1. Entrepreneurship for Computer Science CS 15-390
Financial Accounting- Part I
Lecture 16, March 20, 2018
Mohammad Hammoud

2. Today… Last Session: The Lean Startup Approach- Part III
Today’s Session:
Financial Accounting- Part I
Announcements:
Midterm grades are out.
PS3 is due on March 22 by midnight.

3. Why Financial Accounting?
Accounting is the language of business
It allows you to answer basic questions, alongside controlling, evaluating, and planning operations
What does my company own?
How much does it owe others?
How well did its operations go?
How does it get the cash to fund itself?
You need to interpret core financial statements, answer questions like the above, control, evaluate, and plan operations accordingly, and communicate results to your audience (e.g., employees, investors, customers, etc.,)
A process that can be denoted as financial accounting

4. Matching and allocation most often do not occur at the same time
Types of Accounting
There are two types of accounting:
Accrual accounting
It captures business activities irrespective of cash movement
More precisely, transactions are recorded when activities are performed
E.g., HP sold your startup a rack of servers in March 2018, but your startup will pay HP in February 2019
HP will record the sale, match it against its related cost, and compute the profit in 2018, when the binding contract was signed with you (even if some of the related cost is paid by HP- e.g., to a supplier- at a later period- e.g., 2019)
Your startup will accrue (or allocate) the cost of the rack over its useful time
Matching and allocation most often do not occur at the same time

5. Types of Accounting There are two types of accounting:
Cash basis accounting
It captures cash movement without regard to business activities
More precisely, transactions are recorded only when cash changes hands
Anytime you get cash from a customer, you call that revenue, even if the product or service is not delivered at that time
Anytime you spend cash you call that expense
E.g., If you pay a 2-year rent in 2018, all the rent cost will be recorded as an expense in 2018 and NOT over a period of 2 years
It does not try to match the sales against their related costs

6. Example: Cash Basis Accounting
Month 1:
You offer a service to a customer where the cost to you is $100.
The customer pays you $200 for your service.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
This can be viewed as an oversimplified “Income Statement” (with no taxes, no debt, no interest, etc.), one of the three core financial statements

7. Example: Cash Basis Accounting
Month 2:
You offer a service to a customer where the cost to you is $200.
You and the customer agree that they can pay you $400 next month.
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
Expenses
$100
Profit
= $100
-$200
Cash
=$-100
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
Expenses
$100
Profit
= $100
-$200
Cash
=$-100
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
Expenses
$100
Profit
= $100
-$200
Cash
=$-100
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
Expenses
$100
Profit
= $100
-$200
Cash
=$-100
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
Expenses
$100
Profit
= $100
-$200
Cash
=$-100

8. Example: Cash Basis Accounting
Month 3:
You receive $400 from the customer you offered the service to last month.
You receive $200 in advance from a customer that you have to offer a service to next month.
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
Cash
=$-100
=$500
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
Cash
=$-100
=$500
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
Cash
=$-100
=$500
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
Cash
=$-100
=$500
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
Cash
=$-100
=$500

9. Example: Cash Basis Accounting
Month 4:
You offer your service to the customer who paid you last month.
The service costed you $100.
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
$-100
Cash
=$-100
=$500
=$400
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
$-100
Cash
=$-100
=$500
=$400
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
$-100
Cash
=$-100
=$500
=$400
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
$-100
Cash
=$-100
=$500
=$400
Month 1
Month 2
Month 3
Month 4
Revenue
$200 $0
=$600
Expenses
$100
Profit
= $100
-$200
$600
$-100
Cash
=$-100
=$500
=$400
Profitable
Non-Profitable
Profitable
Non-Profitable
The business is steadier than what the above seems to imply!

10. Example: Accrual Accounting
Month 1:
You offer a service to a customer where the cost to you is $100.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
200 –100 = $100
Cash
Accounts Receivable $0
Deferred Revenue
A money that you will receive in the future for a service/product that you have already delivered.

11. Example: Accrual Accounting
Month 1:
You offer a service to a customer where the cost to you is $100.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
200 –100 = $100
Cash
Accounts Receivable $0
Deferred Revenue
A money that you have received in advance for a service/product that you will deliver in the future.

12. Example: Accrual Accounting
Month 1:
You offer a service to a customer where the cost to you is $100.
The customer pays you $200 for your service.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
= $100
Cash
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
200 –100 = $100
Cash
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
200 –100 = $100
Cash
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
Expenses
$100
Profit
200 –100 = $100
Cash
Accounts Receivable $0
Deferred Revenue

13. Example: Accrual Accounting
Month 2:
You offer a service to a customer where the cost to you is $200.
You and the customer agree that they can pay you $400 next month.
Even though the customer did not pay you!
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue

14. Example: Accrual Accounting
Month 2:
You offer a service to a customer where the cost to you is $200.
You and the customer agree that they can pay you $400 next month.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue

15. Example: Accrual Accounting
Month 2:
You offer a service to a customer where the cost to you is $200.
You and the customer agree that they can pay you $400 next month.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
Accounts Receivable $0
Deferred Revenue

16. Example: Accrual Accounting
Month 3:
You receive $400 from the customer you offered the service to last month.
You receive $200 in advance from a customer that you have to offer a service to next month.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
Accounts Receivable
Deferred Revenue

17. Example: Accrual Accounting
Month 4:
You offer your service to the customer who paid you last month.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue

18. Example: Accrual Accounting
Month 4:
You offer your service to the customer who paid you last month.
The service costed you $100.
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable
Deferred Revenue
The profits reflect better the activities of the business!

19. The Balance Sheet The balance sheet presents:
The assets owned by your company
The liabilities owed to others
And the accumulated investment of the owners (i.e., owner’s equity)
Assets are the resources that the company posses for future benefits
Examples:
Cash
Inventory
Accounts receivable
Equipment
Buildings

20. The Balance Sheet
Liabilities are dollar-specific obligations to pay or repay, and other obligations to provide products or services to others
Examples:
Bank debt
Accounts payable (i.e., amount owed to suppliers)
Prepaid accounts (i.e., advances from customers to deliver products or services)
Taxes owed (or taxes payable)
Wages owed to employees (or wages payable)

21. The Balance Sheet
Owner’s equity is the accumulated dollar measure of the investments made by the owners in the company
Examples (more on these 3 examples later)
Common stock
Paid-in-capital (i.e., the funds raised by the company from equity and not from ongoing operations)
Retained earnings (i.e., reinvestment of earnings)
As its name implies, the balance sheet is a “balance” sheet, where:
Assets (A) = Liabilities (L) + Owner’s Equity (OE)

22. Very Simple Example Income statement of month 2 on an accrual basis
Balance Sheet- End of Month 1
Balance Sheet- End of Month 2 A A
DR = 0 L
DR = 0 L
Income statement of month 2 on an accrual basis
Cash: $100
AR: $0
Equity: $100
Cash: -$100
AR: $400
Equity: $300 OE OE
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable (AR)
Deferred Revenue (DR)

23. Very Simple Example Income statement of month 2 on an accrual basis
Balance Sheet- End of Month 1
Balance Sheet- End of Month 2 A A
DR = 0 L
DR = 0 L
Income statement of month 2 on an accrual basis
Cash: $100
AR: $0
Equity: $100
Cash: -$100
AR: $400
Equity: $300 OE OE
Month 1
Month 2
Month 3
Month 4
Revenue
$200
$400 $0
Expenses
$100
Profit
= $100
= $200
Cash
= $-100
= $500
=$400
Accounts Receivable (AR)
Deferred Revenue (DR)
The balance sheet is a snapshot of a company’s holdings at a given time, while the income statement shows the “flow” of activities and transactions over a specific period of time.

24. Next Class
The three core financial statements- Part II