Accounting Financial Statement Analysis Making it Real

Accounting & Financial Statement Analysis: Making it Real! By: Ms. Eborn Virtual Enterprise- Accounting I

What is Accounting? o The Language of Business o Standard Rules for Measuring Firm’s o o o Performance Assessing Performance is important to: The Firm’s Office Managers & Employees (Measures Performance in different geographic locations) Investors (Current & Potential Shareholders) Lenders (Banks) General Public (Communication to Public Arena)

Why is Accounting Important? o Make Corporate Decisions o Make Investment Decisions (Mutual Funds looking to invest in companies) o Facilitates Corporate and Investment Decision (Assessment & Comparison)

Who Uses Accounting? o Federal Government o Non-Profit Organizations o Small Businesses o Corporations

Standardized U. S. Accounting Regulations (GAAP) Generally Accepted Accounting Principles (GAAP) How does it work? o U. S. Governmental Agency called Securities and Exchange Commission (SEC) authorizes the Financial Accounting Standards Board (FASB) to determine U. S. Accounting Rules o FASB communicates these Rules by issuing Statements of Financial Accounting Standards (SFAS). These statements make up the U. S. Accounting rules known as GAAP.

Purpose of GAAP? l Serve as Guidelines for Financial accounting, to insure that business present their financial information on a fair, consistent, and straightforward basis. l U. S. companies must be prepared according to U. S. GAAP.

What is IFRS? There has been a convergence between the standards for the U. S. and other countries. l In 2001, IASC committee was replaced by the International Accounting Standards Board (IASB). IASB has 14 Board Members that were selected by IASC. IASB (the parent foundation) is solely responsible for developing IFRS. l In 2002, FASB & IASB agreed to work together toward a convergence between GAAP & IFRS, but there still remains differences. l In 2005, all EU countries adopted International Financial Reporting Standards (IFRS). In addition, accounting standards for many countries outside of Europe, including Japan. l

Assessment: Fully write out questions & answers on your paper § Select letter and all answers that apply. There may be more than one answer.

Exercise 1: What is Accounting? A. The language of business B. A standard set of rules for measuring a firm’s financial performance C. An outdated system of tracking a company’s finances D. A framework for assessing a company’s financial performance

Exercise 2: Why is Accounting Important? A. Completely prevents manipulation of financial information B. Serves as a standard language of recording financial performance C. Allows company officers, investors, and general public to assess a firm’s financial performance D. Standardizes financial information so that it can be assessed and compared across companies

Exercise 3: What does GAAP Stand For? A. Generally Accepted Accounting Performance B. General Accounting Accepted Practices C. Generally Accepted Accounting Practices

Exercise 4: Accounting Regulations-GAAP Is: A. Rules and Regulations governing accounting B. Developed by the SEC on behalf of FASB C. Communicated through issuance of Statements of Financial Accounting Standards (SFAS) D. All of the above

Exercise 5: IFRS-International Financial Reporting Standards (IFRS) are: A. Rules and regulations governing international accounting B. Developed by FASB and used by all EU countries C. Converging with U. S. GAAP, but a number of difference still exist D. Converging with U. S. GAAP, with both accounting systems set to be identical by 2010

What is Depreciation Expense? A method where a long-term fixed asset (purchases that are expected to provide benefits for the company for a period of 1 year or more) l This is spread over a future period (number of years) when these assets are expected to be in service & help generate Revenue for a company. l Depreciation quantifies the wear & tear (from use & passage of time) of the physical asset through a systematic decrease (depreciation) of the assets’ book (historical value). l

Depreciable Fixed Assets Include: l Plants l Machinery l Equipment l Furniture l Leasehold Improvements Ø Note Rule: Land is a fixed asset but is not depreciated.

Major Asset Classes & Their Typical Useful Lives: l Building & Improvements: 5 -50 Years l Fixtures & Equipment 5 -12 Years l Transportation Equipment 2 -5 Years l Internally Developed Software: 3 Years l Land: Not Depreciated

Assessment: Fully write out questions & answers on your paper § Select letter and all answers that apply. There may be more than one answer.

Depreciation Exercise 9: Which of the Following Needs to be Depreciated? A. B. C. D. E. Warehouse Administrative Wages Office Furniture Power Plant Land used to build a supermarket

Depreciation Exercise 9 Solution A. Warehouse C. Office Furniture D. Power Plant

Depreciation Expense: Bonus Question n What is Depreciation Expense in your own words?

Operating Expenses Estimating Monthly Demand, Expenses & Overhead

Identify & Estimate Operating Expenses • In business, an expense is defined as the use of an asset. • In other words, as you expend your assets to run and operate your business venture, the dollar value of those assets are noted on an Income Statement as expenses. • The more expenses you have, the less profit you make and the less taxes you pay.

Operating Expenses - use of your assets & services to produce revenue. Some specific, common examples are: • • Cost of Goods Sold (non-cash expense) Rent (cash expense) Prepaid Insurance (non-cash expense) Wages & Salaries (cash expense

How Expenses are Categorized on the Income Statement § Expenses usually are put into one of two categories: § Cost of Goods Sold (CGS) - direct labor & materials. These vary/change as your sales volume increases or decreases. The are the use of your asset called inventory. CGS is usually a noncash expense. The cash was expended in months past to buy the inventory. The amount of the inventory sold each month (expended or used up) is the expense you show on the Income Statement. Overhead - all other expenses of operating your business. These tend to be fixed. They tend not to change as your sales volume changes in the short run. They may be cash or non-cash expenses.

Overhead Includes: § § § operating expenses - rent, insurance selling expenses - commissions, mileage administrative expenses - management salaries, office expenses § Demand - estimate of future sales measured in customers, units, or dollars. Your actual demand is called sales revenue on an Income Statement.

Why Estimate Demand, Expenses & Overhead? § determine total dollar amount needed to start your business § determine appropriate type of financing § assess risk, feasibility, and personal investment § have better information to help make decisions § set appropriate price § manage controllable expenses § assure profitability § manage cash flow

Income Statements § Income statements vary in style, However, there are parts to an Income Statement that help us separate activities and categories for tracking and managing our sales and expenses. § In the simplest form, an Income statement is three lines § Revenue -Expenses = profit/loss

Elements of an Income Statement § The most important element is your Sales Revenue or just revenue. This is the measure of success of your business and marketing strategies. This is the top of the Income Statement. § REVENUE = P x Q (your selling price times quantity sold or demand in units) § DEMAND = Quantity of: § Units (measured in hours, items sold, gallons, meals served, etc. ) § Customers (individuals, groups, businesses, etc. ) § $ (dollar value of the units demanded) § The next section of an Income Statement shows the inventory expended in producing those sales. This figure includes items given away, lost, damaged and sold.

Most Important Element is Sales Revenue or Revenue § This is the top of the Income Statement. § REVENUE = P x Q (your selling price times quantity sold or demand in units) § DEMAND = Quantity of: § Units (measured in hours, items sold, gallons, meals served, etc. ) § Customers (individuals, groups, businesses, etc. ) § $ (dollar value of the units demanded) § The next section of an Income Statement shows the inventory expended in producing those sales. This figure includes items given away, lost, damaged and sold.

CGS = Cost of Goods Sold § portion of inventory sold or otherwise used up to produce sales § cost of making or buying the product sold § The sales revenue minus CGS gives us our gross profit, that is profit before accounting for operating expenses and taxes.

GROSS PROFIT = Revenue less CGS § (gross profit before operating expenses and taxes) OPERATING EXPENSES = Expenses to run the business and generate sales PROFIT/LOSS = the bottom line before taxes §

Operating Expenses and Overhead § Operating expenses are the expenses to produce your sales and to run the business. They usually recur each month with slight fluctuations. § There are two types: § Selling Expenses - may vary with demand; often thought of a variable expenses § General & Administrative Expenses - likely constant; often referred to as fixed costs or overhead

Sales Revenue § Revenue equals price x quantity demanded. We need to use our estimated demand estimated selling price to calculate Revenue. Total Revenue = P x Q § Selling Price = CGS + FCC + Profit

How the Selling Price is Determined Total Costs CGS $5 + Overhead/unit $14 (Fixed Cost Contribution) $ Markup +Target Profit $6 Selling Price = $25

When and How Much Revenue? n There are two methods for determining when and how much revenue to record on an Income Statement. (1) Accrual versus (2) Cash accounting methods n Cash accounting means that you consistently record sales when the cash is received from the customer. Consequently, you must also record expenses when the cash is paid to vendors and suppliers. n Accrual accounting means that you consistently record sales when the deal is struck and the goods are delivered to the customer. Consequently, you must also record expenses when the deal is struck and the supplies are received from the vendors and suppliers.

For example: suppose you had the following sales chart for a typical month Sales Revenue: Cash sales = $35, 000 Accounts Receivable= 15, 000 Total Sales Revenue = $50, 000 What is our Revenue for our Income Statement and tax liability? n By Cash accounting it is $35, 000 n By Accrual accounting it's $50, 000 NOTE: The bank would want to see $50, 000 to give us a loan. We would like the $35, 000 for a lower tax liability.

Typical Income Statement n http: //www. cabrillo. edu/~dambrosini/188 Web/i mages/incomesams. gif n Review the following sample Income Statement n Task: Re-create the next example of an Income Statement on Excel

Income Statement Exercise n Use the following data to make both an Income Statement and a Cash Flow Statement for the same time period. Cash Sales $ 15, 000 Credit Sales 10, 000 CGS 10, 000 Rent 3, 000 Depreciation, buildings 1, 000 Advertising 1, 000 Payroll 2, 500 n The company was started with a $100, 000 loan and an investment of $100, 000.

Basic Financial Analysis n Create the next form on Excel n http: //www. cabrillo. edu/~dambrosini/188 Web/ classsessions/operatingcosts. htm

Cost of Goods Sold n Cost of Goods Sold can be complicated to calculate. The following example illustrates the components of CGS. n Create the next form on Excel