Chapter 10 Accounting the Value of the Business Lecture Slides PDF

CHAPTER 10 Accounting the Value of the Business INTRODUCTION TO BUSINESS Learning Objectives To define accounting and its benefits To explain the importance of using accounting frameworks for financial statements To identify the types of accounting areas available To describe the...

CHAPTER 10 Accounting the Value of the Business INTRODUCTION TO BUSINESS Learning Objectives To define accounting and its benefits To explain the importance of using accounting frameworks for financial statements To identify the types of accounting areas available To describe the accounting equation To interpret financial statements and financial ratios To explain the benefit of financial statements To identify on the importance of internal controls Accounting Is Defined as: “The art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof” (AICPA, 2021).  Helps evaluate a business’ performance Benefits Supports creating budgets and That future projections Accounti Increases the likelihood of complying ng with laws and regulations Brings Supports managing cash flows and To a meeting deadlines Business Helps to obtain financing and bank support As Part of Keeping Records, Businesses Need an Accounting System It is a formal method a business uses to keep track and organize its financial records, such as income, expenses, assets, and liabilities. An accounting system can be manual, usually seen in very small businesses or developing countries. Accounting Systems Manage: Expenses Invoices Funding  While an accounting system is the method to track financial records, an accounting framework is a set of standards to measure, recognize, present, and reveal the information that appears in a business’ financial statements. There Are Two Common Accounting Systems That Are Used Depending on The Country: In the US, the dominant system is GAAP or the Generally Accepted Accounting Principles. In the rest of the world, IFRS or the International Financial Reporting Standards is used. These two have one important thing in common: If a business is using GAAP, anyone familiar with that accounting framework will understand how the accounts are structured, how expenses are accounted for, and all other aspects and that same is true of IFRS. Types of Accounting Financial Public Forensic Accounting Accounting Accounting Types of Accounting (cont.) Governmen Managerial Internal tal Accounting Auditing Accounting Financial Statements The Balance Sheet (1/4) The balance sheet provides detailed information about assets, liabilities, and owner’s equity. All accountants use the same principle called the accounting equation: The Balance Sheet (2/4) Assets. They improve a business’ value. They are resources owned by the business that hold intrinsic, quantifiable value. Assets are categorized by the time in which they can be used: ○ Current ○ Non-current Depreciation. Assets lose value The Balance Sheet (3/4) Liabilities. They are a debt that a business owes to an external person or business, such as a loan. Examples: accounts payable, wages, taxes, and payments to suppliers. Same time categorization as assets. ○ Current The Balance Sheet (4/4) Owners’ Equity. Using the accounting equation, owners’ equity = assets – liabilities. It is the amount of money remaining if a business sold all its assets and paid off its liabilities. Retained earnings. Profits that are not paid out and the owners invested back into the company. The Income Statement (1/3) Financial document that presents a summary of the business’ sales, expenses, gains or losses, and the resulting net income that happened in a period. It helps to determine a business’ profitability, value for investment purposes, and credit worthiness. The Income Statement (2/3) Net Sales. Net sales are inflows from selling goods and providing services. This term is often used interchangeably with revenues. Expenses. These are outflows that are a result of running the business. Cost of Goods Sold. Expenses related to the business’ producing a good, such as purchased materials and labor General and Administrative Expenses. Expenses indirectly related to the business’ producing a good or providing a service, such as The Income Statement (3/3) Depreciation expenses. Account for the reduction of value of an asset. Income. Amount of money that remains from revenues after expenses are deducted. Gross margin. Difference between net sales and cost of goods sold. Operating income. The difference between gross margin and general administrative expenses. Net income. Also called net  Learning to review and analyze an income statement In groups, google the income statement of the team’s selected company. Follow the steps outlined in the book about ‘How to review and analyze an income statement.’ In-class Take notes so a team leader can present the following exercise information to the class: 1. Does the math add up? 2. What is the bottom line? (identify whether there is a net profit or net loss) 3. What are the sources of income? 4. What are the expense categories? 5. What are the largest expenses? The Cash Flow Statement Offers a detailed narrative of what happened to the business’ cash during a period. This statement presents all the areas in which cash was used and received by the business. Cash flow statements are important for managing liquidity. They are also key to understand where cash is being received (net The Cash Flow Statement (cont.) Cash flows are divided into three sections: Cash from Operating Activities. Includes sources and uses of cash from business activities. Cash from Investing Activities. Covers cash flow from buying or selling investments, such as buying or selling real estate (buildings, plants), vehicles. Cash from Financing Activities. Includes cash flow Essential Financial Ratios: Balance Sheet Mixed Ratios Balance Sheet Ratios (1/3) Current Ratio Measures liquidity, or cash flow, to reveal if the business has the current assets on-hand to cover its bills in a timely manner and run its operations efficiently. It is calculated as: Current assets / Current liabilities A ratio greater than 1 means that the business has enough current assets to pay off short-term liabilities Examples: ○ 1.0 indicates current assets match current liabilities ○ 3.0 indicates the business has three times more current assets than current liabilities Balance Sheet Ratios (2/3) Quick Ratio Examples Quick ratio. The quick ratio, also known 1.5 signals the business as the acid-test or liquidity ratio, quick assets are one and measures the current assets that can a half times its current be quickly converted to cash. liabilities It excludes inventory because it cannot.08 signals the business be not easily and quickly converted has $0.80 of current into cash. assets for every $1 of It is calculated as: current liabilities. Not a healthy ratio. Balance Sheet Ratios (3/3) Debt to Equity Ratio Examples Also called the risk ratio, measures the 1.0 indicates creditors amount of all debts and liabilities and stockholders equally against the owner’s equity. In other contribute to the words, it determines whether a business business is borrowing too much money 1.5 indicates the for its operations. business has $1.50 of It is calculated as: debt for every $1 of equity 0.85 indicates the business has $0.85 cents  In-class A current ratio of 0.53 exercise A current ratio of 2.60 #1: Write A quick ratio of 0.75 down A quick ratio of 2.0 what each ratio A debt-to-equity ratio of 0.45 means A debt-to-equity ratio of 3.7  A current ratio of 0.53 = the business only has 0.53 times more current assets than current liabilities. This is not healthy as the business does not have enough current assets to cover In-class current liabilities. exercise A current ratio of 2.60 = the business has 2.60 times more current assets than current liabilities. #1: Write A quick ratio of 0.75 = the business has $0.75 of current down assets for every $1 of current liabilities. Not a healthy ratio. A quick ratio of 2.0 = the business’ quick assets are two times what its current liabilities. each ratio means A debt-to-equity ratio of 0.45 = the business has $0.85 cents of debt for every $1 of equity. A debt-to-equity ratio of 3.7 = the business has $3.7 of debt for every $1 of equity. Combined Ratios Return on Equity Ratio This ratio is important for The return on equity ratio lets investors because, over time, shareholders know how profitable they want to see a sustainable their investment in the business and increasing return on equity. is, and it evaluates that Example: investment’s returns. ○ A 23% ratio indicates that It is calculated as: the business annual net income is about 23% of its shareholders equity Combined Ratios (cont.) Net Profit Margin Ratio It is calculated as: Also known as profit margin, is a measure of how much net profit (remember that is the same as net income) is generated Example: compared to the amount of net ○ A 20% ratio ($50 net sales. profit/$250 net sales x 100) It calculates the percentage of means for every $1 of profits a business generates from revenue the company earns its total sales. $0.20 in net profit  In-class exercise A return on equity ratio of 12.5% #2: A return on equity ratio of 8% Write down A net profit margin ratio of 10% what A net profit margin ratio of 5% each ratio means  In-class A return on equity ratio of 12.5% = the business annual net income is about 12.5% of its shareholder’s exercise equity. #2: A return on equity ratio of 8% = the business Write annual net income is about 8% of its shareholder’s down equity. what each ratio A net profit margin ratio of 10% = indicates for each $1 of revenue the business earns $0.10 in net means profit. A net profit margin ratio of 5% = indicates for each $1 of revenue the business earns $0.05 in net  Internal controls are activities Internal Controls to protect assets, reduce errors, and safeguard operations Internal Controls (cont.)  The bottom line is internal controls provide a It is reasonable assurance that: important Financial information is complete and to dependable emphasiz Policies and procedures are being followed e that Laws and regulations are being complied internal with, and controls Assets and information systems are are not safeguarded against dishonest use infallible