Accounting Professor Myles BassellBus 50.5 Small Business Management

Accounting is important to business for two reasons: it helps managers plan and control a company’s operation

it helps outsiders evaluate a business.

Basic Accounting EquationAssets = Liabilities + Owners’ Equity

Cash Basis vs. Accrual BasisCash basis accounting recognizes revenue at the time payment is received

Accrual basis accounting recognizes the revenue at the time of sale, even if payment is not made.

Accounting

Accounting Professor Myles BassellBus 50.5 Small Business Management

Financial Statements

Balance sheet – the balance sheet provides a snapshot of the business at a particular point in time.

For example, a snapshot as of June 30, 2008 it shows the size of the company, the major assets

owned, how the assets are financed, and the amount of owners’ investment in the business. Its

three main sections include assets, liabilities, and equity of owners. o Current Assets – cash and other items that can be easily be converted to cash within one

year. Expenses paid in advance are also classified as current assets.

Accounts receivables – amounts that are currently due to the companyo Fixed Assets – assets such as buildings, equipment, furniture, and other property

expected to be used for longer than one year.o Current Liabilities – amounts owed that are due to be repaid within in one year.

Accounts payable – short-term credit or debt the company owes its supplierso Long-term Liabilities – debts that are due a year or more after the date of the balance

sheet.o Shareholders’ Equity – money invested in the company for ownership interest, plus

accumulated earnings.

Income Statement – the income statement reflects the results of operations over a period of time.

It is the financial record of a company’s revenues, expenses, and profits over a given period of

time. For example, from May 30, 2007 to June 30, 2008 we can examine the gross revenues, cost

of goods sold, operating expenses, and net income for this time period.

Statement of Cash Flows – the statement of cash flows shows how a company’s cash was

received and spent in three areas: operations, investments, and financing. It gives a sense of the

amount of cash generated or consumed by daily operations, fixed assets, investments, and debt

over a period of time.

Accounting Professor Myles BassellBus 50.5 Small Business Management

Accounting Professor Myles BassellBus 50.5 Small Business Management

1. What is GAAP?GAAP is generally accepted accounting principles that apply to all published financial statements; all U.S. public companies must comply with GAAP. They include basic accounting standards and procedures that have been agreed on by the accounting profession.

2. What is the matching principle?The matching principle requires that expenses incurred in producing revenue be deducted from the revenue they generated during the accounting period.

3. What are the three main profitability ratios, and how is each calculated?The three main profitability ratios are return on sales, return on equity, and earnings per share. Return on sales is calculated by dividing net income after taxes by net sales. Return on equity is calculated by dividing net income after taxes by total equity. Earnings per share are calculated by dividing net income after taxes by the average number of common shares outstanding for that period.

4. Why is accounting important to business?Accounting is important to business for two reasons: First, it helps managers plan and control a company’s operation. Second, it helps outsiders evaluate a business.

Profitability ratios: o return on sales; o return on equity; o earning per share

Liquidity ratios: o current ratio; o quick ratio

Activity ratios: o inventory turnover; o accounts receivable turnover

Leverage ratios: o debt to equity; o debt to total assets

Accounting Professor Myles BassellBus 50.5 Small Business Management

Accounting Professor Myles BassellBus 50.5 Small Business Management

Accounting Professor Myles BassellBus 50.5 Small Business Management