Introduction to Accounting Introduction to Accounting and Financeand Finance

Week 1:

Who does what – Accounting vs. Finance

Setting the stage – Common Business Entities

Communicating Value – The Financial Statements

Who does whatWho does whatAccounting vs. FinanceAccounting vs. Finance

Accounting:Accounting:

““Captures the financial value of the day to day Captures the financial value of the day to day activities of an organization through the application activities of an organization through the application

of specific accounting rules. It allows these of specific accounting rules. It allows these activities to be reported in a way that is transparent, activities to be reported in a way that is transparent, relevant, and comparable to investors, creditors and relevant, and comparable to investors, creditors and

management” management”

Who does whatWho does whatAccounting vs. FinanceAccounting vs. Finance

Finance:Finance:

““Uses accounting information to guide and fund the Uses accounting information to guide and fund the growth of an organization, evaluate new business growth of an organization, evaluate new business

opportunities, and establish the economic value of a opportunities, and establish the economic value of a firm. In essence maximize shareholder value” firm. In essence maximize shareholder value”

Who does whatWho does whatAccounting basicsAccounting basics

Accounting:Accounting: Transparent Transparent

Information is reliable and credible through the Information is reliable and credible through the application of standard rules.application of standard rules.

Relevant Relevant Internal & external users can make decisions Internal & external users can make decisions

from information that is material.from information that is material. ComparableComparable

Financial value can be benchmarked through Financial value can be benchmarked through structured financial statements.structured financial statements.

Who does whatWho does whatFinance basicsFinance basics

Finance:Finance:

Focus is on:Focus is on: Economic value versus book valueEconomic value versus book value Opportunity cost versus actual costOpportunity cost versus actual cost Forecast versus current state Forecast versus current state

Setting the StageSetting the StageCommon Legal EntitiesCommon Legal Entities

Sole proprietorshipOne owner – taxes from profits are paid on owners

personal tax rate (eliminates double taxation) however owner is responsible for all debt.

Partnership Same as sole proprietorship but with multiple owners.

Corporation Many owners who are not personally responsible to pay the debt of an organization (limited liability) but are doubled taxed.

Setting the StageSetting the StageCommon Business FormsCommon Business Forms

Characteristic Proprietorship Partnership CorporationOwners One Mulitple ManyLimited Liability No ** No ** YesUnlimited Life No No YesDouble Taxation No No Yes

** Proprietorships and Partnerships that are set up as LLC's (limitied liability corporations) provide limited liability

Setting the StageSetting the StageCommon Business TypesCommon Business Types

Service Provides a value added activityProvides a value added activity Labor intensiveLabor intensive

ManufacturingConverts raw material into a productCapital intensive

MerchandisingPurchases product in bulk at major discounts and resells Inventory intensive

Setting the StageSetting the StageCommon Business TypesCommon Business Types

Unique Issues Service Manufacturing MerchandiseLabor Intensive High Low Low - MediumPrice sensitivity to raw materials No Extremely Sensitive SensitiveInventory Obsolescence No Concern Depends on Product Big ConcernCapital Intensive Low High Medium to HighScalability Hard Easy EasyProfit Margins High Medium Thin

Unique issues for Accounting and Finance

Communicating the BusinessCommunicating the Business3 Critical Financial Statements3 Critical Financial Statements

Balance Sheet: Represents a snap shot in time of the investments of a firm or it’s assets and

the financing of a firm or it’s liabilities and shareholder equity

Income Statement: Measures the ability of the firm to generate profit in a given period of time

(monthly, quarterly or annual) from it’s operational activities

Cash Flow Statement: Shows the amount of cash generated or used from the firm’s operating,

investing and financing activities during a period of time

Communicating the BusinessCommunicating the BusinessThe Balance SheetThe Balance Sheet

The Balance sheet must have the following equality:

Assets = Liabilities + Equity

Resources needed to produce revenue

Loans needed to buy assets

Investments needed to buy assets

Communicating the BusinessCommunicating the BusinessThe Balance Sheet - AssetsThe Balance Sheet - Assets

Resources owned or

controlled by a company

Resources owned or

controlled by a company

CashCash

Accounts Receivable

Accounts Receivable

InventoryInventory

Notes Receivable

Notes Receivable

IntangibleIntangible

BuildingsBuildings

LandLand

EquipmentEquipment

Assets measures the amount of resources the firm can utilize to generate profit through its operational activities

Short Long

Communicating the BusinessCommunicating the BusinessThe Balance Sheet - LiabilitiesThe Balance Sheet - Liabilities

Taxes Payable

Taxes Payable

Accounts Payable

Accounts Payable

Notes Payable

Notes Payable

Wages Payable

Wages Payable

Creditors’ claims on assets

Creditors’ claims on assets

Liabilities measures the amount of services or benefits the company receives from other firms or creditors in exchange for a

promise of payment

Communicating the BusinessCommunicating the BusinessThe Balance Sheet – EquityThe Balance Sheet – Equity

Equity = Assets - LiabilitiesOwner’s

Claims on Assets

Owner’s Claims on

Assets

Shareholder Equity measures the amount of value that investors can claim after liabilities to creditors are subtracted from the

firm’s assets

The Balance Sheet – Digital MediaThe Balance Sheet – Digital MediaO

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Prior Year Current YearAssetsCurrent Assets

Cash 400,000 650,000 Accounts Receivables 650,000 550,000 Inventory 420,000 525,000 Total Current Assets 1,470,000$ 1,725,000$

Non-Current Fixed AssetsPlant/Equipment 700,000 750,000 Accumulated depreciation (100,000) (150,000) Building/Land (net of depreciation) 850,000 750,000 Total Non-Current Assets 1,450,000$ 1,350,000$

Total Assets 2,920,000$ 3,075,000$

Liabilities and Shareholders' EquityCurrent Liabilities

Accounts Payable 645,000 570,000

Non-Current LiabilitiesBonds Payable 1,562,500 1,462,500

Total Liabilities 2,207,500 2,032,500

Shareholders' EquityCommon Stock 250,000 400,000 Retained Earnings 462,500 642,500

Total Shareholders' Equity 712,500 1,042,500

Total Liabilities and S.H. Equity 2,920,000 3,075,000

Communicating the BusinessCommunicating the BusinessIncome StatementIncome Statement

The Income statement must have the The Income statement must have the following equalityfollowing equality

Profit = Revenue – ExpenseProfit = Revenue – Expense

Income StatementIncome StatementO

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Prior Year Current YearRevenue

Sale of Digital Equipment 2,592,500 3,050,000 Consulting Services 1,147,500 1,350,000 Total Revenue 3,740,000 4,400,000$

Expenses Cost of Goods Sold 2,363,085 2,745,000 Salary & Wages 985,000 1,150,000 General Administration 76,201 123,714 Total Operating Expense 3,424,286 4,018,714

Operating Income (EBITDA) 315,714 381,286

Other ExpensesInterest Expense 120,000 112,200 Depreciation on Fixed Assets 25,000 50,000 Taxes 32,014 39,086 Total Other Expenses 177,014 201,286$

Net Income 138,700 180,000$

Communicating the BusinessCommunicating the BusinessIncome vs. Cash Flow StatementIncome vs. Cash Flow Statement

Profit and cash are separate conceptsProfit and cash are separate concepts Income statement does not account for Income statement does not account for

other sources of cash generated outside of other sources of cash generated outside of it’s operations.it’s operations.

Income statement includes non-cash Income statement includes non-cash expenses which distorts how cash is expenses which distorts how cash is generated.generated.

Communicating the BusinessCommunicating the BusinessThe Cash Flow StatementThe Cash Flow Statement

Shows the amount of cash generated from the firm’s operating, Shows the amount of cash generated from the firm’s operating, investing and financing activities during a period of time.investing and financing activities during a period of time.

The cash flow statement follows this model:The cash flow statement follows this model:

Operations

Investing

Financing

Cash received from sales of goods and services

Cash paid for operating expenses

Cash flow from operations- =

+ or -Cash received from sell of investments and PPE

Cash paid for acquisition of investments and PPE

Cash flow from Investing- =+ or -

Cash received from issue of debt or equity

Cash paid for dividends & repayment of debt or

equityCash flow from Investing- =

Net change in cash flow for the period

=

Cash Flow StatementCash Flow StatementCurrent Year

Cash Flow from Operations Net Income 180,000

Additions:

Depreciation Expense (Not related to Cash) 50,000 Decrease in Accounts Receivable 100,000 Subtractions: Increase in Inventory (105,000) Decrease in Accounts Payable (75,000)

Total Cash Flow from Operations 150,000

Cash Flow from Investing Activities Investment in Plant and Equipment (50,000) Disposition of Real Estate 100,000 Total Cash Flow from Investing Activies 50,000

Cash Flow from Financing Activities Pay down of Long Term Debt (100,000) Cash from issuing Common Stock 150,000 Total Cash from Financing Activities 50,000

Total Change in Cash Account 250,000

Overview of Week 2Overview of Week 2Generally Accepted Accounting PrinciplesGenerally Accepted Accounting PrinciplesDouble Entry AccountingDouble Entry AccountingUsing journal entries to prepareUsing journal entries to prepare

Balance SheetBalance Sheet Income StatementIncome Statement Cash flow statement Cash flow statement