There
are 3 important documents
DEA LER mnemonic is useful to remember
The rule of debit and credit can be summarized as follows:
- Debit increases Expenses and Assets while decreasing Liabilities, Equity, and Revenues.
- Credit increases liabilities, equity, and revenues while decreasing assets and expenses.
current assets are things we plan to sell or move through our company within 1 year.
It has top line (Revenue/ Sales) and bottom line. Income statement is over period of time, created for 1 year.
- Balance Sheet
- Income Statement aka Profit and Loss
- Cash flow statement
Balance Sheet: gives point is time snapshot
reflects what the company owns, owes and what the shareholders put in as
equity.
Assets
(own) = Liability (owe) + Equity (shareholders contributed)
Expanded Accounting Equation
Expanded Accounting Equation
Assets = Liabilities + Equity + Revenues - Expenses
Equity = Owners money [remember each shareholder is also
owns part of business]
DEA LER mnemonic is useful to remember
The rule of debit and credit can be summarized as follows:
- Debit increases Expenses and Assets while decreasing Liabilities, Equity, and Revenues.
- Credit increases liabilities, equity, and revenues while decreasing assets and expenses.
There is a link between the income statement and the
balance sheet. The connection is that at the end of the year the Profit of the
year is transferred to the Equity portion of the balance sheet.
Net income from the income statement is not the Cash on the
balance sheet.
Since accountants know that not all Accounts Receivable
will be collected, the accountants: set up an “Allowance for Doubtful
Accounts" account
Account Receivable -
Allowance for Doubtful Accounts = Net
Receivable
Inventory is an asset that the company plans to sell as a
regular part of their business.
Current
assets = Cash + AR + Inventory
Inventory valuation is 4 types LIFO, FIFO, Average,
Identification
Identification for large like Aircraft, Yacht etc
current assets are things we plan to sell or move through our company within 1 year.
Long Term Assets - You do not plan to sell or liquidate,
that is Property, Plant , Equipment. we plant to use them to make money.
Property, Plant and Equipment are often summarized into a
total called fixed assets on the Balance Sheet
Fixed assets on the Balance Sheet are sometimes referred to
as capital assets .
In accounting language chairs in a restaurant could be
considered Long Term Assets and it is not inventory. Whereas chairs in a
furniture store could be considered inventory.
Amortization or depreciation is used, to make sure fixed
asset values are not overstated on the Balance Sheet
Intangible Assets are trademarks, Patents, buying out
somebody else's rights.
Intangible assets are tremendously important to technology
firms.
Goodwill when companies buys another company example
If a company buys another company that has total assets at
$750,000 and they pay $950,000 for that company, the accountants would record
$200,000 as Goodwill
Amortization is an expense that is always a non-cash item.
One method of calculating amortization is called
straight-line. Under this method the cost (purchase price) of the asset is
divided by the estimated life, in years, of the asset to determine the amount
to be charged to each year.
If you have an asset such as a delivery truck the best
amortization approach is to consider the life of the truck in terms of kilometres
travelled. This is called the “units of production” methodology.
Liabilities:
Current liabilities = Wages payable + Interest payable + Dividend
payable
Accounts payable represent amounts that a company owes and
that is typically due within in one year
Long Term Liability = Bank loan + Bond
Bonds are a type of long-term debt and bonds create
interest charges. On the Balance Sheet these two items are categorized in this
manner
interest is recorded as a current liability and the bond as
a long-term debt.
Long Term Debt is the most significant part in Liabilities.
There is a very strong connection between bankruptcies and
the level of long -term debt in a given corporation. It is not common to file
for bankruptcy if you have no long-term debt and if your current liabilities
are at a reasonable level.
Equity:
A = L + EQ
A = L + EQ
EQ Equity = Common stock + Retained Earnings + Dividends
Common Stock is the cash given by people who bought the
stock directly from the company like IPO, stock issuance
Issuing shares, equity financing, is very common when you
start a business because, banks will not lend you money.
All items on the balance sheet are cumulative by nature,
whereas all figures on the income statement are for a period of time and then
begin at zero when the next period commences.
retained earning is not CASH
Dividends for a given year get deducted from the retained
earnings balance and thus dividends can reduce the value of retained earnings.
liquidity is measure of how quickly an asset can be
converted to cash
In balance sheet most liquid assets start at top
Liquidity
or current Ratio = Current Assets / Current Liability
ideally should be between 1 or 2,
too much liquidity is also not optimal as it indicates you
have lot of assets
Quick Ratio is exactly the same as the current ratio with
the adjustment being that we remove the inventory from the numerator as
Inventory is less liquid and harder to convert to cash.
‘Income Statement’
It has top line (Revenue/ Sales) and bottom line. Income statement is over period of time, created for 1 year.
Revenue
– [Cost or Expense] = Profit or Net Income
We
use brackets to denote subtraction
Income statement is used for period of time. Companies need to report quarterly Income statement if it is listed on Stock exchange. It has start and end. At the end of period all accounts are closed out and next year start afresh. we can consider the balance sheet analogy as a photo and the income statement analogy as a video.
Sales or Revenue
Income statement is used for period of time. Companies need to report quarterly Income statement if it is listed on Stock exchange. It has start and end. At the end of period all accounts are closed out and next year start afresh. we can consider the balance sheet analogy as a photo and the income statement analogy as a video.
Sales or Revenue
<Cost
of Goods Sold COGS> or <Cost of Revenue>
------------------
Gross Margin
<Selling
and Admin>
----------------
Net Income
Net Income
Gross
Margin divided by sales gives gross margin ratio percent. This is useful
as we can compare the ratio for
one firm to that of another firm.
Sales
or Revenue is Top Line
Net
Income is Bottom Line.
When
transaction for example buy of Truck is occurs, it is added in Sales of Income
Statement and Assets section's Acccount Receivables of Balance Sheet and
Inventory in balance sheet is reduced and final net income is flows to Equity
section of Balance sheet.
Account
Receivables, when it gets collected it transfers to CASH
Normal
business to business transactions extend credit for 20-30 days.
SALES
are recorded, triggered when it is EARNED (Revenue Recognition)
EXPENSES
are recorded, triggered when it is CONSUMED
Revenue
recognition is accounting language to explain that if work is complete and
transaction physically done accountants will call it revenue
Inventory
sold in Balance sheet becomes COGS on the income statement.
When
you build inventory, the only costs included in the inventory total are Direct
materials, Direct Labor and Manufacturing overhead.
Cash Flow
statement:
Cash flow is over period of time of 1 year
cash flow statement highlights where cash is generated and
where cash is consumed.
CASH is like the oxygen of the company and fundamentally
very important to company and it has its own statement.
The three main categories on the Cash Flow Statement are
operations, investing and financing.
Managing cash levels is a fundamental role of the finance
department or CFO, but does not equate to a strategy
Investing can be thought of buying Fixed Assets. A negative
number under investing may mean the company may bought assets such as Property,
Plant and Equipment and positive means company might have sold either of PPE
If we had two balance sheets, from the same company,
exactly one year apart in time, we could determine the change in cash for that
year by comparing the two cash totals, with the difference equaling the net
change in cash for that year.
A realistic reason as to why financing might be a negative
number for Toyota is that they may have used cash to "pay down" debt.
The financing section of the Cash Flow Statement records
the cash that comes into the company from the outside market and is split into
two types: debt financing example Bonds and equity financing example common
stock, Dividends
Essentially every accounting category in the Cash Flow
Statement could be a source or use of funds except dividends. Dividends are
always a use or consumption of funds as they decrease the equity account.
RATIOS:
A/R Turnover Rate:
Sales / AR
Accounts receivable turnover rate is: Sales / average
accounts receivable.
A higher turnover rate indicates that a firm is
"good" at collecting its receivables.
If a company always maintains a balance of about $100,000
in accounts receivable and has sales of $200,000 in a year, the number of days
it takes to collect the receivables is about: 180 days
200,000/ 100,000 = 2
365/2 = 182.5 days
Inventory Turnover Rate:
COGS/ Inventory
Inventory turnover rate measures how quickly a company
produces and sells inventory
Companies want to move inventory since it is an asset that
does not by its sheer presence generate income, like a bank loan, until the
inventory is sold.
purpose of calculating the Gross Margin ratio is
profitability
Debt
to equity is calculated as debt/equity and it is used to
measure how much, in comparison, did owners put in relative to creditors.
Return on Equity
ROE : Net Income /
Equity
Return is another description for both net income and
profit.
The investor would have trouble determining EPS since the
number of shares outstanding changes frequently throughout the year.
When looking at the EPS you must be careful, since the
number of total shares outstanding may have changed and this can distort what
you thought was a trend upwards or downwards in the EPS.
Reference:
https://www.edx.org/course/introduction-accounting-ubcx-busacct1x
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/accstate.htm
Reference:
https://www.edx.org/course/introduction-accounting-ubcx-busacct1x
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/accstate.htm
