1. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-1 Chapter 1717 Understanding Financial Information and Accounting 17-1

2. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-2 What is Accounting? Recording, classifying, summarizing, & interpreting financial events & transactions to provide management & other parties information to allow them to make good decisions.

3. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-3 Financial Transactions Include buying & selling goods & services, acquiring insurance, using supplies, & paying taxes.

4. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-4 The Accounting Process DATA PROCESSINGINFORMATION

5. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-5 What Bookkeepers Do o Categorize and and o Record the Data in in o Books of Original Entry o Journals o Ledgers using using o Double Entry

6. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-6 Bookkeeping's Role Bookkeeping -- The recording of business transactions. Bookkeepers divide a firm’s transactions into meaningful categories and post them into a record book or computer program called a journal. Double-Entry Bookkeeping -- Bookkeepers record all transactions in two places so they can check one list of transactions against the other for accuracy.

7. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-7 Bookkeeping's Role Ledger -- A specialized accounting book or program where all information is in one place. Trial Balance -- A summary of all the information in the account ledgers.

8. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-8 Accounting Guidelines Financial Accounting Standards Board (FASB) defines what are Generally Accepted Accounting Principles (GAAP) that accountants must follow

9. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-9 Bookkeeping vs. Accounting Bookkeeping – –Start of Accounting Process – –Recording of Business Transactions – –Record/Journalize Accounting – –Classify – –Summarize – –Analyze – –Interpret – –Recommend

10. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-10 General Journal

11. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-11 Cash No. 101 DateExplanationPRDebitCreditBalance Accounts Receivable No. 106 Date PRDebitCreditBalance Office Supplies No. 124 Date PRDebitCreditBalance Prepaid Insurance No. 128 Date PRDebitCreditBalance General Ledger

12. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-12 The Accounting Cycle

13. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-13 Steps In The Accounting Cycle Analyze Source Documents Record Transactions in Journals Post Journal Entries to Ledger Take a Trial Balance Prepare Financial Statements Analyze Financial Statements

14. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-14 Financial Statements

15. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-15 Financial Statements o o Balance Shee t – Statement of Financial Position (on a specific date) o o Income State ment – Statement of Revenues, Expenses, & Profits (specific period of time) o o Statement of Cash Flows – Statement of Cash Receipts & Disbursements (cash coming in & cash going out)

16. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-16 Balance Sheet Statement of Financial Position (on a specific date)

17. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-17 Terms Assets –What the Company owns LiabilitiesLiabilities –What the Company owes EquityEquity –Owners’ Claims LiquidityLiquidity –How fast an asset can be converted into cash

18. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-18 Accounting (Balance Sheet) Equation Assets Liabilities + Owner’s Equity Owns Owes + Owners’ Claims = =

19. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-19 Classifying Assets o Current Assets -- Items that can or will be converted to cash within one year. o Fixed Assets -- Long-term assets that are relatively permanent such as land, buildings, or equipment. o Intangible Assets -- Long-term assets that have no physical form but do have value such as patents, trademarks, and goodwill.

20. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-20 Classifying Liabilities o Liabilities -- What the business owes to others - its debts. o Accounts Payable -- Current liabilities a firm owes for merchandise or services purchased on credit. o Notes Payable -- Short or long-term liabilities a business promises to pay by a certain date. o Bonds Payable -- Long-term liabilities that the firm must pay back.

21. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-21 Owners’ Equity Accounts Owners’ Equity -- The amount of the business that belongs to the owners minus any liabilities of the owners. Retained Earnings -- Accumulated earnings from the firm’s profitable operations that are reinvested in the business.

22. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-22 Balance Sheet Equation Assets Liabilities + Owner’s Equity = $826,000 = $613,000 + $213,000 $213,000 Very Vegetarian Company

23. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-23 Very Vegetarian’s Balance Sheet (Assets) Period ending 12/31/14 Assets Current Assets Cash$ 15,000 Accounts Receivable 200,000 Notes Receivable 50,000 Inventory 335,000 Total Current Assets$600,000 Fixed Assets Land$ 40,000 Buildings (net) 110,000 Equipment & Vehicles (net) 40,000 Furniture & Fixtures (net) 16,000 Total Fixed Assets$206,000 Intangible Assets Goodwill$ 20,000 Total Intangible Assets$ 20,000 Total Assets$826,000

24. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-24 Very Vegetarian’s Balance Sheet (Liabilities & Owner’s Equity) Period ending 12/31/14 Liabilities & Owners’ Equity Current Liabilities Accounts Payable$ 40,000 Notes Payable 8,000 Accrued Taxes & Salaries 240,000 Total Current Liabilities $288,000 Long-term Liabilities Notes Payable$ 35,000 Bonds Payable 290,000 Total Long-term Liabilities $325,000 Total Liabilities$613,000 Owners’ Equity Common Stock (1M shares) $100,000 Retained Earnings 113,000 Total Owners’ Equity$213,000 Total Liabilities & Owners’ Equity$826,000

25. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-25 Income Statement Statement of Revenues, Expenses, & Profits (specific period of time)

26. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-26 Income Statement Income Statement -- The financial statement that shows a firm’s bottom line - that is, its profit after costs, expenses, and taxes. Net Income/Net Loss -- The revenue left over or depleted.

27. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-27 Accounts of the Income Statement Revenues is the monetary value a firm received for goods sold, services rendered or other payments. Cost of Goods Sold (or Manufactured) -- Measures the cost of merchandise the firms sells or the cost of raw materials and supplies it used in producing items for resale. Gross Profit -- How much a firm earned by buying (or making) and selling merchandise.

28. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-28 Accounts of the Income Statement Operating Expenses -- Expenses a firm incurs in selling goods and services such as rent, salaries and supplies.

29. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-29 Income Statement Equation Profit = Revenues – Expenses

30. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-30 Income Statement Formula Revenues Revenues –Cost of Goods Sold =Gross Profit (Gross Margin) –Operating Expenses =Net Income Before Taxes –Taxes =Net Income (or Loss)

31. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-31 Very Vegetarian Income Statement Period Ending 12/31/14 Revenues Net Sales$ 700,000

32. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-32 Very Vegetarian Income Statement Period Ending 12/31/14 Revenue Net Sales$ 700,000 Cost of Goods Sold Beginning Inventory $ 200,000 Purchases During the Year $ 440,000 Cost of Goods Available for Sale During the Year $ 640,000 Less: Ending Inventory $ 230,000 Less: Cost of Goods Sold $ 410,000 Gross Profit (Gross Margin)$ 290,000

33. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-33 Income Statement Formula Revenues Revenues –Cost of Goods Sold =Gross Profit (Gross Margin) –Operating Expenses =Net Income Before Taxes –Taxes =Net Income (or Loss)

34. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-34 Very Vegetarian’s Income Statement (cont’d) Gross Profit $290,000 Operating Expenses Selling Expenses Salaries$ 90,000 Advertising & Supplies$ 20,000 Total Selling Expenses$ 110,000 General Expenses Office Salaries$ 67,000 Depreciation$ 1,500 Insurance$ 1,500 Rent$ 28,000 Utilities$ 12,000 Miscellaneous$ 2,000 Total General Expenses$ 112,000 Less: Total Operating Expenses - $ 222,000 Net Income (Profit) Before Taxes$ 68,000 Less: Income Tax Expenses -$ 19,000 Net Income (Profit) After Taxes$ 49,000

35. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-35 Statement of Cash Flows Statement of Cash Receipts & Disbursements (cash coming in & cash going out)

36. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-36 Understanding Cash Flow Cash Flow -- The difference between cash coming in and cash going out of a business.

37. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-37 Statement of Cash Flows Reports cash receipts and disbursements related to the firm’s major activities: Operations – cash transactions associated with running the business Investments – cash used in or provided by firm’s investment activities Financing – cash raised from the issuance of new debt or equity capital or cash used to pay business expenses, past debts, or company dividends

38. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-38 Depreciation o o Depreciation -- The systematic write- off of the cost of a tangible asset over its estimated useful life.

39. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-39 Ratio Analysis

40. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-40 Ratio Analysis Assessment of firm’s financial condition and performance through calculations and interpretations of financial ratios developed from the firm’s financial statements

41. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-41 Financial Ratios 1.Help in analyzing actual performance compared to financial objectives 2.Provide insights in to firm’s performance compared to other firms in the industry

42. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-42 Using Financial Ratios o Ratio Analysis -- The assessment of a firm’s financial condition using calculations and financial ratios developed from the firm’s financial statements. o Key ratios include:  Liquidity ratios  Leverage ratios  Activity ratios

43. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-43 Liquidity Ratios

44. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-44 Commonly Used Liquidity Ratios o Liquidity ratios measure a firm’s ability to turn assets into cash to pay its short-term debts. o Two key ratios are: o Current ratio o Acid-test ratio o This information is found on the firm’s Balance Sheet.

45. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-45 Liquidity Ratios Current Assets Current Liabilities Quick (Acid-Test) Ratio Cash + Marketable Securities + Receivables Current Liabilities Current Ratio

46. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-46 Liquidity Ratios Current Assets Current Liabilities Current Ratio

47. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-47 Current Ratio- Very Vegetarian $600,000$288,000 =2.08 Current Assets Current Liabilities

48. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-48 Quick (Acid-Test) Ratio $265,000 $288,000 =0.92 Cash + Marketable Securities + Receivables Current Liabilities

49. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-49 Leverage (Debt) Ratios o Leverage ratios measure the degree to which a firm relies on borrowed funds in its operations. o Key ratios include: o Debt to Owner’s Equity Ratio o This information is found on the firm’s Balance Sheet.

50. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-50 Debt to Equity Ratio $613,000 $213,000 = 287% Total Liabilities Owners’ Equity

51. McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 17-51 Activity Ratios Inventory Turnover = $410,000 = 1.9 $215,000 $215,000 Inventory Turnover Cost of Goods Sold Average Inventory