Accounting and Financial
Management
Chapter 7
7-1
©2007 Prentice Hall
Chapter 7 Objectives
After studying this chapter, you will be able to:
• Discuss how managers and outsiders use
financial information
• Describe what accountants do
• Summarize the impact of the Sarbanes-Oxley
Act
• State the basic accounting equation and explain
the purpose of double-entry bookkeeping and
the matching principle
7-2
©2007 Prentice Hall
Chapter 7 Objectives, cont.
• Differentiate between cash basis and accrual
basis accounting
• Explain the purpose of the balance sheet and
identify its three main sections
• Explain the purpose of the income statement
and statement of cash flows
• Explain the purpose of ratio analysis and list the
four main categories of financial ratios
• Identify the responsibilities of a financial
manager
7-3
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Understanding Accounting
Financial
Accounting
Management
Accounting
Interpreting
Measuring
Communication
Decision Making
7-4
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What Accountants Do
Bookkeeping
Cost
Accounting
Tax
Accounting
Financial
Analysis
7-5
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Ten Most Important
Accounting Skills
• Analytical
• Leadership
• Problem solving
• Decision making
• Interpersonal
• Time management
• Listening
• Teamwork
• Communication
• Computer
7-6
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Types of Accountants
Private
CPA
CMA
Public
Internal
Audit
CPA
External
Audit
7-7
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The Big Four
• Deloitte & Touche
• Ernst & Young
• KPMG
• Price Waterhouse
Coopers
7-8
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The Arthur Anderson Scandal
• Deliberate deception by corporate
clients
• Changes in accounting practices
• Conflict of interests
• Overly aggressive business
practices
7-9
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The Rules of Accounting
Generally Accepted
Accounting Principles
(GAAP)
Financial Accounting
Standards Board
(FASB)
International
Securities and
Accounting Standards Exchange Commission
(IAS)
(SEC)
7-10
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Sarbanes-Oxley Act
Advantages
Disadvantages
Authority of Auditors
Implementation
Conflict of Interest
Cost of Compliance
Investor Protection
Enforcement Issues
Corporate Accountability
Reporting Requirements
7-11
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The Accounting Equation
Owner’s Equity:
Assets – Liabilities = Owner’s Equity
Accounting Equation:
Assets = Liabilities + Owner’s Equity
7-12
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Double-Entry Bookkeeping
• Debit
• Credit
7-13
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Matching Principle
• Accrual basis
• Cash basis
7-14
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How Are Financial Statements
Used?
7-15
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Understanding Financial
Statements
• Balance Sheet
• Income Statement
• Statement of Cash
Flows
7-16
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The Balance Sheet
Assets
Current Assets
Fixed Assets
Liabilities and Shareholder’s Equity
Current
Liabilities
Long-Term
Liabilities
Shareholder’s
Equity
7-17
©2007 Prentice Hall
The Income Statement
Revenues
Gross Sales – Returns and Allowances
Cost of Goods Sold
Beginning Inventory + Purchases – Cost of Goods – Ending Inventory
Operating Expenses
Selling Expenses + General Expenses
Net Operating Income
Gross Profit + Other Income – Operating Expenses
Net Income After Taxes
Net Income Before Taxes – Income Taxes
7-18
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Statement of Cash Flows
• Operations
• Investments
• Financing
7-19
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Analyzing Financial
Statements
Ratio Analysis
Trend Analysis
Uncover
Business
Shifts
Consider
Extraordinary
Circumstances
Consider
More Than
One Ratio
Check
Specific
Data
7-20
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Types of Financial Ratios
Profitability
Ratio
Liquidity
Ratio
Activity
Ratio
Leverage
Ratio
7-21
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Profitability Ratio
Return on Sales =
Net Income
Net Sales
Return on Equity =
Net Income
Total Owner’s Equity
Earnings per Share =
Net Income
Average Shares Outstanding
7-22
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Liquidity Ratio
Working Capital =
Current Assets Current Liabilities
Current Ratio =
Current Assets
Current Liabilities
Quick Ratio =
Current Assets - Liabilities
Current Liabilities
7-23
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Activity Ratios
Inventory Turnover =
Cost of Goods Sold
Average Inventory
Receivables Turnover =
Sales
Average Accounts Receivable
7-24
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Leverage (Debt) Ratio
Debt to Equity =
Total Liabilities
Total Equity
Debt to Total Assets =
Total Liabilities
Total Assets
7-25
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Understanding Financial
Management
Develop and Implement
a Financial Plan
Amount of funds
Sources of funds
Uses of funds
Monitor Cash Flow
Cash
Inventory
Receivables and payables
Develop a Budget
Financial control
Capital investments
Capital budgeting
7-26
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Financial Management
Length of Term
Cost of Capital
Debt or Equity
7-27
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