold)

LIFO — last in, first out; can be used to lower tax liability

FIFO — first in, first out

what is depreciation?

the write-off of the cost of a tangible asset over its estimated useful life.

operating expenses

— rent, salaries, supplies, insurance, depreciation

ratio analysis

the assessment of a firm’s financial condition using ratios coming from a firm’s financial statements

liquidity ratios

Current ratio = current assets / current liabilities

• is the firm financial secure for the long term? 2.0 or better is considered safe

Acid-test/quick ratio = (cash + AR + marketable securities) / current liabilities

• how well can the firm pay of their short-term debt if sales drop? 0.5-2.0 is fine, but not good

leverage (debt) ratios

measures the degree to which a firm relies on borrowed funds

Debt to OE = total liabilities / owner’s equity

• whether it’s good or bad depends on past ratios and trends within the industry.

• in general though, a ratio greater than 1 indicates you have more debt then equity

profitability (performance) ratios

how effectively a firm’s is using resources to profit

EPS (earnings per sale) = net income post taxes / # of common stock shares outstanding

• profit earned for each share of outstanding common stock

Return on sales = net income / net sales

• higher risk of failure, a higher return is expected

Return on equity = net income after tax / total owner’s equity

Activity ratios

how effectively management is turning over inventory

inventory turnover — cost of goods sold / average inventory

• lower-than-average indicates redundant merchandise or poor buying practices

what are the 5 working areas that accountants work in?

• Financial accounting

• Managerial accounting

• Auditing

• Tax accounting

• Government and Nonprofit accounting

what is auditing

reviewing and evaluating information used to prepare a company’s financial statements