Accounting Basics - Kevin Nott


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Accounting Basics - Kevin Nott

  1. 1. Accounting Basics for Non-Financial Individuals
  2. 2. What is Accounting? <ul><li>The practice of recording financial activity of an organization or individual </li></ul><ul><li>The measure of sources and uses of financial resources </li></ul><ul><li>Tool used for making economic decisions about the entity </li></ul>
  3. 3. A Crash Course in Accounting
  4. 4. Basic Measuring Tool: The Account <ul><li>Accounts are “buckets” used to classify and accumulate the results of similar transactions </li></ul><ul><li>Each transaction adds to or takes away from the balance in the “bucket” </li></ul><ul><li>The quantity of accounts used depends upon wants and needs for accounting detail </li></ul>
  5. 5. The Chart of Accounts <ul><li>Systematic listing of all accounts </li></ul><ul><li>Accounts are named and usually numbered </li></ul><ul><li>Called General Ledger accounts or GL accounts </li></ul>
  6. 6. Types of Accounts <ul><li>Assets </li></ul><ul><li>Liabilities </li></ul><ul><li>Equity </li></ul><ul><li>Revenue </li></ul><ul><li>Expenses </li></ul><ul><li>Each account is classified as one of these types </li></ul><ul><li>Each account type is a source or use of financial resources </li></ul>
  7. 7. Assets <ul><li>Assets are a use of financial resources </li></ul><ul><li>Owned property -- tangible and intangible with market value </li></ul><ul><li>Classified as Current or Fixed </li></ul>
  8. 8. Current Assets <ul><li>Assets that will be converted to cash or expenses within 12 months during the normal course of business </li></ul><ul><li>Listed in order of liquidity (how quickly it can be converted into cash) </li></ul><ul><li>Examples: Cash, Accounts Receivable, Inventory, Prepaid Expenses </li></ul>
  9. 9. Fixed Assets <ul><li>Assets that will not be converted to cash or expensed within the next 12 months </li></ul><ul><li>Depreciated or amortized (expensed) over the life of the asset </li></ul><ul><li>Examples: Furniture, Buildings, Vehicles </li></ul>
  10. 10. Liabilities <ul><li>Liabilities are a source of financial resources </li></ul><ul><li>Debts of the organization </li></ul><ul><li>Classified as Current or Long-Term </li></ul>
  11. 11. Current Liabilities <ul><li>Obligations that will be paid for or converted to revenue with the next 12 months as a normal course of business </li></ul><ul><li>Listed in order of maturity </li></ul><ul><li>Examples: Accounts Payable, Payroll Taxes, Short-term Bank Loans </li></ul>
  12. 12. Long-Term Liabilities <ul><li>Obligations that will not be paid or converted to revenue within the next 12 months </li></ul><ul><li>Examples: Mortgages, Long-term Bank Loans </li></ul>
  13. 13. Equity <ul><li>Equity is a source of financial resources </li></ul><ul><li>Investment by owners into the organization </li></ul><ul><li>Equity has two parts </li></ul><ul><ul><li>Paid in capital (Stock) </li></ul></ul><ul><ul><li>Retained Earnings (Profits left in the business by the owners) </li></ul></ul>
  14. 14. Revenue <ul><li>Revenue is a source of financial resources </li></ul><ul><li>Sales of goods and services </li></ul><ul><li>Amount the customer is charged </li></ul>
  15. 15. Expenses <ul><li>Expenses are a use of financial resources </li></ul><ul><li>Costs incurred in the normal course of business </li></ul><ul><li>Two types of expenses </li></ul><ul><ul><li>Cost of Goods Sold (Direct, Variable) </li></ul></ul><ul><ul><li>Overhead (Fixed, Indirect, SG&A) </li></ul></ul>
  16. 16. Cost of Goods Sold <ul><li>Directly associated with revenue (sales) from the same period </li></ul><ul><li>Fluctuate proportionately with revenue </li></ul><ul><li>Examples: </li></ul><ul><ul><li>Labor on a job (including burdens) </li></ul></ul><ul><ul><li>Building materials </li></ul></ul><ul><ul><li>Permits </li></ul></ul><ul><ul><li>Subcontracted work </li></ul></ul><ul><ul><li>Sales commissions (including burdens) </li></ul></ul>
  17. 17. Fixed Costs <ul><li>Costs that do not fluctuate periodically with revenue </li></ul><ul><li>Semi-variable costs that cannot be assigned directly to revenue </li></ul><ul><li>Examples: </li></ul><ul><ul><li>Marketing costs </li></ul></ul><ul><ul><li>Office staff wages </li></ul></ul><ul><ul><li>Building rent </li></ul></ul><ul><ul><li>Vehicle leases </li></ul></ul><ul><ul><li>Office supplies </li></ul></ul>
  18. 18. Recording Transactions with Double Entry <ul><li>Every accounting transaction has two sides -- the source of the resource and the use of the resource </li></ul><ul><li>The two sides are equal and offsetting </li></ul><ul><li>Both sides must be recorded </li></ul>
  19. 19. Introducing: Debits and Credits <ul><li>The accounting terms used to describe the two sides of the transaction are debits and credits. </li></ul>
  20. 20. Debit <ul><li>The side of the transaction that records the use of the financial resource </li></ul><ul><li>Abbreviated as DR </li></ul>
  21. 21. Credit <ul><li>The side of the transaction that records the source of the financial resource </li></ul><ul><li>Abbreviated as CR </li></ul>
  22. 22. All Things Must Be Equal <ul><li>Uses = Sources </li></ul><ul><li>Debits = Credits </li></ul>
  23. 23. The Trial Balance Shows it All <ul><li>A trial balance is a listing of all accounts and their account balances </li></ul><ul><li>Debit balances are listed in the debit column </li></ul><ul><li>Credit balances are listed in the credit column </li></ul><ul><li>The two columns MUST equal -- Balance </li></ul>
  24. 24. Transaction Entry Types
  25. 25. Example <ul><li>A new service van is purchased using a bank loan for the full amount of the purchase price </li></ul><ul><li>We record an increase (debit) to Vehicles (Asset) for the purchase price of the van </li></ul><ul><li>We record an increase (credit) to Bank Loans (Liability) for the amount borrowed </li></ul>
  26. 26. Let’s add a twist <ul><li>We borrow money to purchase the van but we have a cash down payment as well </li></ul><ul><li>We record an increase (debit) to Vehicles (Asset) for the purchase price of the van </li></ul><ul><li>We record an increase (credit) to Bank Loans (Liability) for the amount borrowed </li></ul><ul><li>We record a decrease (credit) to Cash (Asset) for the amount of the down payment </li></ul>
  27. 27. The Accounting Equation Assets = Liabilities + Owners’ Equity where Owners’ Equity includes accumulated profits (losses) and Revenue - expenses = profit (loss)
  28. 28. Making Sense of it all with Financial Reports <ul><li>Reports that show the financial situation of an organization </li></ul><ul><li>Balance Sheet </li></ul><ul><li>Income Statement </li></ul>
  29. 29. Balance Sheet <ul><li>Statement of Current Financial Condition </li></ul><ul><li>Standardized format </li></ul><ul><li>Is a “snap shot” of the organization’s financial position at that moment in time </li></ul><ul><li>Used to demonstrate the financial makeup of an organization </li></ul><ul><li>Shows current and long-term assets and liabilities </li></ul>
  30. 30. Income Statement <ul><li>Statement of Profit and Loss </li></ul><ul><li>Representation of financial activity over a period of time </li></ul><ul><li>Demonstrates organizations ability to generate financial resources (profits) from operations </li></ul><ul><li>Net balances are transferred to Equity on the Balance Sheet at the end of each period </li></ul>
  31. 31. Periodic Reporting <ul><li>An organization’s “life” is divided into segments called accounting periods. </li></ul><ul><li>Most common periods are month, quarter and year </li></ul><ul><li>A reporting is made at the conclusion of the accounting period </li></ul>
  32. 32. The Reporting Year <ul><li>Calendar Year -- Jan 1 to Dec 31 </li></ul><ul><li>Fiscal Year -- Any other annual period </li></ul>
  33. 33. Reporting Frequency <ul><li>Depends upon the needs of the organization </li></ul><ul><li>Shorter periods provide more timely information </li></ul><ul><li>Longer periods smooth out aberrations </li></ul><ul><li>Most organizations employ both </li></ul>
  34. 34. Cash versus Accrual <ul><li>Cash Basis Accounting: Recognize revenue and expenses when cash is exchanged </li></ul><ul><li>Accrual Basis: Recognize revenue and expenses when earned or incurred </li></ul>
  35. 35. The Matching Principle <ul><li>Expenses must be recognized in the same accounting period as the revenue they generate </li></ul>
  36. 36. Financial Analysis Making Sense of Financial Statements <ul><li>Financial statements have meaning </li></ul><ul><li>They tell a story </li></ul><ul><li>They help in looking at the future </li></ul><ul><li>A close look often reveals hidden and unknown facts critical to the organization </li></ul>
  37. 37. Best Practices <ul><li>The theoretic “Best” way to do something </li></ul><ul><li>The most efficient and effective method of accomplish a task </li></ul><ul><li>A benchmark for performance </li></ul>
  38. 38. Gross Profit <ul><li>Variable profit </li></ul><ul><li>Sales less cost of sales </li></ul><ul><li>Measured in dollars and percentage (margin) </li></ul>
  39. 39. Net Profit <ul><li>Net Profit is gross profit less fixed expenses </li></ul><ul><li>Profit left after all expenses are paid </li></ul><ul><li>Net profit becomes equity at the end of each accounting period </li></ul>
  40. 40. Breakeven Revenue <ul><li>The projected revenue needed to pay all fixed (overhead) expenses </li></ul><ul><li>After breakeven, all additional Gross Profit = Net Profit </li></ul><ul><li>Calculating Breakeven </li></ul><ul><li>(Revenue x Gross Margin %) – Fixed Expenses = 0 </li></ul><ul><li>Revenue x Gross Margin % = Fixed Expenses </li></ul><ul><li>Revenue = Fixed Expenses / Gross Margin % </li></ul>
  41. 41. Working Capital <ul><li>Measures the amount of Cash that is available to fund operations </li></ul><ul><li>Calculating Working Capital </li></ul><ul><li>Current Assets – Current Liabilities </li></ul>
  42. 42. Current Ratio <ul><li>Measures the organizations ability to pay it’s current obligations </li></ul><ul><li>Should be greater than 1 </li></ul><ul><li>Calculating Current Ratio </li></ul><ul><li>Current Assets / Current Liabilities </li></ul>
  43. 43. Debt to Equity Ratio <ul><li>Measures the indebtedness of the organization </li></ul><ul><li>Excessive debt is dangerous as it carries payment obligations </li></ul><ul><li>Smaller is better </li></ul><ul><li>Calculating Debt to Equity </li></ul><ul><li>Total Liabilities / Total Equity </li></ul>
  44. 44. Return on Assets <ul><li>Assets are the resources used by an organization to earn a profit </li></ul><ul><li>Return on Assets measures how effective the assets are used </li></ul><ul><li>Measured as a percentage </li></ul><ul><li>Larger is better </li></ul><ul><li>Calculating ROA </li></ul><ul><li>(Net Profit / # months in period x 12) / Total Assets </li></ul>
  45. 45. Return on Equity <ul><li>Equity represents the owners investment in the organization </li></ul><ul><li>Often called Return on Investment or ROI </li></ul><ul><li>ROI measures the profit that is generated on the owners investment </li></ul><ul><li>Bigger is better </li></ul><ul><li>Calculating ROI </li></ul><ul><li>(Net Profit / # months in period x 12) / Equity </li></ul>
  46. 46. Help is Available <ul><li>Your Accountant </li></ul><ul><li>Local colleges </li></ul><ul><li>School District extension services </li></ul><ul><li>Profit Point LLC </li></ul><ul><ul><li>Kevin Nott </li></ul></ul><ul><ul><li>850-1716 </li></ul></ul><ul><ul><li>[email_address] </li></ul></ul>