Using FinancialInformation and Accounting

Using FinancialInformation and Accounting

Chapter 14

Chapter 14 Learning Goals

• Why are financial reports and accounting information important, and who uses them?

• What are the differences between public and private accountants?

• What are the six steps in the accounting cycle?• In what terms does the balance sheet describe the

financial condition of an organization?

Chapter 14 Learning Goals (cont’d.)

• How does the income statement report a firm’s profitability?

• Why is the statement of cash flows an important source of information?

• How can ratio analysis be used to identify a firm’s financial strengths and weaknesses?

• What major trends are affecting the accounting industry today?

Learning Goal 1• Why are financial reports and accounting

information important, and who uses them?– Financial reports give information about a company’s past,

present and future performance to:• Managers

– Can use reports to make decisions about firm’s operations

• Employees• Investors and customers• Suppliers, creditors, and government agencies

AccountingAccounting::

The process of collecting, recording, classifying, summarizing, reporting, and analyzing financial activities; results in reports that describe the financial condition of an organization

Learning Goal 2• What are the differences between public and private

accountants?– Public accountants

• Work for independent firms that provide accounting services to other organizations on a fee basis

– Financial report preparation and auditing

– Tax return preparation

– Management consulting

– Private accountants• Employed to serve one particular organization

– Prepare financial statements

– Tax returns

– Management reports

Public accountantPublic accountant::

Independent accountant who serves organizations & individuals on a fee basis; offers a wide range of services including preparation of financial statements & tax returns, independent auditing, & management consulting

Private accountantPrivate accountant::

Accountant who is employed by one particular organization and works only for it

Learning Goal 3

• What are the six steps in the accounting cycle?– Accounting cycle:Accounting cycle: the process of generating financial

statements• AAnalyzing business transactions

• RRecording transactions in journals

• PPosting transactions to ledgers

• SSummarizing ledger totals in a trial balance

• PPreparing financial statements and reports

• AAnalyzing reports and making decisions

The Accounting Cycle1. Analyze business

transaction documents

2. Record business transactions in journal

3. Post entriesto ledgers

4. Prepare trial balance

5. Prepare financial statements &

management reports

6. Analyze reports

Learning Goal 4• In what terms does the balance sheet describe the financial

condition of an organization?– Balance sheet represents:

• The financial condition of a firm at one moment in time, in terms of assets, liabilities, and owner’s equity

– Assets• Current, fixed and intangible

– Liabilities• Current and long-term

– Owner’s equity• Amount of owners’ investment into the firm after all liabilities have been

paid

The Balance Sheet

• Summarizes a firm’s financial position at a specific point in time

1. AssetsAssets (resources)current, fixed, intangible, depreciation

2. LiabilitiesLiabilities (obligations)current, long-term

3. Assets minus obligations (equityequity)retained earnings

Learning Goal 5• How does the income statement report a firm’s

profitability?– Income statement:

• Summary of firm’s operations over some period

– Main parts of income statement• Revenues

– Gross and net sales

• Cost of goods sold• Operating expenses

– Selling and general and administrative expenses

• Taxes• Net profit or loss

The Income Statement

• Summarizes the firm’s revenues & expenses and shows total profit or loss over a period of time

1. RevenuesRevenuesgross sales, net sales

2. ExpensesExpensescost of goods sold, operating expenses

3. Net profitNet profit or lossloss

The Income Statement: Revenues

• Increased revenues don’t always lead to increased stock value:– US Office ProductsUS Office Products had very high revenue

growth in 1998, but it’s stock price decreaseddecreased 88%

Source: Fortune, Sept. 28, 1998, p. 232.

Learning Goal 6

• Why is the statement of cash flows an important source of information?– Statement of cash flows

• Summarizes the firm’s sources and uses of cash during financial reporting period

• Shows net change in firm’s cash and marketable securities

– Breaks firm’s cash flows into those from:• Operating activities

• Investment activities

• Financing activities

The Statement of Cash Flows

• Summarizes the money flowing into and out of a firm for a period of time

• Sources of cash flow:– operating activities– investment activities– financing activities

Learning Goal 7• How can ratio analysis be used to identify a firm’s financial

strengths and weaknesses?– Ratio analysis

• Using financial statements to gain insight into a firm’s– Operations– Profitability– Overall financial condition

• Comparing ratio’s can indicate trends and highlight financial strengths and weaknesses

– Four main types of ratios• Liquidity ratios• Profitability ratios• Activity ratios• Debt ratios

Analyzing Financial Statements

Ratio analysis:Ratio analysis: calculating & interpreting financial ratios taken from financial reports to assess a firm– liquidity ratios– profitability ratios– activity ratios

• inventory turnover ratio– debt ratios

• debt-to-equity ratio

Liquidity & Profitability Ratios

• Liquidity ratios– current ratio– acid-test (quick) ratio– net working capital

• Profitability ratios– net profit margin– return on equity– earnings per share

Learning Goal 8

• What major trends are affecting the accounting industry today?– Role of accountants has expanded

• Includes management consulting in areas such as:– Computer systems

– Human resources

– Electronic commerce

– Major issue: How to treat key intangible assets• FASB and SEC are raising concerns about quality of reported

earnings

Trends in Accounting

• Accountants expand their role more involvement in operations

• Valuing knowledge assets– R&D, brands, trademarks, employee talent

• Tightening the GAAP reducing loopholes