Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Introduction to Business Chapter Fourteen

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit 1.Explain how the success of a company’s business model can be measured by financial accounts and describe the various kinds of activities that accounting perform. 2.Analyze a company’s balance sheet and describe how it balances the assets a company owns against the capital owed to its creditors and stockholders. 3.Explain how the income statement is used to measure a company’s bottom line profit and the various costs and expenses that must be deducted to arrive at this total. 4.Understand the need for cash, as well as profit, affects a company’s business model, and how the cash flow statement measures the cash that flows into and out of a company. 5.Appreciate how financial ratios can be used to analyze the information in company’s financial statements and how they help both managers and investors evaluate a company’s current and future profitability.

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit ROIC The most accurate measure of a company’s profitability is Return on Invested Capital Increasing profitability and sales suggests the company functions and activities are creating more value for its customers than its competitors and now have a competitive advantage

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit GAAP Accounting is a process of collecting, measuring and recording data in an organized method or generally accepted accounting principles (GAAP)

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit GAAP For example, the matching principle requires that expenses incurred be deducted from the revenue within the same time period

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit GAAP Also the revenue is stated in the time frame when the sale is made not when the customer pays for the sale and companies must follow this accrual basis of accounting

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit GAAP This data is analyzed and then reported the results into financial reports and statement

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Accounting system The financial information system used to measure, record, analyze and report all the transactions involved in its value-creation process All company stakeholders are interested in the financial report and statements resulting from the accounting function

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Accounting System Stockholders, managers, and employees all use these statements to analyze the financial health and improve company performance Employees, even if not stockholders, are concerned the company will be able to reward and employ them in the future

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Accounting Activities Is a hierarchy of data information and knowledge Bookkeeping is the recording activity needed to monitor and track all financial transactions Depreciation is the process of reducing the value of the asset over time as it is used

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Accountants Companies employ accountants, both internal and external, and certified professionals (CPA) To perform the accounting activities necessary to meet strict professional and legal requirements

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Accountants The Sarbanes-Axley Act of 2002 added to these requirements necessitating the CEO as well as others to sign off ( thereby legally liable) on all financial statements

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Accountants Financial accountants who specialize in preparing and analyzing financial data for use by managers Financial accountants who specialize in preparing financial data for use by stakeholders

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Financial Statements Managers of all levels use accounting financial statements and need to understand the accounting methods used to prepare these statements Balance sheet Income statement Statement of cash flows

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Financial Statements The balance sheet is a summary of the financial conditions of a company for a specific time and as of a specific day (think of a “snapshot” or a still picture)

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit The Accounting Equation States that assets minus liabilities equals owner equity Assets are the resources a company owns from cash to all investments Liabilities are the financial obligations that a company incurs from purchasing or borrowing to obtain capital

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit The Accounting Equation The other main source of a company’s capital is its stockholder’s equity which is the total capital invested by its founders and stockholders This equation is balanced by double entry bookkeeping which records the dual effects of a financial transaction on a company’s assets and liabilities

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Key Terms Current liabilities are debts due and payable within one year Total equity is the sum of the capital stock invested and retained earnings

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Key Terms Liquidity is how fast an asset can be converted to cash and may be categorized as current (working) or long term assets

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Income Statement Reports the results of a company’s profitability and may be called a profit and loss statement

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Income Statement The basic equation of sales revenue minus expenses equals profit (or loss) is used on this statement to determine the bottom line profit or the amount of net income (or profits or earnings)

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Cash Flow Statement Shows how much cash a company generates during a specific financial period, and how it is used

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Cash Flow Statement In accounting cash refers to the value of a company’s assets that can be converted into cash immediately

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Financial Ratios Measures of different aspects of a company's performance and profitability and categorized as liquidity, asset management and profitability ratios

Chapter 14 Accounting: Measuring how Efficiently and Effectively Resources are Creating Value and Profit Financial Ratios Note that gross margin indicates how much of each sales dollar remains after deducting cost of goods sold from sales