accounting role of accounting in business exploring business chapter 12 thursday 9/8/11

AccountingAccountingRole of Accounting in BusinessRole of Accounting in Business

Exploring BusinessChapter 12

Thursday 9/8/11

StakeholdersStakeholders

Purpose of Accounting:

To help Stakeholders, i.e., parties who are interested in the activities of the business because they’re affect by them

Accounting ActivitiesAccounting Activities

• Measuring and summarizing business activities

• Analyzing and Interpreting financial statements

• Communicating the results to management and other decision makers.

Two Major Fields of AccountingTwo Major Fields of Accounting

Management Accounting – provides information to decision makers inside the organization to help operate the business

Financial Accounting – furnishes information to individuals and groups inside/outside the organization to assess the firm’s financial performance

Careers In Careers In AccountingAccounting

“People Profession”Skills

• Analytical• Interpersonal• Communication

Job Prospects• Certified Public Accountants- Audits• Private Accountants- Controller• Certified Management Accountants

Financial Accounting Financial Accounting

Statements•Income Statement•Balance Sheet•Statement of Cash Flows

Generally Accepted Accounting Principles [GAAP]

Users OfUsers OfAccounting InformationAccounting Information

Owners &Owners &ManagersManagers

Investors & Investors & CreditorsCreditors

Government Government AgenciesAgencies

Other UsersOther Users

The Users of Accounting The Users of Accounting InformationInformation

The FunctionsThe Functionsof Financial Statementsof Financial Statements

Income Statement [Profit & Loss or P&L Statement]– Shows sales, cost of sales, expenses and if it resulted in a profit or loss

Balance Sheet – Indicates assets/liabilities and amount invested in company

Statement of Cash Flows – Shows how much cash in and out of firm

Income Statement ElementsIncome Statement Elements

Net Revenues: Gross sales less returns

Cost of Goods Sold [COGS]: Variable cost

component of products or services

Gross Profit: Net Revenues - COGS

Operating Expenses: Fixed cost component of

running a business including staff salaries, general

selling expenses, operating costs, R&D, engineering,

rent, interest, depreciation

Net Profit or <Loss>: Gross profit - Operating

Expenses

Equivalent Terms in AccountingEquivalent Terms in Accounting

Term Equivalent Term

The Income StatementThe Income Statement

• A financial report that shows an organization’s profitability over a period of time:– month, quarter, or year

It can represent a single entity or be consolidated

Revenue: Net SalesCost of Goods or Services Sold: Variable costs associated with SalesGross Income: Gross ProfitExpenses: Fixed costs Net Income <Loss>:

Stress-BusterStress-BusterIncome StatementIncome Statement

Month Ending 8/31/11

% of

Sales Gross Revenue (100 units x $10/unit) = $1,000 = 100%

less Cost of Goods Sold ($6/unit) = <$600> = 60%

Gross Profit = $400 = 40%

less Operating Expenses [OH]

Staff Salaries = $240

Advertising, Rent = $60

< $300> = 30%

Net Income [Profit] Before Taxes = $100 = 10%

less Taxes [25%] = $25

Net Income after Taxes = $75

Tool for AnalysisTool for Analysis

Microsoft Excel– Goal Seek – A “what if” analysis tool that

enables you to find the input value needed to achieve a goal or objective.

– For example, “what if” I added $20 to my expenses. How much more in Sales would I need to do to maintain the same bottom line % of Sales?

Proposed Income Statement #1 What if I added a new Proposed Income Statement #1 What if I added a new staff member adding $20 in expenses. How much more staff member adding $20 in expenses. How much more sales do I need to keep the bottom line % the same?sales do I need to keep the bottom line % the same?

Manual Calculation: $320 / 30% = $1067.

Stress- Buster Corp.

Proposed Income Statement #2: What if I found a Proposed Income Statement #2: What if I found a cheaper source of raw materials that drove my COGS cheaper source of raw materials that drove my COGS down to $5/unitdown to $5/unit

Month Ending 8/31/11

% of Sales

Gross Revenue [or Sales] (100 units x $10/unit) = $1,000 = 100%

less COGS ($5/unit) = <$500> = 50%

Gross Profit = $500 = 50%

less Operating Expenses [OH]

Staff Salaries = $240

Advertising, Rent = $60

< $300> = 30%

Net Income [Profit] Before Taxes = $200 = 20%

Stress-Buster Corp.

Proposed Income Statement #3: Proposed Income Statement #3: What if demand for my What if demand for my product drove sales to increase to 150 units per month?product drove sales to increase to 150 units per month?

Assumption: You had extra plant manufacturing capacity to meet demand

% of

Sales Gross Revenue [or Sales] (150 units x $10/unit) = $1,500 = 100%

less COGS ($6/unit) = <$900> = 60%

Gross Profit = $600 = 40%

less Operating Expenses [OH]

Staff Salaries = $240

Advertising, Rent = $60

< $300> = 20%

Net Income [Profit] Before Taxes = $300 = 20%

Stress-Buster Corp

Breakeven AnalysisBreakeven Analysis

$ Fixed Costs$ Variable Costs$ Contribution Margin per unit

$ Breakeven Point In Units

Calculation: Total sales revenue must exactly equal all your expenses

Breakeven AnalysisBreakeven Analysis

Sell Price [SP]/Unit = $10

Variable Cost [VC]/Unit = $6

Contribution Margin [CM]/Unit = SP/Unit – VC/Unit = $4

Fixed Costs [FC]= $300

Breakeven in Units = FC / CM/Unit

= $300 / $4 per Unit = 75 Units

Stress-Buster Corp

Revenue (75 units x $10/unit) = $750

less COGS ($6/unit) = <$450>

Gross Profit = $300

less Operating Expenses [OH]

Staff Salaries = $240

Advertising, Rent = $60

< $300>

Net Income [Profit] Before Taxes = $0

Breakeven Analysis

Stress-Buster Corp

Balance SheetBalance Sheet

Assets: Business resourcesLiabilities: Debts owed to outside entitiesOwner’s Equity: Amount invested

Balance Sheet - tells what you have (and where it came from) at a specific point in time

A “snapshot” of an organization’s financial position at a given moment. It presents an accumulation of all the company’s transactions since it began

Classified Balance SheetClassified Balance Sheet

AssetsCurrent - Convert to cash within a yearLong-Term - Intend to hold for more than a year

LiabilitiesCurrent - Pay off within a yearLong-Term - Not due for more than a year

Stockholder Equity

Balance Sheet Equation: Total Assets = Balance Sheet Equation: Total Assets = Total Liabilities + Stockholder EquityTotal Liabilities + Stockholder Equity

ABC’s Year-End Balance Sheet as of 12/31/09

Assets LiabilitiesCash + Liquid Securities Account Receivables Inventory

Total Current Assets

$(000)

2,000

1,0001,000

Account Payable 900

Wages PayableTaxes PayableInterest Payable

$(000)

500500100

Total Current Liabilities 4,000 2,000

Notes Receivable 1,000

Property & Equipment 6,000

Intangible Assets [GW & TM] 1,000

Total Long Term Assets 8,000 Total Assets 12,000

Long Term Debt 2,000

Total Shareholder Equity 8,000

Total Liabilities & Stockholder Equity 12,000

Balance Sheet Equation: Total Assets = Balance Sheet Equation: Total Assets = Total Liabilities + Stockholder EquityTotal Liabilities + Stockholder Equity

ABC’s Year-End Balance Sheet as of 12/31/10

Assets Liabilities

Account Payable 600

Wages PayableTaxes PayableInterest Payable

Total Current Liabilities

Long Term Debt 2,000

Total Shareholder Equity 6,450

Total Liabilities & Stockholder Equity 10,000

Cash + Liquid Securities Account Receivables Inventory

Total Current Assets

1,500

700 800

3,000

Notes Receivable 1,000

Property & Equipment 5,000

Intangible Assets [GW & TM 1,000

Total Long Term Assets 7,000 Total Assets 10,000

45045050

1,550

The Statement of Cash FlowThe Statement of Cash Flow

• Explains how the company’s cash changed from the beginning of the accounting period to the end. Where did cash come from? Where did it go?

• Three categories:1. Cash from (used for) operating activities2. Cash from (used for) investing activities 3. Cash from (used for) financing activities

Financial Statement AnalysisFinancial Statement Analysis

Profit Margin Ratios – how much of each sales $ is left after certain costs are covered

Management Efficiency – how efficiently your assets are being managed [Asset Utilization]

Management Effectiveness – how effective management is at running the business. It also measures overall company performance

Financial Condition – helps assss the company financial strength

Financial Statement AnalysisFinancial Statement Analysis

1) Need Information from the Income Statement for the same period

2) Need Information from the Balance Sheet for the same period

Ratio AnalysisRatio Analysis

• Vertical Percentage Analysis– Analyze relationships between items on your

income statement; between geographic divisions; etc.

– Compare your financial results with those of other companies in your industry or sector

Year-To-Year Comparative Income Year-To-Year Comparative Income StatementStatement

Financial Statement AnalysisFinancial Statement Analysis

1) Profitability Ratios1) Gross Profit Margin

2) Net Profit Margin

3) Return on Equity

2)Management Efficiency [Asset Utilization]1) Accounts Receivable Ratio

2) Inventory Turnover Ratio

3) Management Effectiveness/Financial Condition 1) Debt to Total Assets

2) Return on Assets Ratio

3) Debt to Equity

4) Current Ratio [Liquidity measure]

5) Acid Test Ratio [Liquidity measure]

4) Per share Data Ratios1) Earnings per Share2) Dividends per Share

Comparative Profitability RatiosComparative Profitability Ratios

How does this compare with your industry?

Profitability DifferencesProfitability Differences

Extreme Examples•Grocery Stores [like Safeway] – Operating Margins in the 1% - 3% range.

How do they operate with such low margins?

What other strategies have they employed over the last few decades to increase profits?

•Semiconductor Manufacturers [like Intel] - Operating Margins in the 30% - 40% range.•How long doies it take Intel to pay off a new $4.5 billion factory [FAB]?

Accounts Receivable Ratio Measures Accounts Receivable Ratio Measures Management EfficiencyManagement Efficiency

A/R is turning over at a rate of 12 times per year and year to year is about the same.Another way to look at it is year–end A/R = 1 month of sales.

Inventory Turnover Ratio MeasuresInventory Turnover Ratio MeasuresManagement Efficiency Management Efficiency

Inventory is “turning over” at a rate of 8 times per year. You make money when you sell inventory, so the higher the number the better.

Return on Assets Ratio Measures Return on Assets Ratio Measures Management Effectiveness Management Effectiveness

Liquidity Ratios Measure Liquidity Ratios Measure Management Effectiveness & Financial ConditionManagement Effectiveness & Financial Condition

Current = Total Current Assets [BS] = 4000

Ratio Total Current Liabilities [BS] 2000 = 2:1

ABC has 2 times the current assets needed to pay its current liabilities

Acid Test = Total Current Assets – Inventory [BS] = 4000 – 1000 = 1.5:1Ratio Total Current Liabilities [BS] 2000ABC has 1.5 times the assets “quickly convertible” to cash it needs to pay off its bills. If the ratio is less than 1, the company may have Problems meeting its current bills.

ABC’s Year-End Balance Sheet as of 12/31/09

Net Working Capital [BS] = Current Assets – Current Liabilities2,000 = 4000 - 2000

This is a measure of ABC’s “Liquidity position”, i.e, it’s ability to pay its bills coming due

Debt Utilization RatiosDebt Utilization Ratios

Debt to total assets

= Total debt

Total assets

Times interest earned

= Income before interest & taxes

Interest expense

Per Share DataPer Share Data

Earnings per share

= Net income

Number of shares outstanding

Dividends per share

= Total dividends paid

Number of shares outstanding