Week 1 business entities & financial statements
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Transcript of Week 1 business entities & financial statements
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