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Part 6 Financing the Enterprise © 2015 McGraw-Hill Education. 14-2 CHAPTER 14 Accounting and Financial Statements CHAPTER 15 Money and the Financial System CHAPTER 16 Financial Management and Securities Markets 14-3 Learning Objectives LO 14-1 Define accounting and describe the different uses of accounting information. LO 14-2 Demonstrate the accounting process. LO 14-3 Examine the various components of an income statement to evaluate a firm’s bottom line. LO 14-4 Interpret a company’s balance sheet to determine its current financial position. LO 14-5 Analyze the statement of cash flows to evaluate the increase and decrease in a company’s cash balance. 14-4 The Nature of Accounting Accounting • The recording, measurement and interpretation of financial information Certified Public Accountant (CPA) • An individual who has been state certified to provide accounting services ranging from the preparation of financial records and the filing of tax returns to complex audits of corporate financial records Private Accountants • Employed by large corporations, government agencies, and other organizations to prepare and analyze their financial statements • Deeply involved in most of the most important financial decisions of the organization Certified Management Accountants (CMAs) • Private accountants who, after rigorous examination, are certified by the National Association of Accountants and who have some managerial responsibility 14-5 Uses of Accounting Information Managerial Accounting • The internal use of accounting statements by managers in planning and directing the organization’s activities Cash Flow • The movement of money through an organization over a daily, weekly, monthly or yearly basis Budget • An internal financial plan that forecasts expenses and income over a set period of time Annual Report • A summary of a firm’s financial information, products, and growth plans for owners and potential investors 14-6 Assets • A firm’s economic resources, or items of value that it owns, such as cash, inventory, land, equipment, buildings, and other tangible and intangible things Liabilities • Debts that a firm owes to others Owners’ Equity • Equals assets minus liabilities and reflects historical values Double-Entry Bookkeeping • A system of recording and classifying business transactions that maintains the balance of the accounting equation Balance Classification • To keep the accounting equation in balance, each transaction must be recorded in two separate accounts • All business transactions are classified as either assets, liabilities, or owner’s equity Break Down • Most organizations further break down these accounts, such as assets may be broken down into cash, inventory and equipment 14-7 Accounting Cycle Accounting Cycle • The four-step procedure of an accounting system: examining source documents, recording transactions in an accounting journal, posting recorded transactions, and preparing financial statements Ledger Journal • A time-ordered list of account transactions • A book or computer file with separate sections for each account 14-8 Income Statement Income Statement • A financial report that shows an organization’s profitability over a period of time – month, quarter, or year Revenue • The total amount of money received from the sale of goods or services, as well as from related business activities Cost of Goods Sold • The amount of money a firm spent to buy or produce the products it sold during the period to which the income statement applies Gross Income (or Profit) • Revenues minus the cost of goods sold required to generate the revenues Expenses • The costs incurred in the day-to-day operations of an organization 14-9 Income Statement Depreciation • The process of spreading the costs of long-lived assets such as building and equipment over the total number of accounting periods in which they are expected to be used Net Income • The total profit (or loss) after all expenses, including taxes, have been deducted from revenue; also called net earnings Balance Sheet • A “snapshot” of an organization’s financial position at a given moment 14-10 Balance Sheet Current Assets • Assets used or converted into cash within the course of a calendar year • Cash, temporary investments, accounts receivable and inventory Accounts Receivable • Money owed a company by its clients or customers who have promised to pay for the products at a later date Current Liabilities • A firm’s financial obligation to short-term creditors, which must be repaid within one year Accounts Payable • The amount a company owes to suppliers for goods and services purchased with credit Accrued Expenses • An account representing all unpaid financial obligations incurred by the organization 14-11 Statement of Cash Flows Statement of Cash Flows • Explains how the company’s cash changed from the beginning of the accounting period to the end Cash From Operating Activities • Calculated by combining the changes in the revenue, expense, current assets and current liability accounts Cash From Investing Activities • Calculated from changes in the long-term or fixed asset accounts Cash From Financing Activities • Calculated from changes in the long-term liability accounts and the contributed capital accounts in owners’ equity 14-12 Ratio Analysis Ratio Analysis • Calculations that measure an organization’s financial health Profitability Ratios • Ratios measuring the amount of operating income or net income an organization is able to generate relative to its assets, owners’ equity, and sales Profit Margin • Net income divided by sales Return on Assets • Net income divided by assets Return on Equity • Net income divided by owners’ equity; also called return on investment (ROI) 14-13 Ratio Analysis Asset Utilization Ratios • Ratios that measure how well a firm uses its assets to generate each $1 of sales Receivables Turnover • Sales divided by accounts receivable Inventory Turnover • Sales divided by total inventory Total Asset Turnover • Sales divided by total assets Liquidity Ratios • Ratios that measure the speed with which a company can turn its assets into cash to meet short-term debt 14-14 Ratio Analysis Current Ratio • Current assets divided by current liabilities Quick Ratio (Acid Test) • A stringent measure of liquidity that eliminates inventory Debt Utilization Ratios • Ratios that measure how much debt an organization is using relative to other sources of capital, such as owners’ equity Debt to Total Assets Ratio • A ratio indicating how much of the firm is financed by debt and how much by owners’ equity 14-15 Ratio Analysis Times Interest Earned Ratio ● Operating income divided by interest expense Earnings Per Share Per Share Data ● Data used by investors to compare the performance of one company with another on a equal, per share basis ● Net income or profit divided by the number of stock shares outstanding Dividends Per Share ● The actual cash received for each share owned