Accounting and Finance

Basic ConceptsProf. Eliseo A. Aurellado, CPA, MBA, PhD

Definitions

• Accounting – - financial information system for decision-

making. Objective: Wealth measurement• Finance - science of the management of cash and

other assets Objective: Creation of wealth

Exploring Wealth

• How do you define wealth?

• How rich are you?

• Assets – things OF VALUE that we OWN

• Liabilities – things OF VALUE that we OWE

• OWN – OWE = NET WORTH

• NET WORTH = WEALTH

Concept of Wealth

Nature of Accounting

• Definition: Process of identifying, measuring, and communicating economic information to perform informed judgments and decisions by users of the information

• Language of business• As old as the merchants of Venice• Governed by principles and conventions

Accounting

Accounting SystemAccounting System(accumulates financial and(accumulates financial and

managerial accounting data)managerial accounting data)

Managerial AccountingManagerial AccountingInformation for decisionInformation for decision

making, and controlmaking, and controlof an organization’sof an organization’s

operations.operations.

Financial AccountingFinancial AccountingPublished financialPublished financial

statements and otherstatements and otherfinancial reports.financial reports.

InternalInternalUsersUsers

ExternalExternalUsersUsers

Exh.1-1

Accounting Process Flow

Economic Event or Transaction

Dual-entry bookkeeping process

Journalizing (Accounting entry in journals )

Posting (T-accounts in Ledger)

Trial Balance

Financial Statements

USERS FS INFORMATION NEEDED

•Stockholders Equity value of the business•Managers Business performance/ Growth and sustainability•Regulatory agencies - BIR Taxable income - SEC Financial reporting compliance•Investors Dividends and price appreciation•Creditors Liquidity, solvency indicators•Employees Benefits and security of tenure

Accounting Equation

Assets = Liabilities + Equity or Assets - Liabilities = Equity

The Business Equation

Revenues - Costs = Profit

Typical Balance Sheet

AssetsCash P 50,000Receivables 600,000Inventory 250,000 Current Assets 900,000

PPE 2,300,000Investments 700,000

Total Assets P3,900,000 =========

Liabilities & EquityAccts payable P600,000Other payables 100,000

Current Liabilities 700,000

Long-term Debt 2,000,000Stockholders Equity Common stock 1,000,000 Retained earnings 200,000 Total S/E 1,200,000

Total Liab.& Equity P 3,900,000 =========

Typical Income StatementSales P 1,200,000Cost of Sales 940,000Gross profit 260,000Operating expenses Selling P60,000 Administrative 100,000 160,000Earnings before interest & taxes 100,000 Interest 30,000 Taxes 21,000 51,000Net income P 49,000 ==========

Typical Cash Flow Statement• Cash flow from operating activities Net income P540,000 Add (deduct): Depreciation 60,000 Decrease in accounts rec’ble 40,000 Increase in inventories (240,000) Increase in prepaid expenses ( 10,000) Decrease in accrued wages (50,000) P 340,000

• Cash flow from investing activities Sale (purchase of plant and equipment) 2,400,000

• Cash flow from financing activities Issuance of bonds payable 1,000,000 Repayment of long-term debt ( 3,500,000) Payment of dividends (1,000,000) (3,500,000)Net increase (decrease) in cash for the period P (760,000) =========

Concepts

• Operating Cycle

Operating Cycle

Cash (Alpha)

Merchandise Inventory

Accounts receivable

Cash (Omega)

Operating Cycle

• Inventory turnover (Days in inventory)

• Accounts receivable (Days in receivable)

• Operating cycle = Days in inventory + Days in receivable

Concepts

• Liquidity

Typical Balance Sheet

AssetsCash P 50,000Receivables 600,000Inventory 250,000 Current Assets 900,000

Liabilities & Equity Accts payable P600,000 Other payables 100,000

Current Liabilities 700,000

Current assets/ current liabilities

= 900,000/ 700,000

= 1.28 : 1

= Current Ratio

Typical Balance Sheet

AssetsCash P 50,000Receivables 600,000Inventory 250,000 Current Assets 900,000

Liabilities & Equity Accts payable P600,000 Other payables 100,000

Current Liabilities 700,000

Cash + receivables / current liabilities

= 650,000/ 700,000

= 0.92 : 1

= Acid-test Ratio

Concepts

• Solvency

Solvency -Typical Balance Sheet

AssetsCash P 50,000Receivables 600,000Inventory 250,000 Current Assets 900,000

PPE 2,300,000Investments 700,000

Total Assets P3,900,000 =========

Liabilities & EquityAccts payable P600,000Other payables 100,000

Current Liabilities 700,000

Long-term Debt 2,000,000Capital stock Common stock 1,000,000 Retained earnings 200,000 Total S/E 1,200,000

Total Liab.& Equity P 3,900,000 =========

Solvency -Typical Balance Sheet

AssetsCash P 50,000Receivables 600,000Inventory 250,000 Current Assets 900,000

PPE 2,300,000Investments 700,000

Total Assets P3,900,000 =========

Liabilities & EquityAccts payable P600,000Other payables 100,000

Current Liabilities 700,000

Long-term Debt 3,600,000Capital stock Common stock 1,000,000 Deficit (1,400,000) Total S/E ( 400,000)

Total Liab.& Equity P 3,900,000 =========

Leverage

WeightFulcrum

LeverDebt

Sales

Equity

Management

Turnover

Concepts

• Profitability

ROI

ROI

• Return on Assets

Net income/ Total Assets

• Return on Equity

Net income/ Stockholders’Equity

Du Pont Analysis

• ROE = Net income X X Equity

Profit margin Asset TO Equity multiplier

Sales Sales

Assets

Assets