Chapter Fourteen Accounting: Measuring how Efficiently and Effectively Resources Are Creating Value and Profit © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin Introduction to Business

Learning Objectives 1.Explain how the success of a company’s business model can be measured by financial accounts and describe the various kinds of activities that accountants perform. 2.Analyze a company’s balance sheet and describe how it balances the assets a company owns against the capital owed to its creditors and stockholders. 3.Explain how the income statement is used to measure a company’s bottom line profit and the various costs and expenses that must be deducted to arrive at this total.

Learning Objectives 4.Understand why the need for cash, as well as profit, affects a company’s business model and how the cash flow statement measures the cash that flows into and out of a company. 5.Appreciate how financial ratios can be used to analyze the information in a company’s financial statements and how they help both managers and investors evaluate a company’s current and future profitability.

The Nature of Accounting Accounting -the process of collecting financial data, organizing and analyzing it using agreed- upon accounting rules, and reporting the results in financial statements

The Nature of Accounting Accounting system -the financial information system a company uses to measure, record, analyze, and report all the transactions involved in its value-creation process

Question? What is the record-keeping activities needed to monitor and track all of the financial transactions related to making and selling goods and services? A.Bookkeeping B.Accounting C.Accounting systems D.Double-entry journals

Types of Accounting Activities Bookkeeping -the record-keeping activities needed to monitor and track all of the financial transactions related to making and selling goods and services

Types of Accounting Activities Depreciate -the act of calculating the reduced value of the assets a company uses to make and sell its products

Accounting Activities Figure 14.1

The Rules of Accounting: GAAP Generally accepted accounting principles -a set of accounting rules and procedures U.S. companies must follow to ensure their financial standing is being reported accurately and honestly

Types of Accountants Certified public accountants (CPAs) -people who have taken 150 semester hours of accounting courses and have passed the CPA exam administered by the American Institute of Certified Public Accountants Steps to become a CPA can be found at cpa-exam.orgcpa-exam.org

Types of Accountants Audit -the formal evaluation of the fairness and reliability of a company’s financial statements

Types of Accountants Managerial accountants -accountants who specialize in preparing and analyzing the financial data used by managers Financial accountants -accountants who specialize in preparing financial data, following GAAP rules, for use by outside stakeholders

Accounting Concepts and Financial Statements The Balance Sheet The Income Statement The Statement of Cash Flows

The Balance Sheet Balance sheet -a summary of the financial condition of a business at the end of a day of a specific reporting period

The Balance Sheet Assets -the productive resources a company owns as well as all of its financial investments Liabilities -the financial obligations a company incurs by borrowing money or buying productive resources on credit

The Balance Sheet Stockholders’ equity -the total capital invested in a company over a time as well as the past profits it has retained in its business

The Basic Accounting Equation Assets - Liabilities = Owners’ Equity

The Basic Accounting Equation Double entry bookkeeping -a method of recording the dual effects of a business’s financial transaction so that the company’s assets, liabilities, and owners’ equity are always in balance

Assets Liquidity -assets listed in the firm’s balance sheet in order of how fast they can be converted into cash Current assets -the total value of a company’s cash, accounts receivable, inventory, and prepaid expenses

Liabilities Current liabilities -debts that are payable within one year’s time, including accounts payable and accrued expenses

Stockholders’ Equity Total equity -the sum of the capital stock invested in a business in addition to its retained earnings

The Income Statement Income statement -the financial report that summarizes the results of a company’s profit-making activities in a specific time period Bottom-line profit -the amount of net income, profit, or earnings a company reports on the bottom line of its income statement

Sales, Expenses, and Profit Figure 14.3

The Income Statement Accrual basis of accounting -the principle that a company’s income statement should reflect the revenue received when the company makes a sale, not when payment is actually received

Question? What is a company’s total profit after deducting the cost of the goods it has sold as well as all of its other expenses? A.Gross profit B.Gross margin C.Net income D.Cash flow

The Income Statement Gross profit -the amount of money left over after a firm deducts the cost of the goods it has sold from the revenues earned from them Net income -a company’s total profit after deducting the cost of the goods it has sold as well as all of its other expenses

The Statement of Cash Flows Cash flow statement -a financial report showing how much cash a company generated during a specific time period, including where the cash came from and how it was used

The Statement of Cash Flows Cash flows from operating activities Cash flows from investing Cash flows from financing

The Statement of Cash Flows Working capital -the amount of cash left over after a company subtracts its current assets from its current liabilities

Using Financial Ratios to Analyze a Company’s Performance Financial ratios -ratios that measure different aspects of a company’s performance

Using Financial Ratios to Analyze a Company’s Performance Liquidity Ratios Asset Management Ratios Profitability Ratios

Liquidity Ratios Current ratio Quick ratio

Asset Management Ratios Inventory turnover ratio -a measure of how quickly a firm’s inventory is being sold Asset turnover ratio -a measure of how well a company’s assets are being put to use to generate sales

Profitability Ratios Gross margin -a measure of how much of each sales dollar is left over after a firm pays for the cost of goods sold Profit margin -a measure of how much profit a company generates from its sales

A Look at Gross Margin Figure 14.4

Dick’s Gross Margin Figure 14.5

Sales and Net Income of Four Major Sports Retailers, 2002 ($ in millions) Figure 14.6

Return on Equity and Earnings Per Share Return on equity -a measure of how much profit a company has earned on each $100 of stockholders’ equity invested in the business Earnings per share -a measure of how much profit a company has earned for each share of stock issued

Return on Invested Capital Return on invested capital -a measure of how much profit a company generates for each dollar invested in its business

Return on Capital Income, 2002 Figure 14.7

ROIC Best-in-Class Retailers, 2002 Figure 14.8

Video: Aon Company Aon Company is a financial services company that provides accounting and other financial services. This video discusses managerial, financial, and tax accounting and the roles that each play at Aon. Identify the steps in the accounting cycle