Introduction to Accounting        and FinanceWeek 1:   Who does what – Accounting vs. Finance   Setting the stage – Comm...
Who does what        Accounting vs. FinanceAccounting:    “Captures the financial value of the day to day   activities of ...
Who does what       Accounting vs. FinanceFinance: “Uses accounting information to guide and fund the   growth of an organ...
Who does what               Accounting basicsAccounting:   Transparent       Information is reliable and credible throug...
Who does what            Finance basicsFinance:  Focus is on:          Economic value versus book value     Opportunity ...
Setting the Stage          Common Legal EntitiesSole proprietorship   One owner – taxes from profits are paid on owners  ...
Setting the Stage          Common Business Forms Characteristic         Proprietorship        Partnership         Corporat...
Setting the Stage        Common Business TypesService   Provides a value added activity   Labor intensiveManufacturing  ...
Setting the Stage             Common Business TypesUnique issues for Accounting and Finance        Unique Issues          ...
Communicating the Business   3 Critical Financial StatementsBalance Sheet:   Represents a snap shot in time of the invest...
Communicating the Business            The Balance Sheet  The Balance sheet must have the following                 equalit...
Communicating the Business      The Balance Sheet - Assets Assets measures the amount of resources the firm can utilize to...
Communicating the Business  The Balance Sheet - Liabilities    Liabilities measures the amount of services or benefits the...
Communicating the Business     The Balance Sheet – Equity Shareholder Equity measures the amount of value that investors  ...
The Balance Sheet – Digital Media                                                                                  Prior Y...
Communicating the Business          Income Statement The Income statement must have the  following equality        Profit...
Income Statement                                                             Prior Year   Current Year                    ...
Communicating the Business Income vs. Cash Flow Statement Profit and cash are separate concepts Income statement does no...
Communicating the Business              The Cash Flow Statement Shows the amount of cash generated from the firm’s operat...
Cash Flow Statement                             Current Year  Cash Flow from Operations   Net Income                      ...
Overview of Week 2 Generally Accepted Accounting Principles Double Entry Accounting Using journal entries to prepare  ...
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Week 1 business entities & financial statements

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  • [Click Next] In this lecture we will discuss three main topics. I will answer the “who does what question” by discussing the role of accounting and finance within an organization and the main differences between the two. [Click Next] I will help you develop some context by setting the stage and introduce you to the different forms and types of businesses that accounting and finance operate under. This will help you develop an understanding of how this impacts accounting and financial analysis. [Click Next] Lastly, we will take a tour of the three important financial statements, the balance sheet, the income statement and the cash flow statement that investors, creditors and senior manager use to asses the financial health of the company. You will gain a clearer understanding of what financial information is communicated by these statements to these groups of individuals.
  • Accounting and finance functions are in many instances blurred in the day to day activities of for profit or not for profit businesses. However, there are distinct differences. Accounting is focused on measuring the financial value of activities that an organization engages in when selling their goods and services.
  • Finance, on the other hand uses accounting information to make decisions on how to finance the growth of the organization, determine what new business opportunities to invest in and establish the economic value of the company. Here the primary goal is to maximize the value of the organization for investors. One could say that accounting is the current “state of affairs” side of the business, where as finance is the forward looking “what if” side of the business.    
  • [Click Next] Accounting is governed by three guiding principles – that is accounting information must be Transparent, Relevant, and Comparable. These three overriding principles form the basis for how accounting is practiced. [Click Next] Accounting information must be easily understood or transparent to creditors and investors through the application of standard rules called Generally Accepted Accounting Principles or GAPP. [Click Next] Accounting is not always black and white. Sometimes accountants have to interpret rules that are in shades of “gray”. As a result, it is not important for accounting to try to financially measure down to the single penny every activity of the firm. What is important is that accounting provides relevant information that will materially impact the decision making of internal and external users. [Click Next] Investors and creditors also need information presented to them in a way that is comparable. Structured and standardized financial statements allow these individuals the ability to benchmark one company’s financial position to another. In this lecture we will take a tour of these financial statements where we will discover what information is being communicated through the Balance Sheet, Income Statement and Cash Flow Statement.
  • There are some key differences between accounting and finance. [Click Next] Accounting is typically focused on the book value of the firm – that is the historic cost of all the assets that a company acquires less the historic cost of its liabilities. However, finance is focused on the economic value of the firm. Economic value is typically referred to as the capitalization of the firm or what an investor is willing to pay to own a stake in a company based on future profits. [Click Next] Finance is also focused on opportunity cost. Here we are interested in the real cost of decision making. If a company invests a $1M to launch a new product line and receives $75K of profit in the first year, an accountant will show that the company made $75K on the income statement. However, if the company could have used this $1M to acquire the rights to a competitors product and instead return at $100K profit, a financial analyst would conclude that the company lost ($25K) over the original decision to launch this internal product. [Click Next] As I mentioned earlier finance is primarily focused with the “what if” side of the business. While accounting focuses on the current financial state of an organization, finance is concerned with forecasting the impacts of future growth on the financial health of the company.
  • In order to understand the impact that accounting and finance can have on an organization, it is important to understand the legal environment that businesses operate under. [Click Next] The basic forms of business are Sole Proprietorships, Partnerships and Corporations. [Click Next] Briefly defined a sole proprietorship is a form of business that has one owner, who is legally responsible for personally paying all the debt of the organization including loans from creditors and unfavorable judgments in lawsuits. The financial advantage of a sole proprietorship is that the owner does not get taxed twice - once for the profits of the business based on the corporate tax rate and again on the distribution of dividends based on personal tax rates. Here the owner can record the profits of the business under their own personal tax rate. [Click Next] Partnerships are the same as sole proprietorships except for the fact that financial risk and return is spread amongst multiple owners. The financial disadvantage of a sole proprietorship and partnership is that the owner or owners have unlimited liability when paying off the firm’s debt. If the company goes bankrupt or is sued in a civil case, the creditors or plaintiffs can not only come after the assets of the company but also the personal assets of each individual owner. This makes it difficult to raise funds from outside investors to support growth and expansion. Typically you see this form of business in small consulting or other professional organizations like private law or accounting firms that want to retain close control over the direction of the company. [Click Next] The corporation on the other was a legal and financial innovation that came into prominence in the late 17th century. One key facet of a corporation is limited liability. This allows investors to risk only what they invest in the company. As a result, the corporation can raise capital through many more investors that have varying degree of risk tolerances. Another key aspect is the idea of unlimited life. Given that a corporation does not end when the owners “cash out”, investors have the ability to actively trade their ownership or stock in a company. This liquidity lowers the cost to raise funds amongst large groups of investors. The financial downside of the corporation is the notion of double taxation. As an investor in a corporation you are in essence taxed twice on the profits that are generated. As I previously mentioned, the business is taxed through the corporate tax rate from the net income it generates. The investor is then taxed again on his or hers personal income tax on any dividends that are paid out from the net income of business.
  • This table highlights the differences between Proprietorships, Partnerships, Corporations, in the 4 main categories that we just discussed. To resolve the disadvantage that proprietorship and partnerships have in comparison to corporation, individual states in the late 70’s and early 80’s allowed these types of firms to use a form of business called a Limited Liability Company or LLC . These LLC’s acted much like a proprietorship and partnership except it allowed owners to limit their liability to only what they invested into the firm.
  • While each organization has a legal form of business, each form can typically be divided into three types of businesses – [Click Next] Service, Manufacturing and Merchandising. These forms of business each have unique issues and challenges for finance and accounting. First let’s define these business types. [Click Next] A service organization provides a value added activity directly to the consumer or another business. These organizations can vary from consulting firms to restaurants to non-profit environmental advocacy groups. The common characteristic of service organizations is that there is high labor involvement. Employees directly interact with the consumer in the consumption of the service. [Click Next] A manufacturing organization takes raw goods and materials and converts them into a product to be sold to a middleman or directly to the consumer. Manufacturing firms are capital intensive meaning that they have high fixed costs that do not vary with the level of production. They are also sensitive to price variations in raw materials. [Click Next] Merchandising companies purchase products in bulk at major discounts and resells them to the customer. To be successful they must cycle through their inventory quickly and efficiently.
  • This chart shows the unique issues that various business types pose to accounting and finance. Since service organizations are labor intensive, controlling labor costs becomes a prime concern. On the plus side, since service organizations typically do not carry inventory they do not have to worry about their inventory becoming obsolete. They also do not have to worry about large changes in commodity prices or raw materials impacting the cost to acquire inventory. Service organizations typically charge a premium for their services allowing for high profit margins ( high price mark up over costs) “review how this is recorded”. However, their business models are usually hard to scale due to the difficulty of replicating their unique services over a large customer base and their highly variable labor cost. Here the profile of a service organization is high margins but lower profit volume. In contrast manufacturing companies use costly equipment to produce a product from raw materials. As a result they are capital intensive and subject to price volatility from commodities of the raw materials that they use. The challenge here is to find sources of funding to purchase upfront the equipment needed to manufacture the product even though the returns may not be immediate. Also the organization must protect against sudden price changes by securing long term contracts with their vendors. Given that costs tend to be relatively fixed to the amount that is being produced, profits are highly impacted by the ability to achieve economies of scale. From a financial perspective successful manufacturing companies are able to spread their costs over a large volume of products. As more orders come in, incremental profit increases as the cost to manufacture an additional product stays relatively flat. Usually in this business model, profit margins are less than service companies. However, it easier for these companies to achieve higher total profit volume. Since, merchandise companies are buying goods at a bulk discount and reselling these good for a profit, the biggest challenge from a financial perspective is effective inventory control. This starts with the purchasing and supply chain functions of the organization. Here the main goal is to purchase as cheaply as possible and secure multiple suppliers for the same type of products in order to diversify risk. It ends with effectively cycling or churning inventory in order to avoid writing off obsolete or unfashionable products. While merchandise companies have razor thin profit margins they are financially successful by achieving large scale distribution of their products. Here the focus is on total profits or maximizing profit volume. In the coming weeks we will talk more in depth on managing the financial growth and health of an organization. This framework of understanding what business type an organization fits under is crucial to develop a context for what unique financial issues an organization faces. This knowledge of business type will be a critical concept to master when analyzing the financial health of a company.
  • Now that we have talked about the different forms of business and how it relates to the accounting and finance function. Let’s now take a tour of the financial statements that companies use to communicate the financial state of their business to various constituents . [Click Next] There are three main financial statements – the balance sheet, the income statement and the cash flow statement. [Click Next] The balance sheet represents a snap shot in time of the investments of a firm or its assets and the financing of a firm or its liabilities and shareholder equity. In essence it is a statement of everything that an organization owns and everything an organization owes. As you will see shortly what a firm owns or its assets must exactly equal what a firm owes or it’s liabilities to creditors and equity to owners. The balance sheet allows investors and creditors to determine the financial health and viability of a company. [Click Next] The income statement measures the ability of the firm to generate profit in a given period of time either monthly, quarterly, or annually from its operational activities. It simply shows the revenue that a firm receives for its services or products less the expenses required to produce those services or products. [Click Next] The cash flow statement shows the amount of cash generated or used from the firm’s operating, investing, and financing activities during a period of time. While the income statement shows the amount of accounting profit generated the cash flow statement shows how the company used it cash to support the business.
  • Let’s take a closer look at the balance sheet. As I mentioned earlier what a company owns and what a company owes must be in balance. Here the balance sheet must adhere to this equality – [Click Next] Assets must equal liabilities plus shareholders equity. [Click Next] Where assets are defined as the resources needed to produce revenue, [Click Next] liabilities are the loans from creditors to buy assets and [Click Next] shareholder’s equity is the investment from owners to buy assets. This equation, which is called the accounting equation, states that dollars coming into the firm from creditors or investors are in balance and reconciled between the assets that are purchased to support the operations of the business.
  • [Click Next] In the previous slide we defined assets as the resources needed to produce revenue. More specifically assets can take the form of short term or long term resources. [Click Next] Short term resources or assets are either cash or can be quickly converted into cash. Besides cash, these current assets can take the form of [Click Next] a ccounts receivable which is the balance that is due from customers for the purchases of a product or service, [Click Next] i nventory which is the raw materials used to make a product or a completed product that will be resold, and [Click Next] notes receivable which is a short term loan that a company may make to another company. Any resources or assets that cannot be quickly converted into cash are called long term assets. [Click Next] These items like equipment, land and buildings typically have an economic life greater than a year. [Click Next] Also listed on long term assets are intangible assets, which is an asset that does not have physical form. Typical examples of intangible assets are copy rights, patents and goodwill. Here goodwill is defined as the premium or amount over book value that a company maybe required to pay in order to acquire another company or another company’s assets.
  • While assets are the resources that support the operations of an organization, the accumulation of liabilities is one mechanism that helps fund the acquisition of assets. Liabilities are the sum total of all the services, raw materials, equipment, products or other benefits that a company receives from other firms or creditors in exchange for a promise of payment. In short it’s the creditors’ claim on assets. Some examples of liabilities are [Click Next] accounts payable which is a promise to pay another business typically 30-60 days after the service or product has been rendered and [Click Next] notes payable which is a loan from a bank or other creditor that can have a maturity or payoff term anywhere from 30 days to 30 years. Also, obligations to [Click Next] pay taxes from the prior year or salary and wages from the prior work period are other examples of liabilities. Again, the main concept in understanding a liability is that it is for a benefit that an organization receives now but defers payment to the future.
  • Shareholder equity is the other way that an organization supports the acquisition of assets. [Click Next] This piece of the balance sheet shows the owners or investors claims on assets. It is important to note that shareholders do not have the same claim on assets as creditors do. Shareholders receive dividend payments from operational profits after all debt payment has been made. Also, in the case of bankruptcy a shareholder is second in line to a creditor. If the assets of the company are liquidated the shareholders receive their share of the payout after the debt from creditors have been paid off. Here shareholder equity is really the amount of value that an investor can claim after liabilities to creditors are subtracted from the firm’s asset. Based on this principle we can rewrite the accounting equation (which again is assets = liabilities + equity) [Click Next] to equity = assets less liabilities. Shareholder’s equity includes not only the initial cash investment from owners which is typically in the form of common or preferred stock but also the operational profit from the company that is reinvested back into the business. This portion of shareholder equity is called retained earnings.
  • Let’s take a look at an example of a balance sheet. Digital Media is a fictitious high tech company that provides consulting services and products in the Digital Media industry. They are a heavy R&D firm that constantly commercializes new digital technology. In this example we are looking at a side by side comparison of the company’s assets, liabilities and shareholder’s equity for the current year and the prior year . You will see that Digital Media’s balance sheet adheres to the accounting equation where total assets of $3.1M in the current year equal the total value of liabilities and shareholder equity. Before I take you on a tour of the balance sheet it is important to understand that the values that are represented in each account are made up of historic value or book value versus current value or market value. The first thing that you will notice is that assets are listed at the top of the balance sheet followed by liabilities and share holders equity . [Click Next] Within the assets section you will notice that short term assets or current assets which are those resources that can be converted into cash quickly are listed first. These are assets that typically derive from the need to support the day to day operational activities of the firm. [Click Next] Assets that cannot be converted quickly into cash or have a long economic life are listed next under non-current or fixed assets. Since these assets are long term investments they show the value of the investing activity that a firm engages in order to support the future growth of the organization. In our example you can see that this company has approximately an equal amount of current and non-current assets in the prior year and slightly greater amount of current assets in the current year . This could signify that the company is curtailing their investments in the firm and may be concentrating on maximizing short term profits. [Click Next] The liability section is also structured by the time frame of when the obligation is due. Obligations like accounts payable and wages payable that are due within a year are listed first under short term liabilities. Obligations like bonds and other long term debt that are due over multiple years are listed under long term liabilities. [Click Next] Shareholder equity is listed after liabilities which symbolically reinforces the fact that creditors take precedent over shareholders. As we discussed, Shareholders’ equity is broken out by the amount of cash that owners have invested into the company and by the amount of operational profit that is re-invested into the firm. In this example these line items are shown as common stock and retained earnings. As you now realize both liabilities and shareholder equity measure the amount of funds needed to acquire the company’s assets. In this example funds raised through creditors are 2 times more then funds raised through investors in the prior year and twice as much in the current year. This could be the result of a few things. Creditors may have become more worrisome in lending to Digital Media or the owners decided it was cheaper to issue more equity than debt. In week 3 we will discuss more in depth what the numbers mean in describing the financial health of an organization.
  • While the balance sheet shows the value of the resources employed to operate the company and the amount of funding required to purchases these resources, the income statement shows the ability of the company to utilize these resources to make money. The income statement must have the following equality – [Click Next] Profit or net income equals revenue less expense. Here revenue measures the cash that flows into a firm when it sells goods or services from utilizing assets on the balance sheet. While expenses measures the net assets used up in generating revenue
  • Here’s an example of Digital Media’s income statement for the prior year and the current year . [Click Next] The first section of the income statement shows profit being generated from the operational activities of the company. This includes revenue broken out into two lines - sales of product for digital equipment and sales of services for consulting. Operating expenses are shown under revenue. This includes salaries, cost of goods sold which is the cost of the raw material to produce the digital equipment and other general administrative expenses like travel, training, office supplies, and other expenses required to keep the administrative offices running. An important measure of how well a company is generating cash from their operational activity is called operating income or EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation, and amortization. This tells investors how efficiently the company can utilize their current assets to convert it into cash through the sale of goods and services. [Click Next] Below operating income are other expense items. These other expense items are interest expense which show the cost of financing the firm through the issue of debt, depreciation expense which shows the cost of utilizing the company’s fixed or long term assets that are needed to build the infrastructure required to produce goods or services, and taxes on property, and income at the state and federal level. Interest expenses and taxes are fairly self explanatory. However, we will look more closely at depreciation expense in week 2
  • [Click Next] It is important to realize that the income statement has no direct bearing on the ability of a company to generate cash. [Click Next] While, the income statement gives an investor or creditor good insight into how efficient the company operations are in generating a return over the cost of acquiring its assets. It however tells nothing about how well the company creates cash from either investing, or finance activities. [Click Next] The income statement also includes non-cash items such as depreciation expense which distorts the actual cash brought into the business from operations. The cash flow statement over comes these deficiencies.
  • For any investor, creditor or senior manager, the cash flow statement is a vital tool that shows how a company funds operations and future growth. [Click Next] The cash flow statement shows the sources and uses of cash from the three key areas of activity – Operations, Investing and Financing. [Click Next] Cash flow from operations is simply defined as the cash received from sales less cash paid for operating expenses. [Click Next] Cash flow from investing is cash received from the sell of investments (like stock and bonds) and long term or fixed assets which are described in this slide as PPE or Property, Plant and Equipment less cash paid for the acquisition of these investments. [Click Next] Cash flow from financing includes cash received from issuing debt or equity less the cash paid out as dividend payments to owners or repayment of debt to creditors. Combined these three sources detail the change in cash flow from one period to the next.
  • Here’s an example of the cash flow statement for Digital Media. Previously we saw that Digital Media generated $180,000 of profit in the current year. However, from a cash flow perspective Digital Media returned $250,000 dollars back to the business from their three sources of activities. They generated $250,000 from operations, paid out $50,000 from the purchase of equipment, received $100,000 from the sale of real estate, and received an additional $50,000 from financing activities. In week 2 we will discuss the cash flow statement in more detail after we develop the conceptual framework on how to apply generally accepted accounting principles to the transactions that build these financial statements.
  • In this lecture we’ve looked at the different forms of legal entities that businesses operate under and some of the advantages and disadvantages to share holders for each entity. We also looked at the unique financial challenges that Service, Manufacturing and Merchandising firms face. We than took a tour of the three main financial statements that investor, creditors and senior managers analyze to determine the financial health and potential growth of a company. [Click Next] In week 2 we will focus on the main principles or rules of accounting as guided by GAPP accounting or Generally Accepted Accounting Principles. [Click Next] We will show through double entry accounting or debits and credits that each accounting entry must increase one account on the balance sheet and at the same time decrease a different account on the balance sheet. [Click Next] We will than walk through a few examples of how journal entries created by the use of debits and credits are utilized to prepare the three financial statements. We will use our fictitious company Digital Media as a back drop to explain these principles. See you next week!
  • Week 1 business entities & financial statements

    1. 1. Introduction to Accounting and FinanceWeek 1:  Who does what – Accounting vs. Finance  Setting the stage – Common Business Entities  Communicating Value – The Financial Statements
    2. 2. Who does what Accounting vs. FinanceAccounting: “Captures the financial value of the day to day activities of an organization through the application of specific accounting rules. It allows these activities to be reported in a way that is transparent, relevant, and comparable to investors, creditors and management”
    3. 3. Who does what Accounting vs. FinanceFinance: “Uses accounting information to guide and fund the growth of an organization, evaluate new business opportunities, and establish the economic value of a firm. In essence maximize shareholder value”
    4. 4. Who does what Accounting basicsAccounting: Transparent  Information is reliable and credible through the application of standard rules. Relevant  Internal & external users can make decisions from information that is material. Comparable  Financial value can be benchmarked through structured financial statements.
    5. 5. Who does what Finance basicsFinance: Focus is on:  Economic value versus book value  Opportunity cost versus actual cost  Forecast versus current state
    6. 6. Setting the Stage Common Legal EntitiesSole proprietorship  One owner – taxes from profits are paid on owners personal tax rate (eliminates double taxation) however owner is responsible for all debt.Partnership  Same as sole proprietorship but with multiple owners.Corporation  Many owners who are not personally responsible to pay the debt of an organization (limited liability) but are doubled taxed.
    7. 7. Setting the Stage Common Business Forms Characteristic Proprietorship Partnership CorporationOwners One Mulitple ManyLimited Liability No ** No ** YesUnlimited Life No No YesDouble Taxation No No Yes** Proprietorships and Partnerships that are set up as LLCs (limitied liabilitycorporations) provide limited liability
    8. 8. Setting the Stage Common Business TypesService  Provides a value added activity  Labor intensiveManufacturing  Converts raw material into a product  Capital intensiveMerchandising  Purchases product in bulk at major discounts and resells  Inventory intensive
    9. 9. Setting the Stage Common Business TypesUnique issues for Accounting and Finance Unique Issues Service Manufacturing MerchandiseLabor Intensive High Low Low - MediumPrice sensitivity to raw materials No Extremely Sensitive SensitiveInventory Obsolescence No Concern Depends on Product Big ConcernCapital Intensive Low High Medium to HighScalability Hard Easy EasyProfit Margins High Medium Thin
    10. 10. Communicating the Business 3 Critical Financial StatementsBalance Sheet:  Represents a snap shot in time of the investments of a firm or it’s assets and the financing of a firm or it’s liabilities and shareholder equityIncome Statement:  Measures the ability of the firm to generate profit in a given period of time (monthly, quarterly or annual) from it’s operational activitiesCash Flow Statement:  Shows the amount of cash generated or used from the firm’s operating, investing and financing activities during a period of time
    11. 11. Communicating the Business The Balance Sheet The Balance sheet must have the following equality: Assets = Liabilities + Equity Resources needed Loans needed to Investments needed to produce revenue buy assets to buy assets
    12. 12. Communicating the Business The Balance Sheet - Assets Assets measures the amount of resources the firm can utilize to generate profit through its operational activities Cash Cash Equipment Equipment Short Long Accounts Accounts Resources Resources Land Land Receivable Receivable owned or owned or controlled by a controlled by a company company Buildings Inventory Inventory Buildings Notes Notes Intangible Intangible Receivable Receivable
    13. 13. Communicating the Business The Balance Sheet - Liabilities Liabilities measures the amount of services or benefits the company receives from other firms or creditors in exchange for a promise of payment Accounts Accounts Notes Notes Payable Payable Payable Payable Creditors’ claims Creditors’ claims on assets on assets Taxes Taxes Wages Wages Payable Payable Payable Payable
    14. 14. Communicating the Business The Balance Sheet – Equity Shareholder Equity measures the amount of value that investors can claim after liabilities to creditors are subtracted from the firm’s assets Owner’s Owner’s Claims on Claims on Equity = Assets - Liabilities Assets Assets
    15. 15. The Balance Sheet – Digital Media Prior Year Current Year Assets Current Assets Operational Cash 400,000 650,000 Activities Accounts Receivables 650,000 550,000 Inventory 420,000 525,000 Total Current Assets $ 1,470,000 $ 1,725,000 Non-Current Fixed Assets Plant/Equipment 700,000 750,000 Investing Activities Accumulated depreciation (100,000) (150,000) Building/Land (net of depreciation) 850,000 750,000 Total Non-Current Assets $ 1,450,000 $ 1,350,000 Total Assets $ 2,920,000 $ 3,075,000 Liabilities and Shareholders Equity Current Liabilities Accounts Payable 645,000 570,000 CreditorsFinancing Activities Non-Current Liabilities Bonds Payable 1,562,500 1,462,500 Total Liabilities 2,207,500 2,032,500 Shareholders Equity Investors Common Stock 250,000 400,000 Retained Earnings 462,500 642,500 Total Shareholders Equity 712,500 1,042,500 Total Liabilities and S.H. Equity 2,920,000 3,075,000
    16. 16. Communicating the Business Income Statement The Income statement must have the following equality Profit = Revenue – Expense
    17. 17. Income Statement Prior Year Current Year Revenue Sale of Digital Equipment 2,592,500 3,050,000 Operational Activities Consulting Services 1,147,500 1,350,000 Total Revenue 3,740,000 $ 4,400,000 Expenses Cost of Goods Sold 2,363,085 2,745,000 Salary & Wages 985,000 1,150,000 General Administration 76,201 123,714 Total Operating Expense 3,424,286 4,018,714 Operating Income (EBITDA) 315,714 381,286 Other Expenses Interest Expense 120,000 112,200Activities Depreciation on Fixed Assets 25,000 50,000 Other Taxes 32,014 39,086 Total Other Expenses 177,014 $ 201,286 Net Income 138,700 $ 180,000
    18. 18. Communicating the Business Income vs. Cash Flow Statement Profit and cash are separate concepts Income statement does not account for other sources of cash generated outside of it’s operations. Income statement includes non-cash expenses which distorts how cash is generated.
    19. 19. Communicating the Business The Cash Flow Statement Shows the amount of cash generated from the firm’s operating, investing and financing activities during a period of time. The cash flow statement follows this model: Cash received from sales Cash paid for operating Cash flow from Operations of goods and services - expenses = operations + or - Cash received from sell Cash paid for acquisition Investing of investments and PPE - of investments and PPE = Cash flow from Investing + or - Cash paid for dividends Cash received from issue Financing of debt or equity - & repayment of debt or = Cash flow from Investing equity = Net change in cash flow for the period
    20. 20. Cash Flow Statement Current Year Cash Flow from Operations Net Income 180,000 Additions: Depreciation Expense (Not related to Cash) 50,000 Decrease in Accounts Receivable 100,000 Subtractions: Increase in Inventory (105,000) Decrease in Accounts Payable (75,000) Total Cash Flow from Operations 150,000 Cash Flow from Investing Activities Investment in Plant and Equipment (50,000) Disposition of Real Estate 100,000 Total Cash Flow from Investing Activies 50,000 Cash Flow from Financing Activities Pay down of Long Term Debt (100,000) Cash from issuing Common Stock 150,000 Total Cash from Financing Activities 50,000 Total Change in Cash Account 250,000
    21. 21. Overview of Week 2 Generally Accepted Accounting Principles Double Entry Accounting Using journal entries to prepare  Balance Sheet  Income Statement  Cash flow statement
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