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1313Small Business Accounting:Small Business Accounting:
Projecting and Projecting and Evaluating PerformanceEvaluating Performance
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
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Why Accounting MattersWhy Accounting Matters• Proves what your business did financially• Shows how much your business is worth• Banks, creditors, development agencies, and
investors require it• Provides easy-to-understand plans for business
operations• You can’t know how your business is doing
without it
Chapter 13Chapter 13
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All of the following are types of accounting All of the following are types of accounting except:except:
a) Financial accounting
b) Tax accounting
c) Managerial accounting
Chapter 13Chapter 13
QuestionQuestion
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• Three types of accountingThree types of accounting:– Managerial accountingManagerial accounting: used by managers
for planning and control– Tax accountingTax accounting: used for calculating and
reporting taxes– Financial accountingFinancial accounting: used by banks and
outside investors
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Basic Accounting ConceptsBasic Accounting Concepts• Business entity conceptBusiness entity concept: a business has an
existence separate from that of its owners• Going concernGoing concern: business is expected to
continue in existence for the foreseeable future
• Accounting equationAccounting equation: assets = liabilities + owner’s equity
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Basic Accounting Concepts Cont.
• Assets : things you own• Liabilities: things you owe• Equity : running total of profits/losses of
bus, less withdrawals, plus contributions• Income - revenues from sales• Expenses- items paid out to operate
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• What is a cost? What is an expense?What is a cost? What is an expense?– CostsCosts: real changes in what you own– ExpensesExpenses: entries made in your accounting
system to record your use of goods and services
– Managerial accounting is focused on predictingpredicting the future, so it uses expenses only for budgeting and planning purpose
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• Information usefulnessInformation usefulness: must be accurate and relevant– Only two reasonstwo reasons to do accounting:
• To produce information that is useful to you for managing your business
• To meet legal or contractual requirements
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• Computerized accountingComputerized accounting: most commonly used (QuickBooks, Peachtree)– Systems should easily accomplish:
• Easy-to-understand user interface
• Context-sensitive help function
• Income statements
• Classified balance sheet
• Development of a cash budget
• Produce financial statements
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Which Accounting Software is Best for You?• Two main types of accounting software:
– industry specific and generic• Consider the following for choosing a package:
– The size of your business – The industry you're in – The components you need – Available support – Financial resources – Professional recommendations – Ease of use
Chapter 13Chapter 13
ExampleExample
http://www.entrepreneur.com/money/moneymanagement/financialmanagementcolumnistpamnewman/article166216.html13-10
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Setting Up an Accounting SystemSetting Up an Accounting System• Accounting functionsAccounting functions:
– Accounts payable
• Payroll– Fixed asset
– Inventory
– Credit card sales
Chapter 13Chapter 13
– Accounts receivable
– Insurance register
– Investments
– Leasehold records
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Accounting System
• Logical system of recording transactions of your business
• Think about this: if you record invoices, deposits, bills, and expenses paid, haven’t you recorded most of what is happening with your business.
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Financial ReportsFinancial Reports• Five common financial statementsFive common financial statements:
– Income statement
– Statement of retained earnings
– Statement of owner’s equity
– Balance sheet
– Cash flow statement• Important thing is that the information flows all the
way from the income statement to the balance sheet
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• Income statementIncome statement: primary source of information about a business’ profitability– Revenues – Expenses = Net incomeRevenues – Expenses = Net income– Difficulties in understanding the income
statement• Disagreements about whatwhat exactly should be
reported as revenue
• Disputes over whenwhen to recognize revenues
– Most small business do not have problems with these; sales are cash, or the same as cash
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• Balance sheetBalance sheet: “Statement of Financial Position”– SnapshotSnapshot of financial holdings and liabilities
at the close of business on a specified date– Minimum detail is to report assets and
liabilities in two categories: CurrentCurrent and Long-termLong-term
– Used to determine the liquidity, financial flexibility, and financial strength of the business
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• Balance sheetBalance sheet: cont.– LimitationsLimitations:
• All values listed are historicalhistorical values– Value recorded in the accounting records
can be widely different from the asset’s current value
• Balance sheet might not completely reflect the business
• Certain assets and liabilities are omitted from the balance sheet
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• Cash flow statementCash flow statement: sources and uses of cash by the business– Cash flows from operating activitiesoperating activities– Cash flows from investing activitiesinvesting activities– Cash flows from financing activitiesfinancing activities
• Net effectNet effect of foreign exchange rates
• Net changeNet change in cash balance during the period
• Non-cashNon-cash investing and financing activities
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Building a Financial Budget• Business budgeting is one of the most powerful
financial tools available • Most effective financial budget includes both a
short-range month-to-month plan for at least a calendar year and a quarter-to-quarter long-range plan you use for financial statement reporting
• It is important to budget both the income statement and balance sheet
Chapter 13Chapter 13
ExampleExample
http://www.entrepreneur.com/money/moneymanagement/financialanalysis/article21942.html13-18
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• Financing activitiesFinancing activities: actions taken by management to finance the operations of the business– Net effect of foreign exchange ratesNet effect of foreign exchange rates: rates
often vary rapidly– Net change in cash balanceNet change in cash balance: reconciles the
net increase and decrease with the beginning balance
– Non-cash investing and financingNon-cash investing and financing: exchange of value other than cash takes place
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Financial accountingFinancial accounting can be a highly valuable aid in decision making
• Reporting to outsiders• Record keeping• Taxation• Control of receivables• Analysis of business operations
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• Managerial accountingManagerial accounting techniques will make you a better small business manager
• More accurateaccurate at forecasting profits, planning operations, and conserving scarce resources
• Managerial functionsManagerial functions:– Planning, organizing, staffing, directing, and
controlling
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• Cost-Volume-Profit analysis: Cost-Volume-Profit analysis: technique which looks at the fixed and variable costs of a business to arrive at a number of unit sales (volume) to maximize profits
• Variable Costs:Variable Costs: costs that change with each unit produced– Raw materials
• Fixed CostsFixed Costs: costs that remain constant regardless of quantity of output– rent
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The point at which total costs equal total sales is called the …
a) Breakeven Point
b) Equalization Point
c) Neutral Point
d) Variable Point
Chapter 13Chapter 13
QuestionQuestion
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Business Plan and the BudgetBusiness Plan and the Budget• Business planBusiness plan: specifies the amounts and types
of inputs required to achieve a set of desired outcomes
• Based on assumptionsassumptions:– How risks can be controlled
– What opportunities can be taken
• BudgetsBudgets have the advantage of being comprised of a series of small schedules
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• Planning / budgetingPlanning / budgeting: process through which strategy is mapped into a series of tactical and operational actions– Budget becomes a standardstandard against which
performance can be measured– BasisBasis for controlling activities and the use of
resources– FewFew small business owners consistently
budget
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• Sales budgetSales budget: projected future level of sales in units multiplied by the sales price per unit
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• Purchases budgetPurchases budget: number of units that are expected to be acquired during the budget period
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• Cost of Goods Sold BudgetCost of Goods Sold Budget: : predicted cost of product actually sold during accounting period
• Labor budgetLabor budget: amount and cost of labor needed to meet required production– Assume that labor can easily be increased or
decreased– Can easily be modeled as a fixed cost
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• Budgeted income statementBudgeted income statement: budgets that have been completed to this point are combined into pro forma financial statements– Common to create the statement in only a
fiscal year formatfiscal year format
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• Completing a comprehensive budgetCompleting a comprehensive budget:– Final processesFinal processes to be accomplished to
produce a complete master budget• Budgeted cash receipts
• Budgeted cash payments
• Cash budget
• From these statements, prepare:– Pro Forma projected balance sheet– Pro Forma projected cash flow statement
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• ControllingControlling: – Managerial accounting provides
information that allows managers to determine how well the business is doing in attaining its goals
– VariancesVariances should be evaluated to determine the significance; they occur due to one of these events
• Prices are different from what was estimated
• Quantities are different from what was estimated
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Decision MakingDecision Making• To make good decisions, you needTo make good decisions, you need:
– Good information
– Efficient ways to condense information
– Methods to help compare alternatives
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• Managerial accountingManagerial accounting is both a source of information and a methodology to reduce the complexity of the information
• AccountingAccounting is useful for:– Managers of small businesses
– Record keeping
– Reporting to absentee owners
– Substantiating assertions made to regulators and taxing agencies
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Tracie’s cheat sheet for accounting – format of BALANCE SHEET
• I. Assets (things you own) Ex. cash, receivables, equipment
• --A. Current assets – either cash or something easily converted to cash
– B. Fixed: Buildings, equipment, less accum depredication
– C. Other Assets: deposits on power, utilities, etc.
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Tracie’s cheat sheet cont. FORMAT OF BALANCE SHEET
• II. Liabilities (things you owe)– A. Current liabilities – things that will
be paid short term, generally a year Ex. Payroll taxes, sales tax, accounts payable
– B. Long term – notes payable
III. Equity – retained earnings, capital contributed, dividends taken
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Tracie’s cheat sheet – format of INCOME STATEMENT
• I. Income – either billings or collection of income
• II. Expenses• A. Cost of goods sold – those directly
related to the production of income, they fluctuate with income levels (variable costs)
• B. Selling and Administrative – indirectly related to sales, fixed in nature, overhead items