Ch 6 Outline
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Introduction
What is Accounting
The Accounting Equation
The Accounting Cycle
Cash Management
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6-2 What Is Accounting?
• The American Accounting Association defines
accounting as “the process of identifying,
measuring, and communicating economic
information to permit informed judgments and
decisions by users of the information.”
• Accounting practices are essential to business
confidence.
– The purpose is to keep track of items of value, in their
current state and in their flow or change over time and
to make reports that are useful in management
decisions.
– Accounting is based on the concept of a financial
transaction.
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Accounting Equation
Accountants:
Assets = Liabilities + Owners’ Equity
Bankers (Lenders):
Assets-Liabilities = Owners’ Equity
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The Accounting Equation
The accounting equation indicates a company’s financial position at any point in time.
On its framework rests the entire accounting process.
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Any business transaction can be analyzed in terms of its effect on the accounting
equation.
According to the accounting equation, a company’s assets equal its liabilities plus
owners’ equity, as shown:
Assets = liabilities + owners’ equity
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Assets: Anything of value owned by the business and used in conducting its
operations.
Liabilities: Debts owed by the business to its creditors, including obligations to
perform services in the future.
Equity: The claims of the owners, partners, and shareholders against the firm’s assets.
Revenues: Inflows of assets resulting from the ongoing operation of a business.
Expenses: Costs incurred to produce revenues.
Revenues result in an increase in owners’ equity, whereas expenses result in a
decrease.
Net income, is the excess of revenues over expenses.
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6-4 The Accounting Cycle
• Accounting cycle: The sequence of steps that are
used to keep track of what has happened in the
business and to report the financial effect of those
events.
– Accountants first analyze the business transactions to
determine which should be recorded and at what
amount.
– Transactions are recorded chronologically in a
journal—general journal or specialized journals.
– Data entered into journals originates from various
source documents.
– Entrepreneurs may need to know the balances of the
various accounting equation elements.
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Exhibit 6-2 The Accounting
Cycle
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Exhibit 6-3 General Journal
Entries
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6-4a Accounts Receivable
• One of the ledgers subsidiary to the general ledger
is the accounts receivable ledger, or AR.
– A cash sale results in a debit or deposit to the bank
account and a credit to the proper sales revenue
account.
– A credit sale is posted as a debit or increase in the asset
AR account and a credit to the sales revenue account.
– The profit or loss, which is the sum of revenues and
expenses, is carried into the balance sheet as current
earnings.
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6-4a Accounts Receivable (cont.)
• The AR accounting system requires the
identification of a customer or vendor for
the transaction.
– The AR system generates three primary reports:
• A ledger or report for a single customer
• An aged accounts report
• Statement or bill to customers
• The accounting system also charges a
customer’s or vendor’s account for amounts
not paid on a timely basis.
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6-4b Accounts Payable
• The accounts payable ledger, or AP, is the mirror
image of the AR ledger.
• Accounts payable: For products or services that
have been acquired and have flowed into
inventory but have not yet been paid for.
– AP accounts carry a credit balance or a liability
balance.
– AP accounts are liabilities.
– AP system produces checks to pay to suppliers.
– AP system also generates a detailed ledger for each
supplier and an aged accounts report.
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6-4d Inventory Control
• Inventory control ledger: Account for each item or
type of item in inventory and to enable the
entrepreneur to know:
– How much of each item is being sold and at what times
of the year.
– How much of each item is in stock.
– How much of each item should be reordered and when.
• Inventory control accounting is more difficult and
takes more attention to detail than do other
accounting subsystems.
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6-5 Cash Management
• The entrepreneur must manage the venture’s cash
and develop projections that provide advance
warning when cash is running low.
– Cash flow: The movement of money into and out of the
business. It flow consists of:
• Inflows: The movement of money into the venture.
• Outflows: The movement of money out of the business.
– Entrepreneurs need to understand cash flow to plan
growth and to repay debts.
• The first step in managing cash effectively is to understand the
venture’s cash flow cycle.
– The cash flow statement records how and when cash
flows into and out of the venture.
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Exhibit 6-5 The Cash Flow Cycle
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6-5a Budgets
• One ways for an organization to achieve
strategic objectives is by preparing budgets
and then monitoring actual performance
against them.
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6-5a Budgets
– Budget: A plan set out in monetary terms,
prepared and approved prior to a defined period
of time, and usually showing either or both the
planned income to be generated and the
expenditure to be incurred during that time
period.
– There are various methodologies for budgeting:
• Incremental budgeting
• Zero-based budgeting
– Successful budgeting results from the careful
development and evaluation of all aspects of
the budgeting process.
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Zero-Based Budgeting
(not from text)
The process of preparing an operating plan
or budget that starts with no authorized
funds. In a zero-based budget, each activity
to be funded must be justified every time a
new budget is prepared.
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6-5a Budgets (cont.)
– A cash budget is prepared specifically to manage the
cash flowing into and out of the venture.
– There are four steps in preparing a cash budget:
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Determine an adequate minimum cash balance for the venture.
Forecast cash receipts.
Forecast cash disbursements.
Determine the end-of-month cash balance.
– The rule of thumb for cash budget is to underestimate
future sales rather than overestimate them.
– It is safer for an entrepreneur to assume that the
venture’s cash flow cycle will be similar to whatever is
standard in the industry.
• Entrepreneurs can estimate cash disbursements by using the
pro forma cash flow statement.
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Cash Management Strategies
(i.e. three ways to increase cash-flow without
necessarily increasing cash sales)
1. Progress Billing
2. Retainers
3. Invoices
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6-5b Cash Management
Strategies
• An Invoice is a standard business form that
informs purchasers of how much they owe, when
they need to make payment to avoid penalty, and
where payment should be sent.
• The most important technique that entrepreneurs
can use to improve cash flow is to have a
systematic procedure for issuing invoices.
– A new venture that is not diligent about invoicing can
expect its cash flow to be affected.
– Mid-size and large corporate customers are likely to
have internal purchasing and payment cycles.
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6-5b Cash Management
Strategies (cont.)
– Aging: Factor that companies consider in
deciding who gets paid first; the older an
invoice, the less likely it is to be paid.
– Factoring: Firms will purchase a venture’s
receivables at a discount.
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6-6 Working with Accountants
• Many entrepreneurs choose to work with
professional accountants to manage the financial
records of their ventures.
– The entrepreneur contacts the lead accountant with any
questions about accounting, taxes, or financial
statements.
– An entrepreneur hires consultants precisely because
they are expert at what they do, allowing the
entrepreneur to focus on other issues.
• Proper management of the external accountant, then, requires a
balance between strict oversight and complete disinterest.
• Entrepreneurs should never completely turn over the reins of
accounting and financial decision making to outside
consultants.
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6-6 Working with Accountants
(cont.)
• When selecting an accounting firm, entrepreneurs
should:
– Look at the number of the firm’s CPAs who are
accredited by the American Institute of Certified Public
Accountants (AICPA).
– Look at references provided or ask for references.
– Look for the following qualities:
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Reputation
Professionalism
Ethics
Reliability
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