Understanding Accounting and
Financial Statements
Adeyl Khan, Faculty, BBA, NSU
Accounting
Accounting is
THE PROCESS
Of measuring,
interpreting, and
communicating
financial
information
TO SUPPORT
internal and
external
business
decision making.
Adeyl Khan, Faculty, BBA, NSU
Open Book Management
•
Open book management - sharing sensitive financial information with
employees and teaching them how to understand and use financial
statements.
•
Viewing financial information may help them better understand how their
work contributes to the company’s success.
•
Outsiders use financial data to evaluate investment opportunities.
Adeyl Khan, Faculty, BBA, NSU
Business Activities Involving
Accounting
 Financing activities provide necessary funds to start
a business and expand it after it begins operating.
 Investing activities provide valuable assets required
to run a business.
 Operating activities focus on selling goods and
services, but they also consider expenses as
important elements of sound financial
management.
Hotel Refurb Group
Adeyl Khan, Faculty, BBA, NSU
Accounting Professionals
 Public Accountants
 Provide accounting services to individuals or business
firms for a fee



(1) auditing, or examining, financial records;
(2) tax preparation, planning, and related services; and
(3) management consulting.
Adeyl Khan, Faculty, BBA, NSU
CPAs
Accounting Professionals …
CMA
 Management Accountants
 Provide timely, relevant, accurate, and concise
information that executives can use to operate their
firms




Where is the company going?
What opportunities await it?
Do certain situations expose the company to excessive risk?
Does the firm’s information system provide detailed and
timely information to all levels of management?
 Government and Not-for-Profit Accountants
Cost accountant, Tax accountant
Internal auditor
Adeyl Khan, Faculty, BBA, NSU
The Foundation of Accounting Systems
• Generally accepted accounting principles (GAAP) encompass the
conventions, rules, and procedures for determining acceptable
accounting practices at a particular time.
• Financial Accounting Standards Board (FASB) is primarily
responsible for evaluating, setting, or modifying GAAP in the U.S.
• Sarbanes-Oxley Act responded to cases of accounting fraud.
– Created the Public Accounting Oversight Board, which sets audit
standards and investigates and sanctions accounting firms that certify the
books of publicly traded firms.
– Senior executives must personally certify that the financial information
reported by the company is correct.
– Resulted in increase in demand for accountants.
Adeyl Khan, Faculty, BBA, NSU
Adeyl Khan, Faculty, BBA, NSU
Accounting process - set of activities involved in converting
information about transactions into financial statements.
The Accounting Equation
• Assets - anything of value owned or leased by a business.
• Liability - claim against a firm’s assets by a creditor.
• Owner’s equity - all claims of the proprietor, partners, or
stockholders against the assets of a firm, equal to the excess of
assets over liabilities.
• Basic accounting equation - relationship that states that
assets equal liabilities plus owners’ equity.
Assets = Liabilities + Owners’ equity
• Double-entry bookkeeping - process by which accounting
transactions are entered; each individual transaction always has
an offsetting transaction.
• A decrease in an asset must be offset by either an increase
in another asset, a decrease in a liability, or a decrease in
owners’ equity.
Adeyl Khan, Faculty, BBA, NSU
Impact of Computers &
The Internet on Accounting
• Simplifies the accounting process by automating data entry and
calculations.
• Available products are customized for businesses of different sizes.
– Entrepreneurs and small businesses use: QuickBooks, Peachtree,
and BusinessWorks.
– Larger firms use larger scale software packages like: Computer
Associates, Oracle, and SAP.
• Specific software based advantages
• International business- different country information/language.
• Web-based package
Adeyl Khan, Faculty, BBA, NSU
Balance Sheet
 Balance sheet - statement of a
firm’s financial position—what it
owns and the claims against its
assets—at a particular point in
time.
 Photograph of firm’s assets
together with its liabilities and
owner’s equity
 Follows the accounting equation
Adeyl Khan, Faculty, BBA, NSU
Balance Sheet
 Current Assets:

Cash and other liquid assets that can or will be converted
to cash within one year.
 Plant, Property, and Equipment (net):

Physical assets expected to last for more than one year;
shown net of accumulated depreciation the cumulative
value that plant, property, and equipment have been
expensed (depreciated).
 Value of assets

such as patents and trademarks.
 Current Liabilities:

Claims of creditors that are to be repaid within one year;
accruals are expenses, such as wages, that have been
incurred but not yet paid.
 Long-Term Debt:

Debts that come due one year or longer after the date on
the balance sheet.
 Owners’ (or shareholders’) Equity:

Claims of the owners against the assets of the firm; the
difference between total assets and total liabilities.
Adeyl Khan, Faculty, BBA, NSU
 Income Statement financial record of a
company’s revenues
and expenses, and
profits over a period
of time.
 Firm’s financial
performance in terms
of revenues, expenses,
and profits over a
given time period.
 Reports profit or loss.
 Focus on revenues and
costs associated with
revenues.
Adeyl Khan, Faculty, BBA, NSU
Bottom Line
Statement of Owner’s Equity
 It is designed to show the components of the change in equity from the end of
one fiscal year to the end of the next.


Begins with the amount of equity shown on the balance sheet at end of the prior year.
Net income is added, and cash dividends paid to owners are subtracted.
Adeyl Khan, Faculty, BBA, NSU
Statement Of Cash Flows
 Statement of cash flows - a firm’s cash receipts
and cash payments that presents information on
its sources and uses of cash.
 Accrual accounting - method that records
revenue and expenses when they occur, not
necessarily when cash actually changes hands.
Adeyl Khan, Faculty, BBA, NSU
1. Operating Activities:
• day-to-day activities
• Increases in accounts receivable and
inventory are uses of cash
• increases in accruals and accounts
payables are sources of cash
• in financially healthy firms, net cash
flow here should be positive.
2. Investing Activities:
• often a use of cash.
3. Financing Activities:
• Ways to transfer cash to or from
creditors and to or from owners; can
be either positive or negative.
4. Net Cash Flow: The sum of cash flow from
operating, investing, and financing
activities, a reconcilement of cash from the
beginning to the end of the accounting
period (one year in this example).
Adeyl Khan, Faculty, BBA, NSU
Financial Ratios Analysis
Ratio analysis - tool for measuring a firm’s liquidity, profitability,
and reliance on debt financing, as well as the effectiveness of
management’s resource utilization.
Adeyl Khan, Faculty, BBA, NSU
Liquidity Ratios
Total current assets
Current ratio compares
current assets to current
liabilities. Rule of thumb
~ 2 to 1
Acid-test (or quick)
ratio measures the
ability of a firm to meet
its debt payments on
short notice.
Rule of thumb ~1
Total current liabilities
Cash and equivalents
+ short-term investments
+ accounts receivable
Total current liabilities
Adeyl Khan, Faculty, BBA, NSU
Activity Ratios
Inventory turnover
ratio indicates the
number of times
merchandise moves
through a business.
Rule of thumb~
industry standards
Adeyl Khan, Faculty, BBA, NSU
Net sales
Average of inventory
Activity Ratios
Receivables turnover = __________________________
Credit sales
Average accounts receivable
Net sales
Total asset turnover ratio
indicates how much in sales
each dollar invested in assets
generates.
Average of total assets
Adeyl Khan, Faculty, BBA, NSU
Profitability Ratios
Profitability ratios measure the organization’s overall financial
performance by evaluating its ability to generate revenues in excess of
operating costs and other expenses.
Adeyl Khan, Faculty, BBA, NSU
Leverage Ratios
• Leverage ratios measure the extent to which a firm relies on
debt financing.
• Total liabilities to total assets ratio > 50 percent indicates that a
firm is relying more on borrowed money than owners’ equity.
Adeyl Khan, Faculty, BBA, NSU
•
Budget - planning and
control tool that reflects a
firm’s expected sales
revenues, operating
expenses, and cash
receipts and outlays.
•
Management estimates of
expected sales, cash
inflows and outflows, and
costs.
•
Budgets are a financial
blueprint that serves as a
financial plan.
•
Cash budget - tracks the
firm’s cash inflows and
outflows.
Adeyl Khan, Faculty, BBA, NSU
International Accounting
• International Accounting Standards Committee (IASC)
promotes worldwide consistency in financial reporting practices.
In 2001, became the International Accounting Standards
Board (IASB). International Financial Reporting Standards
(IFRS) are the standards.
• Exchange Rates - ratio at which a country’s currency can be
exchanged for other currencies.
• Consolidated financial statements must reflect gains and losses
due to changes in exchange rates.
• Can have significant impact on financial statement.
Adeyl Khan, Faculty, BBA, NSU
1
Explain the functions and importance
of accounting, and identify the three
basic activities involving accounting.
2
Describe the roles played by public,
management, government and not-forprofit accountants.
3
4
Identify the foundations of the
accounting system, including GAAP
and the role of the Financial
Accounting Standards Board (FASB).
Outline the steps in the accounting
cycle, and define double-entry
bookkeeping and the accounting
equation.
Adeyl Khan, Faculty, BBA, NSU
5
Explain the functions and major
components of the four principal financial
statements: the balance sheet, the
income statement, the statement of
owner’s equity, and the statement of
cash flows.
6
Discuss how financial ratios are used to
analyze a company’s financial strengths
and weaknesses.
7
Describe the role of budgets in a
business.
8
Outline accounting issues facing global
business and the move toward one set
of worldwide accounting rules.