Chapter 3 Financial Management BCN 4753 Summer 2007

Financial Reports Why is it important to be able to understand financial reports? Why is it important to be able to understand financial reports? Will help you as a manager to: Will help you as a manager to: Plan Plan Control Control Organize Organize Identify Errors Identify Errors Uncover omitted items Uncover omitted items

Financial Management What is the difference between Accounting and bookkeeping? What is the difference between Accounting and bookkeeping? Bookkeeping – recording of business and financial data in a certain manner, all records or specific projects Bookkeeping – recording of business and financial data in a certain manner, all records or specific projects Accounting – design of the system of records, preparation of reports on the data Accounting – design of the system of records, preparation of reports on the data

Financial Management Owned vs Owed Owned vs Owed Assets vs Liabilities Assets vs Liabilities Everything else is owner’s equity Everything else is owner’s equity Assets = Liabilities + Owners Equity Assets = Liabilities + Owners Equity Assets go up then Liabilities + Equity must? Assets go up then Liabilities + Equity must? Go Up Go Up

Financial Management Changes in Equity Changes in Equity Investments or Withdrawals Investments or Withdrawals Earnings or Losses Earnings or Losses Changes in equity are listed separately under their own categories Changes in equity are listed separately under their own categories Revenues Vs Expenses Revenues Vs Expenses Sales Sales Expenses are incurred to produce sales Expenses are incurred to produce sales

Financial Management Accrual Method Accrual Method Account for revenue and Expenses when earned or incurred Account for revenue and Expenses when earned or incurred Accurately match earnings with the activity that generated them Accurately match earnings with the activity that generated them Accounts Accounts Debits vs Credits Debits vs Credits Debit balance or Credit balance Debit balance or Credit balance

Financial Management When do you get revenue? When do you get revenue? Is recorded when customer takes ownership Is recorded when customer takes ownership Not when you are paid for it Not when you are paid for it So, revenue occurs when you complete the contract and bill the customer So, revenue occurs when you complete the contract and bill the customer Becomes an Account Receivable Becomes an Account Receivable When are expenses are recorded? When are expenses are recorded? Time they are incurred Time they are incurred Or if they can be matched to certain revenues Or if they can be matched to certain revenues

Financial Management Recording Transactions Recording Transactions Exchange of value Exchange of value Specific accounts Specific accounts Must be recorded according to GAAP Must be recorded according to GAAPEXAMPLE:

Financial Management Income Statement Income Statement Shows earnings in particular period Shows earnings in particular period Earnings on the Balance Sheet = Net income year-to date Earnings on the Balance Sheet = Net income year-to date Debits and credits to revenue affect income Debits and credits to revenue affect income Previous Year’s Earnings Previous Year’s Earnings Current Year’s Earnings Current Year’s Earnings

Financial Management Journal Journal Lists by date of all transactions Lists by date of all transactions Primary Record Primary Record Ensures record of all transactions Ensures record of all transactions Includes: date, who involved, if $ received, paid or earned and activity that resulted in the transaction Includes: date, who involved, if $ received, paid or earned and activity that resulted in the transaction

Financial Management The Ledger The Ledger Detailed record of one account I.e. A/R Detailed record of one account I.e. A/R Posting Posting Transferring from the Journal to ledger Transferring from the Journal to ledger Compare balances of ledger Compare balances of ledger Trial Balance Trial Balance Work-sheet Work-sheet

Financial Management Income Statement Income Statement Revenues, Expenses and Income Revenues, Expenses and Income Categorized by the type of goods or services provided Categorized by the type of goods or services provided Operating Expenses Operating Expenses Administrative Expenses Administrative Expenses Determine income on income statement Determine income on income statement Add to earnings section should make balance sheet balance Add to earnings section should make balance sheet balance

Financial Management Adjusting Entries Adjusting Entries Needed to comply with Accrual method Needed to comply with Accrual method Helps to match revenues and expenses Helps to match revenues and expenses Should try to match revenues and expenses to the same accounting period Should try to match revenues and expenses to the same accounting period Ex: End of year statements have not come in; must close out books Ex: End of year statements have not come in; must close out books

Financial Management Prepaid Expenses Prepaid Expenses Assets Assets Become expenses over time Become expenses over time Insurance policy Insurance policy Should cost evenly across the whole year Should cost evenly across the whole year Supplies Supplies Matching? Matching? Ending Inventory – Beginning Inventory Ending Inventory – Beginning Inventory

Financial Management Bad Debt Bad Debt Set-up account for Allowance for Doubtful Accounts Set-up account for Allowance for Doubtful Accounts Is subtracted from A/R Is subtracted from A/R Depreciation Depreciation Expense allocated over the life of the asset Expense allocated over the life of the asset Like using up inventory Like using up inventory

Financial Management The MACRS Depreciation System The MACRS Depreciation System Modified Acceleration Cost Recovery System Modified Acceleration Cost Recovery System Assigns specific number of years depending on the type of asset Assigns specific number of years depending on the type of asset Has specific guidelines pertaining to each type of asset Has specific guidelines pertaining to each type of asset ACRS Asset Cost Recovery System ACRS Asset Cost Recovery System Old system Old system

Expensing Equipment Expensing Equipment Allowed 24,000 in year of purchase Allowed 24,000 in year of purchase This is an alternative to depreciating it This is an alternative to depreciating it Does not benefit large purchases Does not benefit large purchases Does benefit smaller purchases Does benefit smaller purchases Improves cash flow by tax deduction Improves cash flow by tax deduction Financial Management

Amortization Amortization What is it? What is it? Refers to intangible assets Refers to intangible assets Same as straight line depreciation Same as straight line depreciation Equal amounts over life of intangible asset Equal amounts over life of intangible asset Most are done over 15 years Most are done over 15 years Some exceptions – computer software 36 months Some exceptions – computer software 36 months Start-up costs and organization costs 60 months Start-up costs and organization costs 60 months

Financial Management Accrued Expenses Accrued Expenses Have incurred, not received a bill or invoice Have incurred, not received a bill or invoice Use adjusting entries to record unpaid Use adjusting entries to record unpaid Can use reversing entry to account for this Can use reversing entry to account for this You reverse the adjusting entry and enter the expense as if the adjusting entry was never made You reverse the adjusting entry and enter the expense as if the adjusting entry was never made Accrued Revenues work same way Accrued Revenues work same way

Financial Management Closing the books Closing the books All revenue and expense accounts must = Zero All revenue and expense accounts must = Zero So new accounting period does not reflect any revenues or expenses from last period So new accounting period does not reflect any revenues or expenses from last period This is done by a lengthy journal entry This is done by a lengthy journal entry The balance is retained in Previous Year’s Earnings account i.e. Retained earnings The balance is retained in Previous Year’s Earnings account i.e. Retained earnings Opening the Books Opening the Books Asset, liabilities, and OE are same as previous balance Not Revenue or Expense Asset, liabilities, and OE are same as previous balance Not Revenue or Expense

Financial Management Differences in Organizations Differences in Organizations Partnerships will have separate accounts for their initial deposits Partnerships will have separate accounts for their initial deposits Owners equity is Stockholders Equity for Corporation Owners equity is Stockholders Equity for Corporation Preferred Stock Preferred Stock Common Stock Common Stock

Financial Management Subsidiary Ledger Subsidiary Ledger Account for each customer, supplier, employee, etc. Account for each customer, supplier, employee, etc. Keeps main ledger uncluttered Keeps main ledger uncluttered Keeps detailed info on accounts Keeps detailed info on accounts When paid When paid How Paid How Paid How much paid How much paid Still outstanding Still outstanding

Financial Management Payroll Payroll Determine gross earnings for pay period Determine gross earnings for pay period Determine employee deductions Determine employee deductions Calculate employer’s association expenses Calculate employer’s association expenses Update employee payroll records Update employee payroll records Create Journal entries Create Journal entries Remit funds to relevant government agencies Remit funds to relevant government agencies

Financial Management Determining Gross Earnings Determining Gross Earnings Regular Pay Regular Pay Overtime Pay Overtime Pay Salary Salary Tips Tips Commissions Commissions Taxable Benefits Taxable Benefits Vacation Pay Vacation Pay

Financial Management Employee Deductions Employee Deductions FIT FIT SIT SIT Social Security Tax (OASDI) Social Security Tax (OASDI) Medicare Tax (HI) Medicare Tax (HI) SUTA SUTA SDI SDI Local Local Union Union Medical Medical Dental Dental

Financial Management SUTA SUTA “The Florida SUTA unemployment insurance tax applies to the first $8000 of wages. The 2005 rate for a new company is 2.7%. After that the rate can vary between.1% and 5.4% depending on payroll totals and the number of UI claims.” “The Florida SUTA unemployment insurance tax applies to the first $8000 of wages. The 2005 rate for a new company is 2.7%. After that the rate can vary between.1% and 5.4% depending on payroll totals and the number of UI claims.”

Financial Management Remitting Funds Remitting Funds IRS IRS Send check for total amount FIT an Medicare, accounted for in journal entry Send check for total amount FIT an Medicare, accounted for in journal entry Must be accompanied by an explanation of check Must be accompanied by an explanation of check Separate check for FUTA Separate check for FUTA Look at the Circular E, Employer’s Tax Guide Look at the Circular E, Employer’s Tax Guide Can go to IRS web site Can go to IRS web siteIRS web siteIRS web site

Financial Management Inventory ownership Inventory ownership FOB FOB FAS FAS CIF CIF Inventory Control Inventory Control FIFO FIFO LIFO LIFO AVG cost AVG cost Item by Item Item by Item

Financial Management Maximizing Cash Flow\ Maximizing Cash Flow\ Bill customers Promptly Bill customers Promptly Deposit cash daily Deposit cash daily Keep close watch on credit customers Keep close watch on credit customers Add late charges Add late charges Pay bills just before due date Pay bills just before due date Keep inventory low Keep inventory low Look at slow moving inventory Items Look at slow moving inventory Items Consider leasing Consider leasing Control Taxes Control Taxes Money market accounts Money market accounts