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CHAPTER 8: Accounting. DECISION MAKING BY THE NUMBERS. Market Information. How can you tell how well you are doing? Measure individual transactions Put them all together – How much “stuff” (acquired wealth) do you have Where did it come from? (assets = liabilities + owners equity)
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CHAPTER 8: Accounting DECISION MAKING BY THE NUMBERS
Market Information • How can you tell how well you are doing? • Measure individual transactions • Put them all together – • How much “stuff” (acquired wealth) do you have • Where did it come from? (assets = liabilities + owners equity) • How much new wealth are you creating with it?(revenue - expense = profit) • Goal of business: To create wealth • Competing for transactions in the market
FINANCIAL STATEMENTS: THE MAIN OUTPUT OF FINANCIAL ACCOUNTING • Financial accounting includes three basic financial statements: • Balance Sheet • assets: value of the stuff the organization controls • liabilities: debt claims against the stuff • owners’ equity: owners’ claims against the stuff • Income Statement • revenues ($ coming in) • expenses ($ going out) • Statement of Cash Flows • Corporations with publicly held stock must publish annual reports with all three statements
BALANCE SHEET: WHAT WE OWN AND HOW WE GOT IT Assets = Liabilities + Owner’s Equity Balance Sheet – summarizes a firm’s financial position at a specific point in time. Liabilities – indicates what the firm owes to non-owners Assets – things of value that the firm owns Owner’s Equity – the claims owners have against their firm’s assets
Stuff & claims against stuff • Stuff • Car $4,000 • Claims against stuff • Dave (owner) $3,000 • Becky (loan) $1,000
Stuff & claims against stuff • Stuff • House $140,000 • Claims against stuff • Bank (debt) $115,000 • Dave (owner) $ 25,000
Stuff & claims against stuff • Stuff • Car $4,000 • Claims against stuff • Dave (owner) $3,000 • Becky (debt: 6 mo) $1,000 • Stuff • House $140,000 • Claims against stuff • Bank (debt) $115,000 • Dave (owner) $ 25,000
Snap shot: The Balance Sheet Assets(stuff) • car 4,000 • house 140,000 • total144,000 Liabilities and Owners Equity • short term liabilities (becky) 1,000 • long term liabilities (bank) 115,000 • equity (car and house) 28,000 • total144,000 $ $
Balance Sheet AssetsCash Accounts Receivable Inventory Total Current Assets Plant & Equipment Accumulated Depreciation Total Fixed Assets Total Assets 12/31/07 26.8% 16.1% 11.3% 54.2% 69.1% -23.2% 45.8% 100.0% Foundation & Accounting Numbers $5,593 $3,353 $2,353 $11,299 $14,400 ($4,848) $9,552 $20,852
Foundation & Accounting Numbers • Liabilities & owner's equity Accounts Payable Current Debt Long Term Debt Total Liabilities Common Stock Retained Earnings Total Equity Total Liability & Owner’s Equity $2,855 $0 $5,200 $8,055 $2,313 $10,485 $12,798 $20,852 13.7% 0.0% 24.9% 38.6% 11.1% 50.3% 61.4% 100.0%
THE INCOME STATEMENT: HOW DID WE DO? Income Statement – summarizes a firm’s operations over a given period of time in terms of profit and loss. Revenue – Expenses = Net Income Expenses – the cash the firm spends or other assets it uses to generate revenue Revenue– the increase in the amount of assets the firm earns Net Income – the profit or loss the firm earns
STATEMENT OF CASH FLOWS: SHOW ME THE MONEY • Cash flowing into and out of the firm • Operations • Investing • Financing • Increase and decrease from all three sources • Total amount of cash on hand • Stakeholders want to know if there is adequate cash to pay workers, creditors, suppliers and IRS
ADDITIONAL FINANCIAL STATEMENTS Statement of Retained Earnings – reports how retained earnings have changed. Stockholder’s Equity Statement – reports how net income and dividends affect retained earnings.
SARBANES-OXLEY ACT OF 2002 • Commonly referred to as SOX • Banned relationships between CPA firms that might create conflict of interest • Created Public Company Accounting Oversight Board (PCOAB)
BEYOND THE STATEMENTS Horizontal Analysis – compares information in a firm’s financial statement over a period of 2 years or more. Vertical Analysis – expresses items on the balance sheet and income statement as a percentage of a key value. Ratio Analysis – compares selected items by computing percentages, rates or proportions.
MANAGERIAL ACCOUNTING: INSIDE INTELLIGENCE • Reports and analysis for informed business decisions • Product Costing • Accurate measure and analysis of costs • Activity Based Costing (ABC)
INCREMENTAL ANALYSIS • Make parts or buy from supplier? • Repair equipment or buy new? • Perform repairs or outsource? • Eliminate or sell product line/business? Evaluates the financial impact of different alternatives in a decision-making situation.
INCREMENTAL ANALYSIS DECISION An electronics firm produces high definition LCD televisions at a rate of 10,000 per month. It currently makes its own speaker sets for the televisions. A supplier offers to sell the firm similar speakers at a cost of $23 per television. The firm could lower costs by buying the speakers, $23 is less than $26. Right?
