Accounting Role of Accounting in Business Exploring Business

Accounting Role of Accounting in Business Exploring Business Chapter 12 Thursday 9/8/11

Stakeholders Purpose of Accounting: To help Stakeholders, i. e. , parties who are interested in the activities of the business because they’re affect by them

Accounting Activities • Measuring and summarizing business activities • Analyzing and Interpreting financial statements • Communicating the results to management and other decision makers.

Two Major Fields of Accounting @Management Accounting – provides information to decision makers inside the organization to help operate the business @Financial Accounting – furnishes information to individuals and groups inside/outside the organization to assess the firm’s financial performance

Careers In Accounting q “People Profession” q Skills • Analytical • Interpersonal • Communication q Job Prospects • Certified Public Accountants- Audits • Private Accountants- Controller • Certified Management Accountants

Financial Accounting &Statements • Income Statement • Balance Sheet • Statement of Cash Flows &Generally Accepted Accounting Principles [GAAP]

Users Of Accounting Information Owners & Managers Government Agencies Other Users Investors & Creditors

The Users of Accounting Information

The Functions of Financial Statements 2 Income Statement [Profit & Loss or P&L Statement]– Shows sales, cost of sales, expenses and if it resulted in a profit or loss 2 Balance Sheet – Indicates assets/liabilities and amount invested in company 2 Statement of Cash Flows – Shows how much cash in and out of firm

Income Statement Elements Ø Net Revenues: Gross sales less returns Ø Cost of Goods Sold [COGS]: Variable cost component of products or services Ø Gross Profit: Net Revenues - COGS Ø Operating Expenses: Fixed cost component of running a business including staff salaries, general selling expenses, operating costs, R&D, engineering, rent, interest, depreciation Ø Net Profit or <Loss>: Gross profit Expenses Operating

Equivalent Terms in Accounting Term Equivalent Term

The Income Statement • A financial report that shows an organization’s profitability over a period of time: – month, quarter, or year It can represent a single entity or be consolidated ØRevenue: Net Sales ØCost of Goods or Services Sold: Variable costs associated with Sales ØGross Income: Gross Profit ØExpenses: Fixed costs ØNet Income <Loss>:

Stress-Buster Income Statement Month Ending 8/31/11 % of Sales Gross Revenue (100 units x $10/unit) = $1, 000 = 100% less Cost of Goods Sold ($6/unit) = <$600> = 60% Gross Profit less Operating Expenses [OH] Staff Salaries = $240 Advertising, Rent = $60 < $300> Net Income [Profit] Before Taxes less Taxes [25%] Net Income after Taxes = $400 = $100 = $25 = $75 = 40% = 30% = 10%

Tool for Analysis Microsoft Excel – Goal Seek – A “what if” analysis tool that enables you to find the input value needed to achieve a goal or objective. – For example, “what if” I added $20 to my expenses. How much more in Sales would I need to do to maintain the same bottom line % of Sales?

Proposed Income Statement #1 What if I added a new staff member adding $20 in expenses. How much more sales do I need to keep the bottom line % the same? Stress- Buster Corp. Manual Calculation: $320 / 30% = $1067.

Proposed Income Statement #2: What if I found a cheaper source of raw materials that drove my COGS down to $5/unit Stress-Buster Corp. Month Ending 8/31/11 % of Sales Gross Revenue [or Sales] (100 units x $10/unit) = $1, 000 = 100% less COGS ($5/unit) = <$500> = 50% Gross Profit less Operating Expenses [OH] Staff Salaries = $240 Advertising, Rent = $60 < $300> = $500 Net Income [Profit] Before Taxes = $200 = 50% = 30% = 20%

Proposed Income Statement #3: What if demand for my product drove sales to increase to 150 units per month? Stress-Buster Corp Assumption: You had extra plant manufacturing capacity to meet demand % of Sales Gross Revenue [or Sales] (150 units x $10/unit) = $1, 500 = 100% less COGS ($6/unit) = <$900> = 60% Gross Profit less Operating Expenses [OH] Staff Salaries = $240 Advertising, Rent = $60 < $300> = $600 Net Income [Profit] Before Taxes = $300 = 40% = 20%

Breakeven Analysis Calculation: Total sales revenue must exactly equal all your expenses $ Fixed Costs $ Variable Costs $ Contribution Margin per unit $ Breakeven Point In Units

Breakeven Analysis Stress-Buster Corp Sell Price [SP]/Unit = $10 Variable Cost [VC]/Unit = $6 Contribution Margin [CM]/Unit = SP/Unit – VC/Unit = $4 Fixed Costs [FC]= $300 Breakeven in Units = FC / CM/Unit = $300 / $4 per Unit = 75 Units

Breakeven Analysis Stress-Buster Corp Revenue less COGS (75 units x $10/unit) ($6/unit) Gross Profit less Operating Expenses [OH] Staff Salaries = $240 Advertising, Rent = $60 < $300> Net Income [Profit] Before Taxes = $750 = <$450> = $300 = $0

Balance Sheet - tells what you have (and where it came from) at a specific point in time A “snapshot” of an organization’s financial position at a given moment. It presents an accumulation of all the company’s transactions since it began Ø Assets: Business resources Ø Liabilities: Debts owed to outside entities Ø Owner’s Equity: Amount invested

Classified Balance Sheet CAssets CCurrent - Convert to cash within a year CLong-Term - Intend to hold for more than a year DLiabilities DCurrent - Pay off within a year DLong-Term - Not due for more than a year Stockholder Equity

Balance Sheet Equation: Total Assets = Total Liabilities + Stockholder Equity ABC’s Year-End Balance Sheet as of 12/31/09 Assets $(000) Liabilities $(000) Cash + Liquid Securities Account Receivables Inventory 2, 000 1, 000 Account Payable Wages Payable Taxes Payable Interest Payable 500 100 Total Current Assets 4, 000 Total Current Liabilities 2, 000 Long Term Debt 2, 000 Notes Receivable 1, 000 Property & Equipment 6, 000 Intangible Assets [GW & TM] 1, 000 900 Total Shareholder Equity 8, 000 Total Long Term Assets 8, 000 Total Assets 12, 000 Total Liabilities & Stockholder Equity 12, 000

Balance Sheet Equation: Total Assets = Total Liabilities + Stockholder Equity ABC’s Year-End Balance Sheet as of 12/31/10 Liabilities Assets Cash + Liquid Securities Account Receivables Inventory 1, 500 800 700 Account Payable 600 Wages Payable Taxes Payable Interest Payable 450 50 Total Current Assets 3, 000 Total Current Liabilities 1, 550 Long Term Debt 2, 000 Notes Receivable 1, 000 Property & Equipment 5, 000 Intangible Assets [GW & TM 1, 000 Total Shareholder Equity 6, 450 Total Long Term Assets 7, 000 Total Assets 10, 000 Total Liabilities & Stockholder Equity 10, 000

The Statement of Cash Flow • Explains how the company’s cash changed from the beginning of the accounting period to the end. Where did cash come from? Where did it go? • Three categories: 1. Cash from (used for) operating activities 2. Cash from (used for) investing activities 3. Cash from (used for) financing activities

Financial Statement Analysis Profit Margin Ratios – how much of each sales $ is left after certain costs are covered Management Efficiency – how efficiently your assets are being managed [Asset Utilization] Management Effectiveness – how effective management is at running the business. It also measures overall company performance Financial Condition – helps assss the company financial strength

Financial Statement Analysis 1) Need Information from the Income Statement for the same period 2) Need Information from the Balance Sheet for the same period

Ratio Analysis • Vertical Percentage Analysis – Analyze relationships between items on your income statement; between geographic divisions; etc. – Compare your financial results with those of other companies in your industry or sector

Year-To-Year Comparative Income Statement

Financial Statement Analysis 1) Profitability Ratios 1) 2) 3) 2) Gross Profit Margin Net Profit Margin Return on Equity Management Efficiency [Asset Utilization] 1) 2) Accounts Receivable Ratio Inventory Turnover Ratio 3) Management Effectiveness/Financial Condition 1) 2) 3) 4) 5) Debt to Total Assets Return on Assets Ratio Debt to Equity Current Ratio [Liquidity measure] Acid Test Ratio [Liquidity measure] 4) Per share Data Ratios 1) 2) Earnings per Share Dividends per Share

Comparative Profitability Ratios How does this compare with your industry?

Profitability Differences Extreme Examples • Grocery Stores [like Safeway] – Operating Margins in the 1% - 3% range. How do they operate with such low margins? What other strategies have they employed over the last few decades to increase profits? • Semiconductor Manufacturers [like Intel] - Operating Margins in the 30% - 40% range. • How long doies it take Intel to pay off a new $4. 5 billion factory [FAB]?

Accounts Receivable Ratio Measures Management Efficiency A/R is turning over at a rate of 12 times per year and year to year is about the same. Another way to look at it is year–end A/R = 1 month of sales.

Inventory Turnover Ratio Measures Management Efficiency Inventory is “turning over” at a rate of 8 times per year. You make money when you sell inventory, so the higher the number the better.

Return on Assets Ratio Measures Management Effectiveness

Liquidity Ratios Measure Management Effectiveness & Financial Condition ABC’s Year-End Balance Sheet as of 12/31/09 Net Working Capital [BS] = Current Assets – Current Liabilities 2, 000 = 4000 2000 This is a measure of ABC’s “Liquidity position”, i. e, it’s ability to pay its bills coming due Current = Total Current Assets [BS] = Ratio Total Current Liabilities [BS] 4000 2000 = 2: 1 ABC has 2 times the current assets needed to pay its current liabilities Acid Test = Total Current Assets – Inventory [BS] = 4000 – 1000 = 1. 5: 1 Ratio Total Current Liabilities [BS] 2000 ABC has 1. 5 times the assets “quickly convertible” to cash it needs to pay off its bills. If the ratio is less than 1, the company may have Problems meeting its current bills.