CIE Lecture 5 Using Financial Information -1

7/31/2019 CIE Lecture 5 Using Financial Information -1

1/14

1

Enterprise Code 0454

Lecture 4

Understanding & Using Financial

Information


2/14

2

What Is Accounting?

Communication

Measuring

Interpreting

FinancialAccounting

FinancialAccounting

ManagementAccounting

ManagementAccounting

Decision Making

Accounting is the system a business uses to identify, measure, and communicate

financial information to others, inside and outside the organization.

Because outsiders and insiders use accounting information for different purposes,

accounting has two distinct facets. Financial accounting is concerned with

preparing financial statements and other information for outsiders such as

stockholders and creditors (people or organizations that have lent a company money

or have extended them credit); management accounting is concerned with

preparing cost analyses, profitability reports, budgets, and other information for

insiders such as management and other company decision makers. To be useful, all

accounting information must be accurate, objective, consistent over time, and

comparable to information supplied by other companies.


3/14

3

What Accountants Do

Tax

Accounting

TaxAccounting

BookkeepingBookkeeping

Financial

Analysis

FinancialAnalysis

CostAccounting

CostAccounting

Some people confuse the work accountants do with bookkeeping, which is the

clerical function of recording the economic activities of a business. Although some

accountants do perform bookkeeping functions, their work generally goes well

beyond the scope of this activity. Accountants design accounting systems, prepare

financial statements, analyze and interpret financial information, prepare financial

forecasts and budgets, and prepare tax returns. Some accountants specialize incertain areas of accounting, such as cost accounting (computing and analyzing

production costs), tax accounting (preparing tax returns and interpreting tax law),

orfinancial analysis (evaluating a companys performance and the financial

implications of strategic decisions such as product pricing, employee benefits, and

business acquisitions).


4/14

4

Ten Most ImportantAccounting Skills

Analytical

Problem solving

Interpersonal

Listening

Communication

Leadership

Decision making

Time management

Teamwork

Computer

In addition to traditional accounting work, accountants may also help clients

improve business processes, plan for the future, evaluate product performance,

analyze profitability by customer and product groups, design and install new

computer systems, assist companies with decision making, and provide a variety of

other management consulting services. Performing these functions requires a strong

business background and a variety of business skills beyond accounting.


5/14

5

FundamentalAccounting Concepts

The Accounting

Equation

Double-Entry

Bookkeeping

The MatchingPrinciple

In their work with financial data, accountants are guided by three basis concepts: the

fundamental accounting equation, double-entry bookkeeping, and the matching

principle.


6/14

6

The Accounting Equation

Owners Equity:

Assets Liabilities = Owners Equity

Accounting Equation:

Assets = Liabilities + Owners Equity

For thousands of years, businesses and governments have kept records of their

assetsvaluable items they own or lease, such as equipment, cash, land, buildings,

inventory, and investments. Claims against those assets are liabilities, or what the

business owes to its creditorssuch as banks and suppliers. For example, when a

company borrows money to purchase a building, the lender or creditor has a claim

against the companys assets. What remains after liabilities have been deductedfrom assets is owners equity:

Assets - Liabilities = Owners equity

Using the principles of algebra, this equation can be restated in a variety of formats.

The most common is the simple accounting equation, which serves as the

framework for the entire accounting process:

Assets =Liabilities + Owners equity

This equation suggests that either creditors or owners provide all the assets in a

corporation. However, the equation must always be in balance; in other words, one

side of the equation must always equal the other side.


7/14

7

Basic Accounting Concepts

Double-EntryBookkeeping

Double-EntryBookkeeping

MatchingPrinciple

MatchingPrinciple

CreditPurchase

CreditPurchase

CashPurchase

CashPurchase

AccrualBasis

AccrualBasis

CashBasis

CashBasis

To keep the accounting equation in balance, companies use a double-entry

bookkeeping system that records every transaction affecting assets, liabilities, or

owners equity.

The matching principle requires that expenses incurred in producing revenues be

deducted from the revenue they generated during the same accounting period. This

matching of expenses and revenue is necessary for the companys financial

statements to present an accurate picture of the profitability of a business.

Accountants match revenue to expenses by adopting the accrual basis of

accounting, which states that revenue is recognized when you make a sale or

provide a service, not when you get paid. Similarly, your expenses are recorded

when you receive the benefit of a service or when you use an asset to produce

revenuenot when you pay for it.

If a business runs on a cash basis, the company records revenue only when money

from the sale is actually received. The trouble with cash-based accounting, however,

is that it can be misleading. You can misrepresent expenses and income by the way

you time payments. Its easy to inflate income, for example, by delaying the

payment of bills. For that reason, public companies are required to keep their books

on an accrual basis.


8/14

8

Understanding FinancialStatements

Balance Sheet

Income Statement

Cash-Flow Statement

Financial statements consist of three separate yet interrelated reports: the balance

sheet, the income statement, and thestatement of cash flows. Together these

statements provide information about an organizations financial strength and

ability to meet current obligations, the effectiveness of its sales and collection

efforts, and its effectiveness in managing its assets. Organizations and individuals

use financial statements to spot opportunities and problems, to make businessdecisions, and to evaluate a companys past performance, present condition, and

future prospects. In sum, theyre indispensable.


9/14

9

The Balance Sheet

Assets

Current Assets Fixed Assets

Liabilities and Shareholders Equity

Current

Liabilities

Long-Term

Liabilities

Shareholders

Equity

The balance sheet, also known as thestatement of financial position, is a snapshot

of a companys financial position on a particular date. This statement includes all

elements in the accounting equation and shows the balance between assets on one

side and liabilities and owners equity on the other side.

Assets can consist of cash, things that can be converted into cash, and equipment.

Current assets include cash and other items that will or can become cash within the

following year. Fixed assets are long-term investments in buildings, equipment,

furniture and fixtures, transportation equipment, land, and other tangible property

used in running the business. Fixed assets have a useful life of more than one year.

Liabilities represent claims against the companys assets. The balance sheet gives

subtotals forcurrent liabilities (obligations that will have to be met within one year

of the date of the balance sheet) and long-term liabilities (obligations that are due

one year or more after the date of the balance sheet), and then it gives a grand total

for all liabilities.

The owners investment in a business is listed on the balance sheet under

shareholders equity. Shareholders equity for a corporation is presented in terms of

the amount of common stock that is outstanding, meaning the amount that is in the

hands of the shareholders. Shareholders equity also includes a corporations

retained earningsthe portion of shareholders equity that is not distributed to its

owners in the form of dividends.


10/14

10

The Income Statement

OperatingExpenses

OperatingExpenses

RevenuesRevenues

Net IncomeAfter Taxes

Net IncomeAfter Taxes

Cost ofGoods Sold

Cost ofGoods Sold

The income statement shows an organizations profit performance over a specific

period of time, typically one year. It summarizes all revenues (or sales), the

amounts that have been or are to be received from customers for goods or services

delivered to them, and all expenses, the costs that have arisen in generating

revenues. Expenses and income taxes are then subtracted from revenues to show the

actual profit or loss of a company, a figure known as net incomeprofit, or thebottom line.


11/14

11

The Cash-Flow Statement

Operations

Investments

Financing

In addition to preparing a balance sheet and an income statement, all public

companies and many privately owned companies prepare a statement of cash flows

to show how much cash the company generated over time and where it went.

The statement tracks cash flows from operations, investments, and financing. It

reveals the increase or decrease in the companys cash for the period and

summarizes (by category) the sources of that change.

From a brief review of this statement you should have a general sense of the amount

of cash created or consumed by daily operations, the amount of cash invested in

fixed or other assets, the amount of debt borrowed or repaid, and the proceeds from

the sale of stock or payments for dividends. In addition, an analysis of cash flows

provides a good idea of a companys ability to pay its short-term obligations when

they become due.


12/14

12

Analysing FinancialStatements

Trend Analysis Ratio Analysis

Consider More

Than One RatioUncover Business Shifts

Consider Extraordinary

CircumstancesCheck Specific Data

The process of comparing financial data from year to year in order to see how they

have changed is known as trend analysis. You can use trend analysis to uncover

shifts in the nature of the business over time. Of course, when you are comparing

one period with another, its important to take into account the effects of

extraordinary or unusual items such as the sale of major assets, the purchase of a

new line of products from another company, weather, or economic conditions thatmay have affected the company in one period but not the next.

Ratio analysis compares two elements from the same years financial figures. They

are called ratios because they are computed by dividing one element of a financial

statement by another. The advantage of using ratios is that it puts companies on the

same footing; that is, it makes it possible to compare different-size companies and

changing dollar amounts.

Before reviewing specific ratios, consider two rules of thumb: First, avoid drawing

too strong a conclusion from any one ratio. Second, once ratios have presented a

general indication, refer back to the specific data involved to see whether the

numbers confirm what the ratios suggest. In other words do a little investigating,because statistics can be misleading.


13/14

13

Types of Financial Ratios

Activity Leverage

Profitability Liquidity

You can analyze how well a company is conducting its ongoing operations by

computing profitability ratios, which show the state of the companys financial

performance or how well its generating profits.

Liquidity ratios measure the ability of the firm to pay its short-term obligations.

As you might expect, lenders and creditors are keenly interested in liquidity

measures.

A number ofactivity ratios may be used to analyze how well a company is

managing its assets.

You can measure a companys ability to pay its long-term debts by calculating its

debt ratios, or leverage ratios. Lenders look at these ratios to determine whether the

potential borrower has put enough money into the business to serve as a protective

cushion for the loan.


14/14

14

Financial Management

Developing and Implementing

a Financial Plan

Monitoring Cash Flow

Developing a Budget

Amount of funds

Sources of funds

Uses of funds

Cash

Inventory

Receivables and payables

Financial control

Capital investmentsCapital budgeting

Planning for a firms current and future money needs is the foundation offinancial

management, or finance.

Normally in the form of a budget, a financial plan is a document that shows the

funds a firm will need for a period of time as well as the sources and uses of those

funds. When you prepare a financial plan for a company, you have two objectives:

achieving a positive cash flow and efficiently investing excess cash flow to make

your company grow.

An underlying concept of any financial plan is that all money should be used

productively. This concept is important because without cash a company cannot

purchase the assets and supplies it needs to operate. One way financial mangers

improve a company's cash flow is by monitoring its working capital accounts: cash,

inventory, accounts receivable, and accounts payable.

In addition to developing a financial plan and monitoring cash flow, financial

managers are responsible for developing a budget, a financial blueprint for a given

period (often one year). Once a budget has been developed, the finance manager

compares actual results with projections to discover variances and recommends

corrective actiona process known as financial control. In addition, financial

managers forecast and plan for a firms capital investments such as major

expenditures in buildings or equipment. This process is called capital budgeting.

Documents

CIE Lecture 5 Using Financial Information -1