Accounting: Measuring how Efficiently and Effectively

Resources are Creating Value and Profit

© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/IrwinIntroduction to Business

Chapter Fourteen

14 - 3

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

1. Explain how the success of a company’s business model can be measured by financial accounts and describe the various kinds of activities that accounting perform.

2. Analyze a company’s balance sheet and describe how it balances the assets a company owns against the capital owed to its creditors and stockholders.

3. Explain how the income statement is used to measure a company’s bottom line profit and the various costs and expenses that must be deducted to arrive at this total.

4. Understand the need for cash, as well as profit, affects a company’s business model, and how the cash flow statement measures the cash that flows into and out of a company.

5. Appreciate how financial ratios can be used to analyze the information in company’s financial statements and how they help both managers and investors evaluate a company’s current and future profitability.

14 - 4

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

ROIC• Accurate measure of company’s profitability • Increasing profitability and sales suggests customer value

and a competitive advantage• Evaluate ROIC and relate to creating value and profit.

Explain its significance • Evaluate the ROIC calculation and relate to creating

value and profit. Explain its significance

14 - 5

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

GAAP• Accounting is a process of collecting, measuring and

recording data in an organized method or generally accepted accounting principles (GAAP)

• Evaluate GAAP and relate to creating value and profit. Explain its caveat significance

14 - 6

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

GAAP• For example, the matching principle requires that

expenses incurred be deducted from the revenue within the same time period.

14 - 7

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

GAAP• Also the revenue is stated in the time frame when the

sale is made not when the customer pays for the sale and companies must follow this accrual basis of accounting

14 - 8

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

GAAP• This data is analyzed and then reported the results

into financial reports and statement

14 - 9

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Accounting System• The financial information system used to measure,

record, analyze and report all the transactions involved in its value-creation process

• All company stakeholders are interested in the financial report and statements resulting from the accounting function

• Stockholders, managers, and employees all use these statements to analyze the financial health and improve company performance

14 - 10

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Accounting System• Employees, even if not stockholders, are concerned

the company will be able to reward and employ them in the future

• Evaluate the illustration of a cost accounting system (scroll down the page) and relate how it contributes value and profit. Why is it illustrated as a puzzle?

14 - 11

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Accounting Activities• Is a hierarchy of data information and knowledge• Bookkeeping is the recording activity needed to

monitor and track all financial transactions• Depreciation is the process of reducing the value of

the asset over time as it is used

14 - 12

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Accountants • Companies employ accountants, both internal and

external, and certified professionals (CPA)• To perform the accounting activities necessary to meet

strict professional and legal requirements • Evaluate the role of Accounting and relate to the AON

video

14 - 13

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Accountants• The Sarbanes-Oxley Act of 2002 added to these

requirements necessitating the CEO as well as others to sign off (thereby legally liable) on all financial statements

14 - 14

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Accountants• Financial accountants who specialize in

preparing and analyzing financial data for use by managers

• Financial accountants who specialize in preparing financial data for use by stakeholders

• Evaluate the role of Franchising in Accounting and relate to creating value and profit

14 - 15

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Financial Statements• Managers of all levels use accounting financial

statements and need to understand the accounting methods used to prepare these statementsBalance sheetIncome statementStatement of cash flows

14 - 16

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Financial Statements• The balance sheet is a summary of the financial

conditions of a company for a specific time and as of a specific day (think of a “snapshot” or a still picture)

• Evaluate the role/purposes of personal financial statements and relate to creating value to you

14 - 17

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

The Accounting Equation

• Assets minus liabilities equals owner equity• Assets are the resources a company owns from cash to all

investments• Liabilities are the financial obligations a company incurs

from purchasing or borrowing to obtain capital• The other main source of a company’s capital is its

stockholder’s equity which is the total capital invested by its founders and stockholders

14 - 18

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

The Accounting Equation • This equation is balanced by double entry

bookkeeping which records the dual effects of a financial transaction on a company’s assets and liabilities

• Evaluate the efficiency and effectiveness of the accounting equation and relate how it creates value and profit to the business organization

14 - 19

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Key Terms• Current liabilities are debts due and payable within

one year• Total equity is the sum of the capital stock invested

and retained earnings

14 - 20

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Key Terms• Liquidity is how fast an asset can be converted to cash

and may be categorized as current (working) or long term assets

14 - 21

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Income Statement• Reports the results of a company’s profitability and

may be called a profit and loss statement

14 - 22

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Income Statement• The basic equation of sales revenue minus expenses

equals profit (or loss) is used on this statement to determine the bottom line profit or the amount of net income (or profits or earnings)

14 - 23

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Cash Flow Statement • Shows how much cash a company generates during a

specific financial period, and how it is used

14 - 24

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Cash Flow Statement• In accounting cash refers to the value of a company’s

assets that can be converted into cash immediately

14 - 25

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Financial Ratios• Measures of different aspects of a company's

performance and profitability and categorized as liquidity, asset management and profitability ratios

14 - 26

Chapter 14Accounting: Measuring how Efficiently and

Effectively Resources are Creating Value and Profit

Financial Ratios• Note that gross margin indicates how much of each

sales dollar remains after deducting cost of goods sold from sales