ACCOUNTING BASICS PDF

# ACCOUNTING BASICS ## Financial vs. Managerial Accounting - Financial accounting provides information to external stakeholders, such as investors and creditors. - Managerial accounting provides information to internal stakeholders, such as managers. ### Financial Accounting - The process of i...

# ACCOUNTING BASICS ## Financial vs. Managerial Accounting - Financial accounting provides information to external stakeholders, such as investors and creditors. - Managerial accounting provides information to internal stakeholders, such as managers. ### Financial Accounting - The process of identifying, recording, summarizing and analyzing an entity's financial transactions and reporting them in financial statements. ### Core Principles - **Accounting Equation**: Assets = Liabilities + Equity - **Assets**: Stuff a business owns - **Liabilities**: Stuff a business owes (to third party suppliers) - **Equity**: Owners' claim on the business - **Debit**: Destination of economic benefits flows *to*. - **Credit**: Source of economic benefits flows *from*. ### Accounting Rule Books * **Rules change depending on where a business is based**: 1. **International Financial Reporting Standards (IFRS)** 2. **Generally Accepted Accounting Principles (GAAP)** * **They make sure that financial statements are**: - Timely - Reliable - Comparable - Consistent * **Both follow the accrual method of accounting**: - **Accrual Method of Accounting**: - Revenue is recognized as it is earned - Expenses are recorded as they are incurred (first mentioned) * **Most accurate way to calculate profit**. ### Financial Statements - Accounting reports that summarize a business's activities over a period of time. - **Three main types of financial statements**: - **Balance Sheet**: Summarizes assets, liabilities, and equity at a single point in time. - **Income Statement**: Summarizes revenue and expenses over a period of time. - **Cash Flow Statement**: Summarizes cash inflows and outflows over a period of time. ### FA Steps / Accounting Cycle 1. **Identify Transactions**: e.g. $1000 annual subscription from 1/2/23 - 1/2/24. 2. **Prepare Journal Entries**: Double entry accounting: affects at least 2 accounts, Debit = Credit. 3. **Post to General Ledger**: - A database that stores complete records of *all* accounts and journal entries. - A place where we record, sort, and store all financial transactions that affect related groups of items. - **6 Types of Accounts**: - Assets - Liabilities - Equity - Income/Revenue - Expenses - Withdrawals/Dividends 4. **Put Together Unadjusted Trial Balance**: - Helps check for errors. - Mostly used for making financial statements. 5. **Post Adjusting Entries**: - Post proper error/future reports (accounting period is over) 6. **Post Adjusted Trial Balance**: - Winning a new/adjusted trial balance in accordance to accrual accounting methods. 7. **Create Financial Statements**: - For other groups to compare. - For investors to consider investing. 8. **Post Closing Entries**: - To prepare books for the next year/clear out all temp accounts. - Transfer balances from temporary accounts to permanent accounts in the balance sheet. ## Financial Ratios ### Financial Ratio Analysis - The process of comparing different financial ratios over time and across different businesses. - **Ratios**: One thing, compared to another thing. - In finance: Ratio = SIZE LINE IN A FINANCIAL STATEMENT / ANOTHER LINE ITEM. - Most of the time, shown as percentages. ### Types of Different Ratios - **5 Main FRs**: - Profitability - Price - Leverage - Efficiency - Liquidity ### Profitability Ratios - **Split Into**: - **Margin Ratios**: Revenue - Profit - **Return Ratios**: _TYPE OF _PROFIT_ / _ASSETS/ EQUITY/CAPITAL EMPLOYED_ - **How efficiently a business generates profit from four different things**: - Revenue - Assets - Equity - Capital Employed ### Liquidity Ratios - **How well a business can cover its short term debt obligations using its assets**. - General formula: _LIQUIDITY_ = _GROUP OF CURRENT ASSETS_ / CURRENT LIABILITIES ### Efficiency Ratios - How effective a business is at selling inventory to customers, how quickly it's able to collect cash-back from them, and how reliably it pays off its creditors. - **Split Into**: - **Turnover Ratios**: _ONE LINE (From Income Statement) / RELATED LINE ITEM (Balance Sheet)_ - **Cash Conversion Cycle**: _DAYS SALES + # OF DAYS OUTSTANDING_ ### Leverage Ratios - Leverage: up your risk by taking on debt in order to maximize return/reward. - **Split Into**: - **Balance Sheet Ratios**: - **Debt to Assets (DTA)** = _TOT LIABILITIES_ / _TOT ASSETS_ - **Debt to Equity (DTE)** = _TOT LIABILITIES_ / _TOT EQUITY_ - **Income Statement Ratios**: - **Interest Coverage**: Operating Income / Interest Expense - **Debt Service Coverage (DSCR)**: EBITDA / Total Debt Service ### Price Ratios - Used in financial analysis to evaluate the share price of a business and determine if it's worth investing in. - **Split Into**: - **Earnings-Based Ratios**: - **Earnings Per Share (EPS)**: ((Net Profit - Preferred Dividends)) / Common Shares Outstanding - **Price to Earnings (P/E)**: Share Price / Earnings Per Share - **P/E to Growth (PEG)**: P/E Ratio / EPS Growth - **Dividend-Based Ratios**: - **Dividends Per Share (DPS)**: Dividends Paid / Common Shares Outstanding - **Dividends Yield Ratio**: Dividends Per Share / Share Price - **Dividends Payout**: Dividend Paid / Net Profit ## List of Ratios ### Profitability - **Margin Profits General Formula**: _PROFIT_ / _REVENUE_ - **Gross Profit Margin (GPM)**: Gross Profit / Revenue - **Operating Profit Margin (OPM)**: Operating Profit / Revenue - **Net Profit Margin (NPM)**: Net Profit / Revenue - **Return Ratios General Formula**: _TYPE OF _PROFIT_ / _ASSETS/ EQUITY/ CAPITAL EMPLOYED_ - **Return on Assets (ROA)**: Net Profit / Total Assets - **Return on Equity (ROE)**: Net Profit / Total Equity - **Return on Capital Employed (ROCE)**: (Net Profit - Preferred Dividends) / (Total Assets - Current Liabilities) OR Operating Profit / Capital Employed ### Liquidity - **Cash Ratio**: Cash / Current Liabilities - **Quick Ratio**: Liquid Assets / Current Liabilities - **Current Ratio**: Current Assets / Current Liabilities ### Turnover Ratios - **Inventory Turnover**: Cost of Goods Sold / Inventory - **Receivables Turnover**: Revenue / Accounts Receivable - **Asset Turnover**: Revenue / Total Assets - **Payables Turnover**: Cost of Goods Sold / Accounts Payable ### Cash Conversion Cycle - **Days Sales of Inventory (DSI)**: Inventory / Cost of Goods Sold x 365 - **Days Sales Outstanding (DSO)**: Accounts Receivable / Revenue x 365 - **Days Payable Outstanding (DPO)**: Accounts Payable / Cost of Goods Sold x 365