C H A P T E R

UNDERSTANDING FINANCIAL INFORMATION AND ACCOUNTING IN BUSINESS

MGT153

FUNDAMENTAL OF ACCOUNTING CONCEPT

Accounting Process

The accounting equation Assets = Liabilities + Owners equity

Assetsthe resources that a business owns (e.g., cash, inventory, equipment, and real estate) Liabilitiesthe firms debts Owners equitythe difference between assets and liabilities (what would be left for the owners if the firms assets were sold and the money used to pay off its liabilities) Double-entry bookkeeping system: Each financial

transaction is recorded as two separate accounting entries to maintain the balance of the accounting equation

The accounting cycle

- done on a regular basis

Done at the end of the period

- preparing the trial balance of all general ledger accounts - preparing financial statements and closing the books

The Accounting Cycle

The Balance Sheet

A summary of the dollar amounts of a firms assets, liabilities, and owners equity accounts at the end of a specific accounting period (also called statement of financial position)
a) b) c)

Assets Liabilities Owners or stockholders equity

The Income Statement

A summary of a firms revenues and expenses during a specified accounting period
- Profit (cash surplus) - Loss (cash deficit)

a) Revenues b) Gross profit

- firms net sales less the cost of goods sold

c) Cost of goods sold

- the dollar amount equal to beginning inventory plus net purchases less ending inventory

d) e) f)

Operating expenses Net income Net loss

The Statement of Cash Flows

Illustrates how the operating, investing, and financing activities of a company affect cash during an accounting period

HOW FIRMS USE ACCOUNTING

Why Accounting Information Is Important

Recent accounting problems for corporations and their auditors

- Pressure on corporate executives to look good to analysts and investors

Why audited financial statements are important

- Bankers, creditors, investors, and government agencies rely on an auditors opinion

Who uses accounting information

a) b)

c)

d)

Managers are primary users Lenders require financial information before lending Stockholders want to know whether to invest or how well their investment is doing Government agencies require a variety of information

Careers in Accounting
Qualities to be successful in accounting
a) b) c)

d)

Be responsible, honest, ethical Have a strong background in financial management Know how to use a computer and accounting software Be able to communicate with people who need accounting information

Private Accountant
Employed by a specific organization Services performed for the employer
General accounting (recording transactions and preparing statements) Budgeting (for sales and operating expenses) Cost accounting (determining costs of producing products and services) Tax accounting (planning strategy and preparing returns) Internal auditing (reviewing finances and operations against goals)

Public Accountant
Provides services to clients on a fee basis Self-employed or employee of an accounting firm

Certified Public Accountant (CPA)

Has met state requirements for accounting education and experience and has passed a rigorous two-day accounting examination prepared by the AICPA Participates in continuing-education programs to maintain certification

FINANCE MANAGEMENT IN BUSINESS

Financial management involves the financial manager acquiring and managing funds for the organization - Ensuring money is used in keeping with the organizations goals - Planning (i.e.investment ventures) Maintenance and creation of economic value @ wealth - Investment decisions & financing decisions The need for financing - When expenses are high or sales are low - Opportunities to expand

The need for financing

a) Short-term financing Money that will be used for one year
or less
Cash flow Inventory

a) Long-term financing Money that will be used for longer than one year Often involves large amounts of money

The need for financial management

a) Risk-return ratio b) Proper financial management can ensure that
Financing priorities are in line with organizational goals and objectives Spending is planned and controlled Sufficient financing is available when it is needed Credit customers pay on time and delinquencies are reduced Bills are paid promptly Taxes are paid in a timely manner Excess cash is invested in interest-bearing

The responsibilities of a financial manager

a) Deciding how much financing the organization need b) Deciding the best source of short term funds and long term funds c) Determining the right use of the funds and managing it most effectively d) Obtaining the funds at the cheapest cost

Careers in Finance

Skills and traits of successful financial managers

a) Responsible and honest b) Strong background in accounting or math c) Knowledge of how to use a computer to analyze data d) Expert in written and oral communications

Jobs
a) b) c) d) e) f) Bank officer Credit officer Financial analyst Financial planner Insurance analyst Investment account executive

Financial Planning

Financial plan
- A plan for obtaining and using the money needed to implement an organizations goals

Developing the financial plan

- Establishing organizational goals and objectives - Budgeting for financial needs - Identifying sources of funds

Legal Forms of Business Organiation

Sole proprietorship
a) Owned by a single. b) Maintain tuitle to the assets and personally responsible for all the debt incurred. c) Personal assets that not related can be foreclosed by the creditors should there is insufficient asset in business to offset the outstanding debt

Partnerships
a) General & limited b) Two or more owners in the business c) Each general partners will be fully responsible for the liability incurred(same with sole proprietorship) d) Stipulated by the partnership agreement , document or roral commitment.

Corporation a) Regarded as a legal entity; can be treated as a legal person and has it own accord, can enter contractual agreement and subject to all legal litigations and proceedings. b) Fast growing and has large assets c) Allows many investors through equity ownership and shareholders. d) Governed under MALAYSIAN COMPANIES ACT 1965 Can be categorised under two categories; private(SDN BHD) public (BHD)More than 50 shareholders

Tax environment

Double taxation
a) Company taxes b) Income taxes * i.e. a corporation pay dividends to the shareholders.

Capital Structure

The amount of debt versus equity financing Engage in business need capital Capital = is a money that the corporation uses to duns the business investment activities and other operating expenditures Sources of capital= the owners/shareholders (equity) + the creditors(debt)30% equity 7% debt -risky High level of debt in its capital structure can be said as high leveraged

Short-term Financing

Sort-term financing is one important task of a financial manager whereby he has to manage the current assets and liabilities found on the balance sheet
a) Current assets are financial resources that can be converted into cash with in a year b) Current liabilities are organizations short-term debt obligations that must be paid within a year

Short-term financing is money that the company need to use for a period of one year and is necessary to meet business daily operational needs
The purpose of a short-term financing: a) to pay bills while waiting for customers payment b) to meet seasonal financial demand and the firm is engaged in speculative production c) buying goods with cash discounts d) catering for unexpected opportunities e) emergencies creating capital need for a brief period o time

Business sources of short-term financing include:

a) b) c) d) e) f) g) h) Trade credit Promissory notes Trade draft Bank credit Revolving credit agreement Commercial paper Finance companies Factoring accounts receivable

Long-term Financing
Long-term agreement Getting a loan

Know potential lenders Maintain a good credit rating Fill out an application; submit a business plan and financial statements; compile references Meet with loan officer If denied, determine why

Business firms sources of long term financing can be from

a) Debt financing b) Equity financing

Debt Financing

This is a long term borrowing available outside the company. The funds obtained are payable more than one year after they were originally issued There are two types funding available:
a) Long-term loans b) Corporate bonds

Long-term loan

Can be obtained from commercial banks, credit companies and insurance companies Popular to businesses and individuals because a) Loans arrangement can be made quickly and the number of parties involved is limited b) The purpose of the loan is not required and the firm does not need to disclose its business plan c) The loans duration usually match borrowers needs d) Loans clauses can be changed

Corporate bonds

A contract whereby it consists of a promise by the issuer to pay a certain amount of money on a specified date to the holder Advantages a) The sale of bonds does not affect the firms management control because bondholders do not have voting right b) Interest on bonds is a deductible expense from corporate income c) Shareholders equity are not affected or diluted because no additional shares are issued Disadvantages a) Interest are charged on debt repayment b) During periods of low earning, the fix interest charges can become a heavy financial burden

Equity financing

Activity of selling a companys stock to raise money

The buyer of the stocks becomes part owner of the company

Advantages
a) b) c) No interest charges to be paid to the owner A firm with equity financing is usually stronger and can with stand a business recession compared to firms that uses debt Firms ability to borrow capital is improved

Disadvantages
a) b) It is not always a dependable and easily available source of money Having additional partners may create dissatisfaction

There are three sources of long-term equity financing:

a) Common stock b) Preferred stock c) Retained earnings

Common stock

Represents ownership in an organization Issued with or without par - Par value is the value printed on the stock certificate - No-par-value stock is a stock certificate with no stated value - Paid-in-surplus is a condition when a common stock is sold more than the par Two other values of the common stock - Book value - The market value

Preferred stock

Owner of a preferred stock usually have these privileges a) Right to receive their dividends before common stockholders b) Receive a dividend at a stated rate c) If the organization goes broke the owner has prior claim on asset ahead of common stock owner Dividend to preferred stock may be cumulative or non-cumulative Participating preferred stock - It has the advantage of obtaining dividends by participating in the common stock

Retained Earnings
Organizations profits that have been paid out as dividends to stock holders The earnings are usually limited

ANALYZING FINANCIAL STATEMENTS ELEMENTS

Important Uses of Financial Statement

A financial statement are the key summaries of the firms accounting records - Prepared ex-post to indicate financial events that have occurred since the last statement Provide a useful tool for controlling three major conditions of an organization: a) Its liquidity b) Its general financial condition c) Its profitability

Managers can obtain information about trends or events in time to enable them make corrective action in the coming period of month
Give management a financial picture of the business
- It serves as a useful report, summarizing a companys financial status to aid in managerial decision making

Types of Financial Statements

There are two types of financial statements:

a) The Balance Sheet b) The Income Statement

The Balance Sheet

Statement indicating a financial condition of a business or institution for a specific date or period

It can be changed when new transactions occur

The balance sheet describes the companys financial position in term of: a) Assets b) Liabilities

1)

Assets - Include all items owned by the business that has value, and companys can expect to gain some future benefits by keeping and awning them a) Current assets b) Fixed assets c) Intangible assets

2)

Liabilities - a firms debt a) current liabilities b) long term liabilities Owners Equity - also known as capital - consists of capital stock a) preferred common stock b) retained earning

3)

The Income Statement

Summary of a firms revenues and expenses during a specified accounting period or a given interval of time Shows the firms operations and reflect its profit or loss status Also knows as the Profit and Loss Account

Basic parts of an income statement:

a) Revenues b) Cost of Goods Sold-include Raw Material, transportation and labor c) Operating expenses - they are those costs that do not result directly from the purchase or manufacture of the product it sells d) Net income - the amount left after subtracting all costs and expenses

Analyzing Financial Statement

Financial statements are used by managers stockholders and other outside the business to evaluate the organizations performance Ratios are used to analyze the financial statement. Ratios can be grouped into three major classification: a) Solvency ratios b) Profitability ratios c) Activity ratios

Solvency Ratios

Used o estimate risk in investing in a firm a) Short term solvency ratios are used by organizations to measure a companys relative liquidity, which then indicate a companys ability to pay its immediate debts b) Long term solvency ratio is used to measure the risk the company is facing in relation to the companys debt

Profitability Ratios

Profitability ratios are financial ratio for measuring a firms potential earning a) Return on investment (return on equity) shows the relationship between profits and investment

b) Earnings per share is profitability ratio measuring the size of the dividend that a firm can pay to shareholder

Activity Ratio

Activity ratio is a financial ratio measuring how efficiently a firm uses its resources in generating profit

a) Inventory turnover ratio is an activity ratio measuring the average number of times that inventory is sold and restocked during the year