Unit 2 – Finance Topic 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: Company purchases computer equipment for $5000.00. Company pays an employee $300 for wages earned. A customer purchases $100 worth of merchandise 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 Concepts Double-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 Owner’s Equity The dollar value of a person after subtracting all their debts from what they own. (Own – Owe = Net Worth) Owner’s Equity The 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

Net Worth For Business 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

Accounting Concepts Assets 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 Concepts Liabilities 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 Balance Sheet Income Statement/ Statement of Operations 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 Assets Liquidity 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 Shop Balance Sheet September 30, 2011 Assets Liabilities Cash $ 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 Assets Cash $ 6 500 Accounts Receivable 8 100 Supplies 500 Inventory 4 000 Equipment 25 000 Building 175 000 Total Assets $ 219 600 Liabilities Accounts Payable $ 7 350 Bank Loan 11 050 Mortgage Payable 110 000 Total Liabilities $ 128 400 Owner’s Equity Bianchet, Equity 91 200 Total Liabilities and Owner’s Equity $ 219 600

Income Statement Income 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 Statement Step 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.

Mark’s Repair Shop Income Statement For the month ending September 30, 2011 Revenue Repairs Revenue $ 9 900 Total Revenue $ 9 900 Operating Expenses Salaries $ 2 600 Rent 2 000 Advertising 850 Supplies 185 Utilities 235 Insurance 150 Delivery Expense 770 Total Expenses $ 6 790 Net Income $ 3 110

Clare’s Shirt Shop Income Statement For the month ending September 30, 2011 Revenue Sales $ 5 000 Total Revenue $ 5 000 Cost of Goods Sold Cost of Goods Sold 1 000 Gross Profit $ 4 000 Operating Expenses Wages $ 1 300 Rent 1 000 Advertising 300 Supplies 100 Utilities 200 Insurance 150 Total Expenses $ 3 050 Net 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 the company (payment of Accounts Payable, cash payment of bills, or purchases 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 Increase the price of goods Reduce your costs and expenses where possible. Shop around for the best deal. Consider leasing instead of purchasing. Reduce the amount of inventory on hand. Use long-term debt as much as possible as opposed to short-term debt Manage your Accounts Receivables better 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 Wilson, Jack et al. The World of Business (5th ed.) Toronto: Nelson Education Ltd., 2007