Unit 2 – FinanceTopic 1 - Accounting

Accounting

• Accounting Information helps individuals both working for the company and those who may have another financial interest in the company make accurate and timely decisions.

Users of Accounting Information

Examples include…

Managers• Where can we reduce our company expenses?• Is it wise for the company to stop producing a

particular product.• Should the company purchase another

company?• How much profit did we make this year?• Can we afford to take on more debt?

Users of Accounting Information

Examples include…Banks• Do we want to provide a loan to this company?

How much debt do they already have? What were their sales and profits like in previous years.

Investors• Should I buy shares in this company?• Is this company making steady profits and

paying out regular dividends.• Do I want to sell my shares?

Accounting Defined

Accounting

• The process of recording, analyzing, and interpreting the economic/financial activities of a business.

Accounting Concepts

Transaction• Any business activity that involves the exchange

of money.

Examples: 1. Company purchases computer equipment for

$5000.00.2. Company pays an employee $300 for wages

earned.3. A customer purchases $100 worth of

merchandise4. The business pays a portion of the bank loan it

owes to the bank.

Accounting Concepts

Bookkeeping

• The recording of all the business transactions

• Most businesses use a computer software to record and track financial information.

Accounting ConceptsDouble-Entry Bookkeeping• Each transaction involves at least two changes.

Examples:

Employees get paid $3000 for weeks wages.• Business bank account decreases.• The total amount of money the company has spent to date on

wages increases.

The business purchases computer equipment for $500.• The business bank account decreases.• The amount the business has spent on computer equipment has

increased.

The bank receives a bank loan for $20 000• The business bank account increases.• The total debt the business now owes increases.

Accounting Concepts

Net Worth The dollar value of a person after

subtracting all their debts from what they own. (Own – Owe = Net Worth)

Owner’s EquityThe dollar value of a business after subtracting all its debts from what

the business owns.

(Assets – Liabilities = Owner’s Equity)

Calculating Your Net Worth

OWN OWE

Calculating Your Net Worth

OWN - OWE = Net Worth

Individual

Assets - Liabilities = Net Worth

Sole Proprietorship Business: • One owner • Assets - Liabilities = Owner’s Equity

Partnership• Two or more owners• Assets – Liabilities = Partnership Equity

Corporation• Shareholders are the owners• Assets – Liabilities = Shareholder’s Equity

Net Worth For Business

Accounting ConceptsAssets• Item that is owned• Items may be purchased with cash (equity); or• Items may be purchased through debt (a loan)• Items may be a gift• Money a customer owes the business

Examples may include:• Equipment• Furniture• Electronics• House• Building• Automobiles• Accounts Receivable – money owed by a customer

Accounting ConceptsLiabilities• Debts or amounts owed to others

(creditors)

Examples:• Bank Loan• Accounts Payable – money owed

to a supplier

Transaction example:You received a bank loan to purchase

a car.• Your assets increased by the

amount of the car.• But the total amount you owe, your

liabilities have also increased by the same amount.

U.S.’s Net Worth

• http://www.brillig.com/debt_clock/

• http://www.usdebtclock.org/

Preparing Financial Statements

Three Types of Financial Statements

1. Balance Sheet

2. Income Statement/ Statement of Operations

3. Cash Flow Statement

Balance Sheet

Balance Sheet• States the financial

position of a company on a specific date

• Lists the company’s assets, liabilities and owner’s equity.

Preparing the Balance Sheet

Step 1: Fill in the statement heading

• Who? The name of the business

• What? The name of the financial statement

• When? The date the statement is prepared

Preparing the Balance Sheet

Step 2: List the AssetsLiquidity• Assets are listed in order according to how

easily they can be converted into cash. • For example, cash requires no conversion

so it is listed first. • Accounts receivable is money customers

owe and is usually paid within 30 days, so it is listed second.

Preparing the Balance Sheet

Step 3: List the Liabilities

• Listed in the order by maturity date - the date which they must be repaid with the earliest being recorded first.

• For example, accounts payable will likely be repaid before a bank loan and a mortgage.

Preparing the Balance Sheet

Step 4 – Complete the Owner’s Equity Section• State the owner’s equity amount

Step 5 – Balancing the Balance Sheet• Total Assets should be equal to Total Liabilities and

Owner’s Equity. • Total Assets should be indicated on the same line as

Total Liabilities and Total Owner’s Equity.• The totals should be double underlined.

Mark’s Repair ShopBalance Sheet

September 30, 2011

Assets LiabilitiesCash $ 6 500 Accounts Payable $ 7 350

Accounts Receivable 8 100 Bank Loan 11 050

Supplies 500 Mortgage Payable 110 000

Inventory 4 000 Total Liabilities $128 400

Equipment 25 500

Building 175 000 Owner’s Equity

_______ Bianchet, Equity $ 91 200

Total Assets $219 600 Total Liabilities & Owner’s Equity $ 219 600

Report Form of a Balance Sheet Marks’ Repair Shop Balance Sheet September, 30, 2011

AssetsCash $ 6 500Accounts Receivable 8 100Supplies 500Inventory 4 000Equipment 25 000Building 175 000Total Assets $ 219 600

LiabilitiesAccounts Payable $ 7 350Bank Loan 11 050Mortgage Payable 110 000Total Liabilities $ 128 400

Owner’s EquityBianchet, Equity 91 200Total Liabilities and Owner’s Equity $ 219 600

Income StatementIncome Statement• States the revenues and expenses of a business and its net profit/income

and/or loss over a specific period of time.

Revenues• Money received or the promise of money, received from the sale of goods

and/or services.

Example• Book Store sold $30 worth of books for cash.• Book Store sold $1 000 worth of text books on credit. The school will pay

the book store in 30 days. (Accounts Receivable)

Expenses• Costs of operating the business on a daily basis. • Salaries and wages expense, hydro expense, telephone expense,

advertising expense

Income Statement

Service Business:• Net Profit/Income = Total Revenues > Total Operating Expenses

• Net Loss = Total Revenues < Total Operating Expenses

Merchandise Business:

• Businesses purchase merchandise and then sell it at a higher price to consumers.

• Cost of the merchandise/inventory sold must also be subtracted from the total revenues.

• Net Profit = Total Revenues – Cost of Goods Sold – Operating Expenses; when Total Revenues > than Cost of Goods Sold + Operating Expenses.

Preparing the Income Statement

Step 1: Fill in the statement heading

• Who? The name of the business

• What? The name of the financial statement

• When? The period of time which the statement is covering.

i.e. (For the year ended December 31, 2009)

(For the month ended November 30, 2009)

(For 3 months ended July 30, 2009)

Preparing the Income StatementStep 2 : • List all the sources of revenue

Step 3:• Prepare the Cost of Goods Sold Section for a

Merchandise Company

Step 4:• List all the operating expenses • This is step 3 for a Service Business.

Final Step:• Calculate the net income/profit or net loss.

RevenueRepairs Revenue $ 9 900Total Revenue $ 9 900

Operating ExpensesSalaries $ 2 600Rent 2 000Advertising 850Supplies 185Utilities 235Insurance 150Delivery Expense 770Total Expenses $ 6 790Net Income $ 3 110

Mark’s Repair ShopIncome Statement

For the month ending September 30, 2011

Clare’s Shirt ShopIncome Statement

For the month ending September 30, 2011

RevenueSales $ 5 000Total Revenue $ 5 000

Cost of Goods SoldCost of Goods Sold 1 000Gross Profit $ 4 000

Operating ExpensesWages $ 1 300Rent 1 000Advertising 300Supplies 100Utilities 200Insurance 150Total Expenses $ 3 050Net Income $ 950

Cash Flow Statement

Cash Inflow• Lists all the cash coming into

the business (i.e. cash sales, payment of Accounts Receivables, )

Cash Outflow• Lists all the cash going out of

thecompany (payment of Accounts Payable, cash payment of bills, orpurchases of assets, payments made on loans)

Cash Flow Terminology

Positive Cash Flow

• There is more money flowing into the company than flowing out of it.

Negative Cash Flow

• There is more money flowing out of the company than there is flowing into it.

Key Points

• Just because a company has made a profit, does not mean it has a positive cash flow.

• Where does the cash from sales go to? - purchasing assets - paying expenses - paying off debts

• Cash outflows can still exceed any net profits.

Cash Flow Key Points

• A negative cash flow can lead to insolvency and potentially bankruptcy of a company if it is not managed carefully.

7 Ways To Boost Your Cash Flow

1. Increase the price of goods2. Reduce your costs and expenses

where possible. Shop around for the best deal.

3. Consider leasing instead of purchasing.

4. Reduce the amount of inventory on hand.

5. Use long-term debt as much as possible as opposed to short-term debt

6. Manage your Accounts Receivables better

7. Stretch your deadlines for Accounts Payable if possible

Interpreting Financial Statement

• Comparing information from one year to the next or from one company to the next.

• Information is then used to help make effective business and financial decisions.

Resources

1. Wilson, Jack et al. The World of Business (5th ed.) Toronto: Nelson Education Ltd., 2007