Lesson 7 : Financial Analysis and Accounting Basics

Accounting

Process of measuring, interpreting, and communicating financial information to support internal and external business decision making.

Open book management

Sharing sensitive financial information with employees and teaching them how to understand and use financial statements.

Financing activities

Provide necessary funds to start and expand a business.

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.

Public Accountants

Accountant who works for an independent accounting firm.

Certified Public Accountant (CPA)

Accountant who meets specified educational and experiential requirements and has passed a comprehensive examination on accounting theory and practice.

Management accountant

Accountant employed by a business other than a public accounting firm

Collects and records financial transactions and prepares financial statements used by the firm's managers in decision making

Government and Not-for-Profit Accountants

Perform professional services similar to those of management accountants

Accounting Process

Set of activities involved in converting information about transactions into financial statements.

Generally accepted accounting principles (GAAP)

Principles that encompass the conventions, rules, and procedures for determining acceptable accounting practices at a particular time

Financial Accounting Standards Board (FASB)

Organization primarily responsible for evaluating, setting, or modifying GAAP in the U.S.

Sarbanes-Oxley Act

A response to cases of accounting fraud.

Public Accounting Oversight Board

Created the ____________,which sets audit standards and investigates and sanctions accounting firms that certify the books of publicly traded firms.

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

Assets = Liabilities + Owner's Equity

Double-entry bookkeeping

Process by which accounting transactions are entered; each individual transaction always has an offsetting transaction.

Financial Statements

Provide managers with information for evaluating organization's ability to meet current obligations and needs, its profitability, and its overall financial health.

The Balance Sheet

Statement of a firm's financial position—what it owns and the claims against its assets—at a particular point in time

Income Statement

Financial record of a company's revenues, expenses, and profits over a period of time.

Statement of cash flows

Statement of a firm's cash receipts and cash payments that presents information on its sources and uses of cash.

Accrual accounting

Accounting method that records revenue and expenses when they occur, not necessarily when cash actually changes hands.

Inadequate cash flow

is a reason for many business failures.

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

Firm's ability to meet short-term obligations when they must be paid.

Current ratio = Total current assets / Total current liabilities

Acid-test (or quick) ratio

measures the ability of a firm to meet its debt payments on short notice.

Acid-test ratio = Total current assets / Total current liabilities

Activity Ratios

Measure the effectiveness of management's use of the firm's resources.

Inventory turnover = Net sales / Average of Inventory

Turnover Ratios

Total asset turnover ratio indicates how much in sales each dollar invested in assets generates.

Total asset turnover = Net sales / Average of Inventory

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 the extent to which a firm relies on debt financing.

Cash budget

Tracks the firm's cash inflows and outflows.