Ferrell Hirt Ferrell BUSINESS A CHANGING WORLD EIGHTH
Ferrell Hirt Ferrell BUSINESS A CHANGING WORLD EIGHTH EDITION FHF Mc. Graw-Hill/Irwin Copyright © 2011 by The Mc. Graw-Hill Companies, Inc. All rights reserved.
part Financing the Enterprise 6 CHAPTER 14 Accounting and Financial Statements CHAPTER 15 Money and the Financial System CHAPTER 16 Financial Management and Securities Markets FHF 14 -2
Accounting Ø The recording, measurement and interpretation of financial information, often used in making business decisions § The Financial Accounting Standards Board sets principles of financial accounting and reporting • Accounting can be a difficult and contentious science …continued on next page FHF 14 -3
Accounting § GAAP § Generally accepted accounting principles § SEC § Securities & Exchange Commission provides oversight § Has assumed a larger oversight role in recent years FHF 14 -4
Types of Accounting Certified Public Accountant (CPA) § An independent professional who provides accounting services to the public (individuals or firms) for a fee Private Accountant § An accountant employed by a corporation, government agency, or other organization § Can be CPAs and CMAs (Certified Management Accountant) FHF 14 -5
Forensic Accounting Ø Analyzing financial data in search of fraudulent entries or financial misconduct § Can help uncover money laundering, terrorist activity § Marital and family law § A growth area for public accountants FHF 14 -6
Accounting or Bookkeeping? Bookkeeping § Often (mistakenly) used interchangeably with accounting § The routine day-to-day recording of business transactions Ø Bookkeepers obtain and record the financial information that accountants then analyze FHF 14 -7
Uses of Accounting Information Internal § Managerial accounting is the internal use of accounting statements by managers in planning and directing organizational activities § Cash flow, the movement of money through an organization, is management’s greatest concern § Accounting helps management prepare a budget, an internal financial plan that forecasts expenses and income over a set period of time …continued on next page FHF 14 -8
Uses of Accounting Information External § Reporting to the IRS § The annual report, which is a summary of financial information, products and growth plans § Obtaining credit § As a gauge of performance FHF 14 -9
Deceptive Accounting Practices Countries, states and companies have all engaged in deceptive accounting practices • Hiding debt through off-balance sheet accounts • Using derivatives to hide financial instability • Overleveraging with too many loans • Regulations try to minimize the practice • Impossible to do away with all deceptive accounting FHF 14 -10
The Accounting Equation Assets = Liabilities + Owners Equity Things of value that a firm owns = A firm’s debts and obligations + The difference between a firm’s assets and its liabilities Ø The relationship between assets, liabilities and owners’ equity FHF 14 -11
Double-Entry Bookkeeping Assets $ 325 = = Liabilities $ -700 + + Owners Equity $ 1, 025 Notice that both sides of the equation balance Ø A system of recording and classifying business transactions in separate accounts in order to maintain the balance of accounting equation FHF 14 -12
The Accounting Cycle A four-step process through which financial data pass 1. Examine source documents 2. Record transactions in an accounting journal 3. Post transactions to a ledger. Ø If the trial balance does not balance, one must look for mistakes and try again 4. Prepare financial statements and have them certified by an accountant FHF 14 -13
Financial Statements The end results of the accounting process are a series of financial statements § Income statement § Balance sheet § Statement of cash flows Financial statements are provided to: ü ü Stockholders and potential investors Creditors Government agencies Internal Revenue Service FHF 14 -14
The Income Statement A financial report that shows an organization’s overall profitability or loss over a period of time § Month § Quarter § Year Ø Shows a firm’s bottom line: its expenses minus revenues FHF 14 -15
Income Statement: Key Terms § Revenue: The total amount of money received or promised from the sale of goods/services and other activities • Cost of Goods Sold: The amount of money the firm spent to buy and produce the products it sold • Cost of goods sold= beginning inventory+ interim purchases – ending inventory Ø Gross Income/Profit: Revenues minus the cost of goods sold …continued on next page FHF 14 -16
Income Statement: Key Terms Expenses: The costs incurred in day-to-day operations of an organization § Common expense accounts shown on income statements are: ü Selling, general & administrative ü R&D, engineering ü Interest …continued on next page FHF 14 -17
Income Statement: Key Terms Depreciation: A special type of expense included in general and administrative category § Involves spreading the costs of long-lived assets over the total number of accounting periods in which they are to be used Net Income: The total profit or loss after all expenses are deducted from revenue § Accountants usually divide profits into subcategories (e. g. operating income) FHF 14 -18
John’s Pizza Income Statement December 31, 2011 FHF 14 -19
The Balance Sheet Ø A “snapshot” of an organization’s financial position at a given moment § Presents an accumulation of all the company’s transactions since it began § Shows what an organization owns and controls and sources of income used to pay for assets FHF 14 -20
Balance Sheet: Key Terms Assets § Current Assets (Short-Term Assets): Used or converted to cash within a calendar year § Accounts Receivable: Money owed the company by clients or customers who have promised to pay at a later date • Accountants usually include an allowance for bad debts, which the firm does not expect to collect § Long-Term Assets (Fixed Assets): Represent a commitment of funds for more than one year • Includes tangible assets (plant, equipment) and intangibles (corporate goodwill, reputation) …continued on next page FHF 14 -21
Balance Sheet: Key Terms Liabilities § Current Liabilities: Obligations to short-term creditors § Accounts Payable: Amounts owed to suppliers for goods and services purchased on credit § Accrued Expenses: All unpaid financial obligations incurred by the company …continued on next page FHF 14 -22
Balance Sheet: Key Terms Owner’s Equity § All the owners’ contributions to the organization, along with income earned by the organization, retained for financing growth and development FHF 14 -23
John’s Pizza Balance Sheet December 31, 2009 FHF 14 -24
Statement of Cash Flows § Explains how the company’s cash changed from the beginning of the accounting period to the end § Takes the cash balance from two successive balance sheets and compares them Ø Change in cash explained in three categories: 1. Cash from (used for) operating activities 2. Cash from (used for) investing activities 3. Cash from (used for) financing activities FHF 14 -25
Ratio Analysis Calculations that measure an organization’s financial health § Profitability ratios § Asset utilization ratios § Liquidity ratios § Debt utilization ratios § Per share data FHF 14 -26
Profitability Ratios Profit Margin = Net Income / Sales Return on Assets = Net Income / Assets Return on Equity = Net Income / Equity FHF 14 -27
Asset Utilization Ratios Receivables Turnover = Sales (Total Net Revenues) / Receivables Inventory Turnover = Sales / Inventory Total Asset Turnover = Sales / Total Assets FHF 14 -28
Liquidity Ratios Current Ratio = Current Assets / Current Liabilities Quick Ratio = Current Assets – Inventory / Current Liabilities FHF 14 -29
Debt Utilization Ratios Debt to Total Assets = Debts (Total liabilities) / Total Assets Times Interest Earned = Income Before Interest & Taxes (Operating Income) / Interest Expense FHF 14 -30
Per Share Data Earnings per Share = Net Income / Number of Shares Outstanding Dividends per share = Dividends Paid / Number of Shares Outstanding FHF 14 -31
Accounting and the Impact of the Financial Crisis Even after the passage of Sarbanes-Oxley, the financial crises and recession of 2007 -2010 are an example of failed accounting audits • Many financial institutions manipulated their books to appear financially healthier and downplay risky decisions § Accountants and regulators need to be more thorough § Mark-to-market accounting blamed for many problems • Problems valuing assets/liabilities under mark-to-market rules FHF 14 -32
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