Small Business Accounting

Projecting and Evaluating Performance

Chapter 13
McGraw-Hill/Irwin Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives
LO1 Review the basic concepts of accounting LO2 Specify the requirements for a small business accounting system LO3 Explain the content and format of common financial statements LO4 Use accounting information as a tool for managing your business effectively LO5 Develop a complete set of budgets for your business LO6 Use accounting information to make better business decisions
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Why 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 cant know how your business is doing without it

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Types of Accounting
Managerial accounting
Accounting methods that are specifically intended to be used by managers for planning, directing, and controlling a business.

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Types of Accounting
Tax accounting
An accounting approach based on specific accounting requirements set by governmental taxing agencies.

Financial accounting
A formal, rule-based set of accounting principles and procedures intended for use by outside owners, investors, banks, and regulators.
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Basic Accounting Concepts

Business entity concept
The concept that a business has an existence separate from that of its owners.

Going concern concept

The accounting concept that a business is expected to continue in existence for the foreseeable future.

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The Accounting Equation

Accounting equation
The statement that assets equal liabilities plus owners equity (assets liabilities owners equity).

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The Accounting Equation

Asset
something the business owns that will have value in the future

Liability
a legal obligation to pay some amount at a time in the future.

Owners equity
whatever value is left after all liabilities have been paid.
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Revenues, Expenses, and Costs

Cost
The value given up to obtain something that you want.

Expense
A decrease in owners equity caused by consuming your product or service.

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Information Usefulness
Only two reasons to do accounting: 1. To produce information that is useful to you for managing your business 2. To meet legal or contractual requirements

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Why Does Accounting Matter?

MACRS rate
the Modified Accelerated Cost Recovery System lets taxpayers depreciate more of the cost earlier

Depreciation
Regular and systematic reduction in income that transfers asset value to expense over time.
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Accounting Systems for Small Business

Computerized systems simplify the accounting process by providing automatic error checking, entry screens that look like the common business forms, and automatic production of financial statements and management reports.

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Financial Reports
Financial statements
Formal summaries of the content of an accounting systems records of transactions.

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Financial Reports
Five common financial statements
Income statement Statement of retained earnings Statement of owners equity Balance sheet Cash flow statement

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Flow of Information in Financial Statements

Figure 13.1

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Financial Reports
Retained earnings
The sum of all profits and losses, less all dividends paid since the beginning of the business.

Articulate
The concept that information flows from the income statement through the statements of retained earnings and owners equity to the balance sheet.
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Everyday Financial Documents and Similar Financial Reports

Figure 13.2

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Financial Reports
Income statement
A statement that lists revenues and expenses and shows the amount of profit a business makes for a specified period of time.

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Organization of the Income Statement

Figure 13.3

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Typical Single-Step Format Income Statement

Figure 13.4A

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Typical Multiple-Step Income Statement

Figure 13.4B

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Financial Reports
Balance sheet
A statement of what a business owns (assets), what it owes to others (liabilities), and how much value the owners have invested in it (equity). Liquidity
A measure of how quickly a company can raise money through internal sources by converting assets to cash.
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Organization of the Balance Sheet

Figure 13.5

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Typical Balance Sheet

Figure 13.6

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Balance Sheet
Financial flexibility
A businesss ability to manage cash flows in such a manner that the company can respond appropriately to unexpected opportunities and needs.

Financial strength
The ability of a business to survive adverse financial events.

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Cash Flow Statement

Cash flow statement
A statement of the sources and uses of cash in a business for a specific period of time.

GAAP
Generally Accepted Accounting Principles are the standardized rules for accounting procedures used in all audits and submissions of accounting reports to the government.

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Typical Cash Inflows and Outflows on the Cash Flow Statement

Figure 13.7

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Cash Flow Statement

Operating activities
Activities involved in producing and selling goods and services.

Financing activities
Activities through which cash is obtained from and paid to lenders, owners, and investors.

Investing activities
The purchase and sale of land, buildings, equipment, and securities.

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Uses of Financial Accounting

Reporting to Outsiders

Record Keeping

Taxation

Control of Receivables

Analysis of Business Operations

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Uses of Managerial Accounting

External (cost) factors
Aspects of the world outside the business which could cause the businesss costs to change.

Internal (cost) factors

Aspects of or choices within the business which could cause the businesss costs to change.

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Uses of Managerial Accounting

Cost-volume-profit analysis
A managerial accounting 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, fixed costs

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Total Costs

Figure 13.8

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Breakeven Point
Breakeven point
The point at which total costs equal gross revenue.

Figure 13.11

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The Business Plan and the Budget Process

Budget
A financial plan for the future, based on a single level of operations; a quantitative expression of the use of resources necessary to achieve a businesss strategic goals. Pro forma indicates estimated or hypothetical information
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Budgeting Relationships

Figure 13.2
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The Business Plan and the Budget Process

Master budget
A budget which consists of sets of budgets that detail all projected receipts and spending for the budgeted period. also referred to as a comprehensive budget

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The Business Plan and the Budget Process

Cost of goods sold budget
A schedule that shows the predicted cost of product actually sold during the accounting period.

Activity-based cost estimates

An accounting method which assigns costs based on the different types of work a business does in order to sell a particular product or service.
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Controlling
Variance
The difference between an actual and budgeted revenue or cost

Variance analysis
The process of determining the effect of price and quantity changes on revenues and expenses.

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Controlling
Favorable/unfavorable variance
A label applied to variances to indicate their effect upon the income statement; Favorable variances would result in profits being greater than budgeted, all other things being equal; Unfavorable variances would result in profits being less than budgeted, all other things being equal.
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Decision Making
To make good decisions we need: 1. Good information 2. Efficient ways to condense information so it is understandable 3. Methods to help compare alternatives.

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