MGT 3361 Ch 8

Assets

Any resources that a business owns an expert's to use to its benefits.

Accounting equations Page 195 to 197

Assets = liabilities + owners equity (balance sheet) Owners equity = assets - liabilities What you have= what you own - what you owe Any entry you make on one side of the equation must also be entered on the other side to maintain a balance. Profit = revenue - expenses ( income statement) The money you get to keep = The money your business brings in - what you have to spend Represents the activity described on the income statement. In other words the money you get to keep equals the money your business brings in minus what you have to spend. Cash flow= Receipts - disbursements (cash flow statement) The money you have on hand at any given time = The money you bring in - what you have to pay out Is the basis of the cash flow statement. The money you have on hand at any given time equals the money you bring in minus what you have to pay out.

Benchmarking

Benchmarking is taking an industry leader or major competitor, computing their ratios, and then comparing the small business to that firm. Since ratios take away the size differential, even a new start up can compare it self to the best in the industry and said financial targets based upon industry leaders.

Financial ratios

Calculations that compare important financial aspects of a business. Three types of ratio comparison can be employed: - Bench marking analysis (which compares firms to industry leaders) - Industry average analysis (which compares firms financial ratios to the industry averages) - trend analysis (which compares a single firms present performance with its own pass performances, preferable for more than two years)

The accounting process helps you to translate numbers, the language of business, and two plain English

Computers help us take piles of raw data and turn them into usable information with which to make managerial decisions. If you were to enter all of these data into a statistical program on a computer, you could organize them into means, trends, and a few meaningful numbers, into information that would enable you to make marketing decisions.

Liquidity ratios

Financial ratios used to measure a firms ability to meet it's short term obligations to creditors as they come due. Liquidity ratios are used to measure a firms ability to meet it's short term obligations to creditors as they come due. Liquidity refers to how quickly an asset can be turned in to the amount of cash it is actually currently worth, the more quickly it can become cash, the more liquid it is said to be. The firms data used to determine liquidity are the firms current assets and current liabilities found on the balance sheet. There are two important liquidity ratios: The current ratio The quick (or acid test) ratio

Pro forma financial statements

Financial statements that project want a firms financial condition will be in the future. Making financial projections can reveal whether you should even start a business. Are the financial risk you are about to take Worth the realistic return you can expect? Such projections are made in the pro forma financial statements, which are either full or partial estimates, pro forma is Latin meaning for the sake of form. These statements help you determine your future cash needs and financial conditions, a new business should prepare them at least every quarter, if not every month.

Leverage ratios

Leverage ratios measures the extent to which a firm uses debt as a source of financing and it's ability to service that debt. The term leverage refers to the magnification of risk and potential return that come with using other peoples money to generate profits.

How do you start the accounting process

Many business owners start by purchasing a simple accounting software package. Another piece of advice is to pay in accounting firm that specializes in small businesses to set up your accounting system. You don't have to use the firm to handle all of your accounting needs like payroll preparation, tax form preparation, and creation of monthly financial statements, although you could. Money would be wisely spent getting a system that will work for your business from the very beginning. Do yourself and your business a favor and get started correctly by using the services of professional. You will likely start out with a part time, external service professional who will set up your accounting system. Choosing this accounting professional upon those advise you will depend is a big decision.

Inventory turnover

Measures the liquidity of the firms inventory, how quickly goods are sold and replenished. The higher the inventory turnover, the more times the firm is selling, or turning over, it's inventory. A high inventory ratio generally implies efficient inventory management. Inventory turnover = cost of goods sold/ inventory

assets utilization ratios

Measures the speed with which various assets are converted into sales or cash. These ratios are often used to measure how efficiently a firm uses its assets. For important asset utilization Ratios exist: Inventory turnover Average collection. Fixed asset turnover Total asset turnover

How important our financial records

Most of the mismanaged decisions that spill the doom of many small businesses are related to financial and accounting issues. The last thing small business owners think of is careful accounting, but it should really be the first issue addressed. Mini small business owners don't hire an accountant right away because they are afraid of the cost, but many accounting firms specialize in small businesses and are at reasonable prices. Getting things right the first time cost less than fixing mistakes the second or third time.

There is no one-size-fits-all computer accounting program that is suitable for all small businesses.

On the subject of beginning simply: Always use separate checkbooks for your business and your personal life. Avoid the temptation to combine the two by thinking that the business money and personal money are all mine, At some point you will need to separate them, which can be very difficult to do later. Write checks instead of paying for items with cash. They serve as an accurate form of recordkeeping. Reconcile your bank accounts monthly and make sure all errors are corrected.

Profitability ratios

Profitability ratios are used to measure the ability of a company to turn sales into profits and to earn profits on assets committed. Profitability ratios allow some insight into the overall effectiveness of the management team. There are three important profitability ratios: - net profit margin - Return on assets - return on equity

Return on assets

Return on assets also known as return on investment, return on assets indicates the firms effectiveness in generating profits from its available assets. The higher this ratio is, the better. A high ratio shows effective management and good chances for future growth. Return on assets = net profit after taxes/Total assets

Generally excepted accounting principles (GAAP)

Standards established so that all businesses produce comparable financial statements. To turn data into management information, you need to follow certain guidelines, or standards, called generally excepted accounting principles (GAAP). The GAAP guidelines are intended to create financial statement formats that are uniform across industries.

Owners equity

The amount of money the owner of a business would receive if all of these assets were sold and all of the liabilities were paid.

Average Collection Period

The average collection period is a measure of how long it takes a firm to convert a credit sale, internal store credit, not credit card sales, into a usable form cash. All firms that extend credit must compute this ratio to determine the effectiveness of their credit granting and collection policies. High average collection periods usually indicate mini uncollectible receivables, where is low average collection. May indicate overly restrictive credit granting policies. Average collection period = accounts receivable/average sales per day

Debt ratio

The debt ratio measures the proportion of a firms total assets that is required with borrowed funds. Total debt includes short term debts, long-term debts, and long-term obligations such as leases. A high ratio indicates a more aggressive approach to financing and is evidence of a high risk, high expected return strategy. A low ratio indicates a more conservative approach to financing. Debt ratio = total debt/Total assets

Fixed asset turnover

The fixed asset turnover ratio measures how effectively the firm is using is assets to generate sales. This ratio is particularly important for businesses with a lot of equipment or buildings since it is measuring the effectiveness of these assets in generating sales. A low ratio can indicate that cells are off do perhaps two marketing efforts that are in effective or that the equipment being use is older and requiring increasing downtime for maintenance. Fixed asset turnover = sales/net fixed assets

Banking and tax requirements

The information on your financial statements is needed to prepare your tax returns. Bankers and investors and use your financial statements to evaluate the condition of your business.

Timing of cash flows

The major complications of cash flow management is timing. While some cash inflows and outflows will transpire on a regular schedule, such as a monthly interest income for payroll, other cash flows occur on no schedule whatsoever.

Net profit margin

The net profit margin measures the percentage of each sales dollar that remains as profit after all expenses, including taxes have been paid. This ratio is widely used as a gauge of management efficiency. Although net profit margin's vary greatly by industry, a low ratio may indicate that expenses are too high relative to sales. Net profit = net income/cells

Cash-to-Cash Cycle (C2C) (operating cycle)

The period of time from when money is spent on raw materials until it is collected from the sale of a finished good. The cash to cash cycle of the firm sometimes known as the operating cycle, tracks the way cash flows through the business. It identifies how long it takes from the time a firm makes a cash outlay for raw materials or inventory until the cash is collected from the sale of the finished good.

Quick (Acid Test) Ratio

The quick acid test ratio measures the firms ability to meet its current obligations with the most liquid of its current assets. Quick ratio = current assets - inventory / current liabilities

Ratio analysis

The reality is that fair comparisons can be made only when we demonstrate the relationship between differing financial accounts of the businesses. The relationships that show the relative size of some financial quantity to another financial quantity of a firm or call financial ratios. For important categories of financial ratios are: The liquidity Asset utilization Leverage Profitability ratios

Return on equity

The return on equity measures the return the firm earned on its owners investment in the firm. The higher this ratio, the better off financially the owner will be. Return on equity is highly affected by the amount of financial leverage, borrowed money, used by the firm and may not provide an accurate measure of management effectiveness. This ratio tells a business owner if he or she is receiving enough return from invested money. Return on equity = net profit after taxes/owners equity

cash flow

The sum of net income plus any non-cash expenses such as depreciation and amortization or the difference between the actual amount of cash a company brings in and the actual amount of cash a company disperses in a given time. Each business day, a dozen US small businesses declare bankruptcy, the major of these businesses failures are caused by poor cash flow management. A company that does not effectively manage its cash flow is poison for collapse. Cash flow is the sum of net income plus any non-cash expenses, such as depreciation and amortization. This treatment of cash flow is largely misunderstood by many small business owners. The most important aspects of this refined definition are the inclusion of the terms actual cash and time period. The goal of good cash flow management is to have enough cash on hand when you need it.

Accounting

The system within a business for converting raw data from source documents like invoices, sales receipts, bills, and checks, into information that will help a manager make business decisions.

Accounts Receivable

The total amount of money owed to a business. The first place to look for ways to improve cash flow is in accounts receivable. The key to an effective cash flow management system is the ability to collect receivables quickly. If customers abuse your credit policy by paying slowly, any future sales to them will have to be (COD ) cash on delivery, until they prove that you will receive your money in a reasonable amount of time.

Total asset turnover

The total asset turnover ratio measures how effectively the firms uses of all its assets to generate sales, so a high ratio generally reflects good overall management. A low ratio may indicate flaws in the firms overall strategy, poor marketing efforts, or improper capital expenditures. Total assets turn over = sales/total assets

Times interest earned ratio

Time interest earned calculates the firms ability to meet its interest requirements. It shows how far operating income can decline before the firm will likely experience difficulties in servicing it's debt obligations. A high ratio indicates a low risk situation but may also suggest an in inefficient use of leverage. A low ratio indicates immediate action should be taken to ensure that no debt payments will go into default status. Times interest earned= operating income/interest expense

Balance sheet

While the income statement shows the financial condition of your business overtime, the balance sheet provides an instant snapshot of your business at any given moment. Usually at the end of the month, quarter, or fiscal year. A balance sheet has two main sections: - One showing the assets of the business - One showing their liabilities and owners equity of the business

Accurate information for management

You need to have accurate financial information to know the financial health of your business. Acord financial records also allow you to identify problems and make needed changes before the problems becomes a threat to your business.

Cash basis method of accounting

You record transactions when cash is actually received and expenses are actually paid. A method of accounting in which income and expenses are recorded at the time they are paid, rather than when they are incurred.

Your accounting system should be easy to use

Your accounting system should be easy to use, accurate, timely, consistent, understandable, dependable, and complete.

Banks

Your bank should be your partner in cash flow management. The small business owner should request the firms bank to provide an account analysis. This analysis shows the banking services the business use during the month, the banks charge for each service, the balance maintained in all accounts during the month, and the minimum balance required by the bank to pay for the services. Determine how quickly checks that your firm deposits in the bank become available as cash. Banks normally require delays of up to two business days. They should have an availability schedule, and the small business owner needs to request one from each bank in the area to determine whether his bank is competitive. Remember the faster a deposit check becomes available as cash, the sooner your business has use of the money for other purposes.

Accounts Payable

money owed by a company to its creditors. Under trade terms a small business owner works with his suppliers to establish win, how much, and under what conditions payments are made to suppliers. This allows small business owners to more effectively control cash layouts, since a major part of cash often goes to paying suppliers. Vendors, when I approached upfront, are often more than willing to work out a payment schedule that benefits the small business owner if it also ensures they get paid on a basis they can depend upon.

journal

A chronological record of different types of financial transactions of a business. Your accounting actually begins when you record your raw data from sources such as sales slips, purchase invoices, and check stubs in journals. A journal is a simply a place to write down the date of your transactions, the amounts, and the account to be debited and credited. You will have several journals, such as sales, purchases, cash receipts, and cash disbursements journals.

Industry average analysis

A comparison of a firms financial ratios to the industry averages. Industry average analysis is often done by comparing an individual firms ratios against the standard ratios for the firms industry. Search industry ratios may be found in resources available in most college or large public library's.

Trend analysis

A comparison of a single firms present performance with its own past performance, preferable for more than two years. Trend analysis involves comparing your own numbers to your numbers from last year and the year before. Trends can be seen using this analysis that can show a small business owner where changes need to occur in order to keep the company profitable. If there is potential trouble in any of the four main areas of analysis, liquidity, assets utilities assets, leverage, and profitability, managers will have time to correct these problems before the problems become overbearing.

Liabilities

A debt owed by the business to another organization or individual.

Current ratio

A financial ratio that measures the number of times a firm can cover its current liabilities with its current assets. The current ratio assumes that both accounts receivable and inventory can be easily converted to cash. Current ratios of 1.0 or less are considered low and indicative of financial difficulties. Current ratios of more than 2.0 often suggest excessive liquidy that may be adverse to the firms profitability. Current ratio = current assets/current liabilities

Common size financial statement

A financial statement that includes a percentage breakdown of each item. Common size financial statements are valuable tools for checking the efficiency trends of your business by measuring and controlling individual expense items.

Statement of cash flow

A financial statement that shows the cash inflows and outflows of a business. The statement of cash flow highlights the cash coming into in outgoing out of your business. It is summarized by the accounting equation of cash flow = receipts - disbursements. The importance of tracking and forecasting your cash flow is difficult to overstate because it is often more critical to survival of the business than profits. It is common for new businesses to experience a situation in which more cash goes out then comes in, which is called negative cash flow. This condition is not too alarming if it happens when the business is very young or if it happens only occasionally. However if you are experience negative cash flow regularly, you may be undercapitalized, which is a serious problem.

Income statement (also called profit and loss)

A financial statement that shows the revenue and expenses of a firm, allowing you to calculate the profit or loss produced in a specific period of time. The income statement, also called the profit and loss statement, summarizes the income and expenses your company has totaled over a period of time. The income statement illustrates the accounting equation of profit = revenue - expenses. This statement can generally be broken down into the following sections: - net sales - Cost of goods sold - Gross margin -expenses - operating income - Net income or loss Not only does the income statement show an itemization of your sales, cost of goods sold, and expenses, but it also allows you to calculate the percentage relationship of each item of expense to sales.

Cash flow fundamentals (Motors for having cash)

A firm needs cash for three reasons: 1. To make transactions 2. To protect against on anticipated problems 3. To invest in opportunities as they arise The primary motive is to make transactions, to pay the bills incurred by the business. If the business cannot meet its obligations, it is insolvent continue insolvency leads directly to bankruptcy. Businesses occasionally run into unanticipated problems, theft, fires, floods, and other natural and human made disasters affect businesses in the same way they affect individuals. Those business have save for a rainy day are able to withstand such setbacks. Sometimes a business is presented with an opportunity to invest in a profitable venture. If the business has enough cash on hand to do so it may reap significantly rewards. If not it has lost a chance to add to its cash flow in a way other than through normal operations.

Macro-aging schedule

A list of accounts receivable by age category. A macro aging schedule simply list categories of outstanding accounts with the percentage of accounts that fall within each category. This schedule allows a small business owner to forecast the collection of receivables.

Micro-aging schedule

A list of accounts receivable showing each customer, the amount that customer owes, and the amount that is past due. The micro aging schedule offers another approach to showing receivables. This technique lists the status of each credit consumers account. It allows the small business owner to concentrate his collection efforts on the specific companies that are delinquent in their payments.

Inventory

A list of possessions or goods on hand. Inventory is another area that can drain cash flow. Inventory costs are often overlooked or overstated by small businesses. Cash flow determines how much inventory a firm can safely carry while still allowing sufficient cash for other operations. The inventory turnover ratio leads insight into the situation. The cash flow management goal is to commit just enough cash to inventory to meet demand.

Aging schedules

A listing of a firm's accounts receivable according to the length of time they are outstanding.

Accrual basis method

A method of accounting in which income and expenses are recorded at the time they are incurred rather than when they are paid. Sales you make on credit are recorded as accounts receivable that have not yet been collected. The accrual method also allows you to record payment of expenses over a period of time, even if the actual payment is made in a single installment. Example you may pay for insurance once or twice a year, but you can record the payments on a monthly basis.

Cash budgets

A plan for short term uses and sources of cash. Cash budgets also known as cash forecasts allow the firm to plan it's short term cash needs, paying particular attention to periods of surplus and storage. Whenever the firm is likely to experience a cash surplus, it can plan to make a short term investment. When the firm is expected to experience a cash shortage, it can plan to arrange for a short term loan. A cash budget typically covers a one year. That is divided into smaller intervals. The number of intervals is detected by the nature of the business. By forecasting the inflows and outflows of cash, the small business owner will have a picture of when the firm will have cash surplus us and cash shortages. This knowledge allows the cash flow to be managed proactively rather than reactively. Cash budgeting is however not always easy to do. There are always disruptions to the process unforeseen cash outflows and inconsistent cash inflows plug mini small businesses.

General ledger

A record of all financial transactions divided into accounts and usually compiled at the end of each month from your different journals. At some regular time interval, daily, weekly, monthly, you will post a transactions recorded in all your journals in a general ledger. A general ledger is a summary book for recording all transactions and account balances. Each account is assigned to a two digit number. The first digit indicates the class of the account (1 for assets, 2 for liabilities, 3 for capital, 4 for income, and 5 for expenses) The second digit is assigned to each account within the class. At the end of your accounting. Or fiscal year, you will close and total each individual account in your general ledger.

Single entry accounting systems

A single entry accounting system does exist and may be used by small sole proprietor ships. With a single entry system, you record the flow of income and expenses in a running log, basically like a checkbook. It allows you to produce a monthly statement but not to make a balance sheet, an income statement, or other financial records. The single entry system is simple but not self checking, as is a double entry system.

Double entry accounting systems

Accounting systems revolve around three elements: assets, liabilities, and owners equity. Assets: are what your business owns Liabilities: are what your business owed Owners equity: is what you the owner have invested in the business, it can also be called capital or net worth Double entry accounting system all transactions are recorded in two ways, once as a debit to one account and again as a credit to another account Every plus must be balanced by a minus. A double entry accounting system increases the accuracy of your system and provides a self checking audit. If you make a mistake in recording a transaction, your accounts will not balance, indicating that you need to go back over the books to find the arrow. Debits must always equal credits.

Accounting systems accomplish a similar purpose

Accounting systems transform piles of data into smaller bits of unusual information by first recording every transaction that occurs in your business in journals. Then transferring reposting the entries into ledgers From the ledger you make financial statements like a balance sheet, income statement, and statement of cash flow. These statements communicate how are you business is faring much better than the stacks of papers with which used started. In the last step in the accounting process you take certain numbers from your financial statements to compute key ratios that can be compared to industry averages or historical figures from your own business to help you make financial decisions.