Accounting and Finance

1. Accounting and Finance Introduction to Business

2. Accounting in Business Accounting is the measurement and communication process used to report on the activities of profit-seeking business organizations. It is the language of business. Accounting represents all of the financial transactions of a business in a format that can be interpreted and understood by both internal and external stakeholders.

3. Internal And External Users Users of accounting information are separated into two groups: internal and external. Internal = people within a business, HR, product managers External = IRS, potential stock holders, finance companies, local tax authorities

4. Key Financial Statements Financial statements are the means by which companies communicate their story. Together these statements represent the profitability and financial strength of a company. Key Financial Statements include: • Income statement • Statement of owners equity • Balance sheet • Statement of cash flows

5. Income Statement • Also called “earnings statement” or “profit and loss statement” • First financial statement prepared because it provides information for the remaining 3 statements • Provides information about the profitability of a stated period of time, usually a calendar year  • Made up of 2 types of accounts • Revenues • Expenses Revenues – Expenses = Net Income

6. Example of an Income Statement

7. Statement of Owner’s Equity • Also known as “statement of retained earnings” • Explains the changes in retained earnings between two balance sheet dates

8. Example: Statement of Retained Earnings

9. Balance Sheets • Also known as “statement of financial position” • Provides a snapshot of company’s financial position at a particular moment in time • Lists a company’s • Assets • Liabilities • Equity The Accounting Equation Assets – Liabilities = Owner’s or Shareholders’ Equity

10. Example of Balance Sheet

11. Statement of Cash Flow • Reports the cash receipts and cash disbursements during an accounting period • Reports effects on cash of a company’s • Operating activities • Investing activities • Financing activities • Includes both cash and cash equivalents (ex. investments) • Last statement prepared, using information from income statement, statement of owners equity and balance sheet

12. Operating Activities: Cash Inflows Cash inflows from operating activities include: • Cash from sales of goods or services • Interest • Dividends • Cash received from the sale of trading securities • Other cash receipts that do not arise from transactions defined as investing or financing activities

13. Operating Activities: Cash Outflows Cash outflows for operating activities include payments to: • Acquire inventory • Suppliers and employees for other goods or services • Lenders and other creditors for interest • Purchase trading securities • All other cash payments that do not arise from transactions defined as investing or financing activities

14. Investing Activities Cash inflows from investing activities include: • Sale of property, plant, and equipment • Sale of available-for-sale and held-to-maturity securities • Collection of long-term loans made to others Cash outflows for investing activities include: • Purchase of property, plant, and equipment • Purchase of available-for-sale and held-to-maturity securities • Long-term loans to others

15. Financing Activities Cash inflows from financing activities include: • Cash received from issuing capital stock and bonds, mortgages, and notes, and from other short- or long-term borrowing Cash outflows for financing activities include: • Payments of cash dividends or other distributions to owners (including cash paid to purchase treasury stock) and repayments of amounts borrowed

16. The Break Even Point Businesses, both large and small, are concerned with determining the point at which their revenues exceed their expenses and they begin to make a profit. The point at which revenue equals expenses (and profit is therefore $0) is called the break-even point.

17. Fixed and Variable Costs Fixed costs are expenses that are not dependent on the amount of goods or services produced by the business. • Examples: salaries or rents paid per month Variable Costs are volume related and are paid per quantity or unit produced. • Examples: gas or tires for a car

18. Contribution Margin Contribution margin is the portion of revenue that is not consumed by variable cost. It is important to know the contribution margin in order to calculate what portion of the revenue from a product is consumed by the variable costs and what portion can be used to cover, or contribute to, fixed costs.

19. Calculating the Break Even Point BE units sold = BE in sales dollars= The contribution margin ratio expresses the contribution margin as a percentage of sales

20. Margin of Safety Margin of safety is when a company’s current sales are more than its break-even point Margin of safety = Current sales – Break-even sales The margin of safety rate is equal to:

21. Financial Ratios • Allow business to represent the relationships between components of their financial operations as ratios. • Used to measure a firm’s financial health in four areas • Liquidity • Long-term solvency • Profitability tests • The market • These ratios can be used to compare the company’s performance across periods (months, quarters, years) or to similar companies within the same industry.

22. Financial Ratios Chart

23. Liquidity Ratios

24. Financial Ratio Calculations

25. Ethics in Accounting Unethical financial reporting has cost taxpayers billions of dollars, employees their jobs, and the accounting profession its untarnished reputation. The Sarbanes-Oxley act was passed to combat unethical accounting.

26. Sarbanes-Oxley (SOX)  • Attempt to foster ethical behavior in business accounting • Top management must individually certify the accuracy of financial information • Penalties for fraudulent financial activity are much more severe • Increased the oversight role of boards of directors and the independence of outside auditors • Has improved investor confidence and made financial statements more accurate and reliable

27. Practice Question You want to know how profitable a business was last year. Which financial statement would you look at to determine this most efficiently? • Income statement • Statement of retained earnings • Balance sheet • Statement of cash flows

28. Quick Review • What is accounting? What is its role as a form of business communication? • What are key financial statements and their components, and what is the primary use of each type of statement? • How do you calculate the break-even point, where profit will be equal to $0, using information from financial statements? • How do you use financial statements to calculate basic financial ratios to measure the profitability and health of a business? • Why are ethical practices in accounting important? What are the implications of unethical behavior?