Financial Accounting
Going beyond the basic understanding of a company's finances, financial accounting contains the in depth calculations of your numbers. This is where you’ll be looking at an organization's balance sheet, income statement, cash flow statement, statement of stockholders equity and other financial statements. The data in these documents are all calculated using several different formulas while following the generally accepted accounting principles (GAAP). These financial documents are prepared in a standardized format because their main purpose is to be reviewed by external users such as auditors to assess the overall health of a company. As your company experiences growth, solid financial accounting practices become a necessity to obtain potential stakeholders and maintain a profitable reputation.
The Financial Statements & Recording Transactions
Accounting is the language of business in the form of numbers. These numbers help businesses record, summarize and analyze their tasks. Through accounting we learn what a company owns, how much a company owes others, how well a company’s operations perform and how the company obtains the cash to fund itself. Understanding the numbers allows effective decision making to happen in the finance, marketing, and operations units of the organization. Most companies will refer to their financial statements for decision making.
Financial statements should be well-understood by business owners. They are issued at the end of a certain time period in the organization and serve as the final product in the accounting stage. The three most common financial statements are: the balance sheet, income statement, and statement of cash flows.
The Balance Sheet shows the assets owned by a company, the liabilities owed to others, and the accumulated investment of its owners. This is a snapshot at a given specific time of the company and shows the foundation of the company.
The records must be balanced by utilizing a double entry system. Assets (A) = Liabilities (L) + Owner’s Equity (OE)
The Income Statement shows the ‘flow’ of activity and transactions over a specific period. Here we have revenues from sales and expenses relating to those revenues. Income is calculated as revenue minus expenses. You can find several key items on the income statement, such as gross margin is sales minus cost of goods sold, operating profit is earning s before interest and taxes (EBIT), and net income is the final result of the income statement.
To track the income statement transactions, the journal entries will be recorded as credits (right side) and debits (left side). The Income Statement is combined with balance sheet entries, because a sale means we gained an asset.
The Statement of Cash Flows ‘Cash is King’
The cash flow statement shows the ‘sources’ and ‘uses’ of cash for your business. It’s important to realize that the measure of cash is the real value of the business, not the income statement’s net profit. This concept has deceived many business owners in assessing the value of their company.
The balance statement could be utilized as well to understand the cash flow statement. An increase in a current liability on the right would mean an increase in cash on the left. Increasing your debts to suppliers frees up a business’s cash for other purposes. If you were to purchase additional inventory, that means cash has decreased.
The importance of the cash flow statement is to help management avoid liquidity problems. It’s a great tool for managers to understand the operations, investing, and financing activities of a company. We want to understand the deeper meaning and logic behind the numbers.
Operating Activities: This demonstrates the day-to-day activities of a business. Net income is adjusted to a cash basis. Increases in current assets are ‘uses’ and current liabilities are ‘sources’ of cash.
Investing Activities: This reflects the cash effects of transactions in long-term (non-current) assets on the balance sheet. When a company buys or sells a long-term asset, it is reflected here.
Financing Activities: are when managers borrow money or raise money from investors.
Overall, the meaning of the cash flow statement is the net change in cash for the year. It shows how profitable the company was and how they achieved that profitability. If a company is healthy, operating activities will generate cash.
Ratio Analysis
Ratios are often industry-specific, but profitability is obviously paramount. Some industries just need cash, office furniture, and customer receivables to survive and profit. Competition is a key factor as well. The true comparison model of ratios is when one company compares itself to another company in the same industry.
To keep things simple, here are some common examples of ratios without the formulas.
Liquidity ratios: show how comfortably a company can pay their bills. If the ratio is greater than 1, that shows liquidity.
Capitalization ratios: show how debt-laden a company is and whether its investors are financing the company or if it can fund itself. A ratio of greater than 50 percent shows a high level of debt.
Activity ratios: demonstrate how actively the firm uses all of its assets. It measures the efficiency of the firm because the ratio is inventory specific amongst the sales number.
Profitability ratios: show the return on just about any part of the balance sheet and income statement. We can see how profitable the company is in relation to its assets and the sales that make its profits possible.
Accounting is the language of business in the form of numbers. These numbers help businesses record, summarize and analyze their tasks. Through accounting we learn what a company owns, how much a company owes others, how well a company’s operations perform and how the company obtains the cash to fund itself. Understanding the numbers allows effective decision making to happen in the finance, marketing, and operations units of the organization. Most companies will refer to their financial statements for decision making.
Financial statements should be well-understood by business owners. They are issued at the end of a certain time period in the organization and serve as the final product in the accounting stage. The three most common financial statements are: the balance sheet, income statement, and statement of cash flows.
The Balance Sheet shows the assets owned by a company, the liabilities owed to others, and the accumulated investment of its owners. This is a snapshot at a given specific time of the company and shows the foundation of the company.
- Assets are listed as cash, inventory, accounts receivable, equipment, or buildings.
- Liabilities are listed as bank debt, accounts payable, prepaid accounts (future goods), taxes owed, and wages owed to employees.
- Owner’s Equity are listed as common stock, additional paid in capital, and retained earnings.
The records must be balanced by utilizing a double entry system. Assets (A) = Liabilities (L) + Owner’s Equity (OE)
The Income Statement shows the ‘flow’ of activity and transactions over a specific period. Here we have revenues from sales and expenses relating to those revenues. Income is calculated as revenue minus expenses. You can find several key items on the income statement, such as gross margin is sales minus cost of goods sold, operating profit is earning s before interest and taxes (EBIT), and net income is the final result of the income statement.
To track the income statement transactions, the journal entries will be recorded as credits (right side) and debits (left side). The Income Statement is combined with balance sheet entries, because a sale means we gained an asset.
The Statement of Cash Flows ‘Cash is King’
The cash flow statement shows the ‘sources’ and ‘uses’ of cash for your business. It’s important to realize that the measure of cash is the real value of the business, not the income statement’s net profit. This concept has deceived many business owners in assessing the value of their company.
The balance statement could be utilized as well to understand the cash flow statement. An increase in a current liability on the right would mean an increase in cash on the left. Increasing your debts to suppliers frees up a business’s cash for other purposes. If you were to purchase additional inventory, that means cash has decreased.
The importance of the cash flow statement is to help management avoid liquidity problems. It’s a great tool for managers to understand the operations, investing, and financing activities of a company. We want to understand the deeper meaning and logic behind the numbers.
Operating Activities: This demonstrates the day-to-day activities of a business. Net income is adjusted to a cash basis. Increases in current assets are ‘uses’ and current liabilities are ‘sources’ of cash.
Investing Activities: This reflects the cash effects of transactions in long-term (non-current) assets on the balance sheet. When a company buys or sells a long-term asset, it is reflected here.
Financing Activities: are when managers borrow money or raise money from investors.
Overall, the meaning of the cash flow statement is the net change in cash for the year. It shows how profitable the company was and how they achieved that profitability. If a company is healthy, operating activities will generate cash.
Ratio Analysis
Ratios are often industry-specific, but profitability is obviously paramount. Some industries just need cash, office furniture, and customer receivables to survive and profit. Competition is a key factor as well. The true comparison model of ratios is when one company compares itself to another company in the same industry.
To keep things simple, here are some common examples of ratios without the formulas.
Liquidity ratios: show how comfortably a company can pay their bills. If the ratio is greater than 1, that shows liquidity.
Capitalization ratios: show how debt-laden a company is and whether its investors are financing the company or if it can fund itself. A ratio of greater than 50 percent shows a high level of debt.
Activity ratios: demonstrate how actively the firm uses all of its assets. It measures the efficiency of the firm because the ratio is inventory specific amongst the sales number.
Profitability ratios: show the return on just about any part of the balance sheet and income statement. We can see how profitable the company is in relation to its assets and the sales that make its profits possible.
