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What is Accounting?
• The practice of recording financial activity of an organization or individual
• The measure of sources and uses of financial resources
• Tool used for making economic decisions about the entity
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A Crash Course in Accounting
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Basic Measuring Tool:The Account
• Accounts are “buckets” used to classify and accumulate the results of similar transactions
• Each transaction adds to or takes away from the balance in the “bucket”
• The quantity of accounts used depends upon wants and needs for accounting detail
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The Chart of Accounts
• Systematic listing of all accounts
• Accounts are named and usually numbered
• Called General Ledger accounts or GL accounts
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Types of Accounts
• Assets
• Liabilities
• Equity
• Revenue
• Expenses
• Each account is classified as one of these types
• Each account type is a source or use of financial resources
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Assets
• Assets are a use of financial resources
• Owned property -- tangible and intangible with market value
• Classified as Current or Fixed
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Current Assets
• Assets that will be converted to cash or expenses within 12 months during the normal course of business
• Listed in order of liquidity (how quickly it can be converted into cash)
• Examples: Cash, Accounts Receivable, Inventory, Prepaid Expenses
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Fixed Assets
• Assets that will not be converted to cash or expensed within the next 12 months
• Depreciated or amortized (expensed) over the life of the asset
• Examples: Furniture, Buildings, Vehicles
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Liabilities
• Liabilities are a source of financial resources
• Debts of the organization
• Classified as Current or Long-Term
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Current Liabilities
• Obligations that will be paid for or converted to revenue with the next 12 months as a normal course of business
• Listed in order of maturity• Examples: Accounts Payable,
Payroll Taxes, Short-term Bank Loans
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Long-Term Liabilities
• Obligations that will not be paid or converted to revenue within the next 12 months
• Examples: Mortgages, Long-term Bank Loans
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Equity
• Equity is a source of financial resources
• Investment by owners into the organization
• Equity has two parts– Paid in capital (Stock)– Retained Earnings (Profits left in the
business by the owners)
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Revenue
• Revenue is a source of financial resources
• Sales of goods and services
• Amount the customer is charged
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Expenses
• Expenses are a use of financial resources
• Costs incurred in the normal course of business
• Two types of expenses– Cost of Goods Sold (Direct, Variable)– Overhead (Fixed, Indirect, SG&A)
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Cost of Goods Sold
• Directly associated with revenue (sales) from the same period
• Fluctuate proportionately with revenue• Examples:
– Labor on a job (including burdens)– Building materials– Permits– Subcontracted work– Sales commissions (including burdens)
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Fixed Costs
• Costs that do not fluctuate periodically with revenue
• Semi-variable costs that cannot be assigned directly to revenue
• Examples: – Marketing costs– Office staff wages– Building rent– Vehicle leases– Office supplies
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Recording Transactions with Double Entry
• Every accounting transaction has two sides -- the source of the resource and the use of the resource
• The two sides are equal and offsetting
• Both sides must be recorded
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Introducing:Debits and Credits
The accounting terms used to describe the two sides of the transaction are debits and credits.
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Debit
• The side of the transaction that records the use of the financial resource
• Abbreviated as DR
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Credit
• The side of the transaction that records the source of the financial resource
• Abbreviated as CR
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All Things Must Be Equal
• Uses = Sources
• Debits = Credits
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The Trial Balance Shows it All
• A trial balance is a listing of all accounts and their account balances
• Debit balances are listed in the debit column
• Credit balances are listed in the credit column
• The two columns MUST equal -- Balance
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Transaction Entry Types
Account Type
Increase With
Decrease With
Source /Use
Asset Debit Credit Use
Liability Credit Debit Source
Equity Credit Debit Source
Revenue Credit Debit Source
Expense Debit Credit Use
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Example
A new service van is purchased using a bank loan for the full amount of the
purchase price• We record an increase (debit) to
Vehicles (Asset) for the purchase price of the van
• We record an increase (credit) to Bank Loans (Liability) for the amount borrowed
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Let’s add a twist
We borrow money to purchase the van but we have a cash down payment as well
• We record an increase (debit) to Vehicles (Asset) for the purchase price of the van
• We record an increase (credit) to Bank Loans (Liability) for the amount borrowed
• We record a decrease (credit) to Cash (Asset) for the amount of the down payment
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The Accounting Equation
Assets = Liabilities + Owners’ Equity
where
Owners’ Equity includes accumulated profits (losses)
and
Revenue - expenses = profit (loss)
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Making Sense of it all with Financial Reports
Reports that show the financial situation of an organization
• Balance Sheet
• Income Statement
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Balance Sheet
Statement of Current Financial Condition• Standardized format• Is a “snap shot” of the organization’s
financial position at that moment in time• Used to demonstrate the financial
makeup of an organization• Shows current and long-term assets
and liabilities
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Income Statement
Statement of Profit and Loss• Representation of financial activity over
a period of time• Demonstrates organizations ability to
generate financial resources (profits) from operations
• Net balances are transferred to Equity on the Balance Sheet at the end of each period
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Periodic Reporting
• An organization’s “life” is divided into segments called accounting periods.
• Most common periods are month, quarter and year
• A reporting is made at the conclusion of the accounting period
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The Reporting Year
• Calendar Year -- Jan 1 to Dec 31
• Fiscal Year -- Any other annual period
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Reporting Frequency
• Depends upon the needs of the organization
• Shorter periods provide more timely information
• Longer periods smooth out aberrations
• Most organizations employ both
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Cash versus Accrual
• Cash Basis Accounting: Recognize revenue and expenses when cash is exchanged
• Accrual Basis: Recognize revenue and expenses when earned or incurred
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The Matching Principle
Expenses must be recognized in the same accounting period as the revenue they generate
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Financial AnalysisMaking Sense of Financial Statements
• Financial statements have meaning
• They tell a story
• They help in looking at the future
• A close look often reveals hidden and unknown facts critical to the organization
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Best Practices
• The theoretic “Best” way to do something
• The most efficient and effective method of accomplish a task
• A benchmark for performance
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Gross Profit
• Variable profit
• Sales less cost of sales
• Measured in dollars and percentage (margin)
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Net Profit
• Net Profit is gross profit less fixed expenses
• Profit left after all expenses are paid
• Net profit becomes equity at the end of each accounting period
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Breakeven Revenue
• The projected revenue needed to pay all fixed (overhead) expenses
• After breakeven, all additional Gross Profit = Net Profit
Calculating Breakeven(Revenue x Gross Margin %) – Fixed Expenses = 0
Revenue x Gross Margin % = Fixed ExpensesRevenue = Fixed Expenses / Gross Margin %
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Working Capital
• Measures the amount of Cash that is available to fund operations
Calculating Working CapitalCurrent Assets – Current Liabilities
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Current Ratio
• Measures the organizations ability to pay it’s current obligations
• Should be greater than 1
Calculating Current RatioCurrent Assets / Current Liabilities
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Debt to Equity Ratio
• Measures the indebtedness of the organization
• Excessive debt is dangerous as it carries payment obligations
• Smaller is better
Calculating Debt to EquityTotal Liabilities / Total Equity
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Return on Assets
• Assets are the resources used by an organization to earn a profit
• Return on Assets measures how effective the assets are used
• Measured as a percentage• Larger is better
Calculating ROA(Net Profit / # months in period x 12) / Total Assets
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Return on Equity
• Equity represents the owners investment in the organization
• Often called Return on Investment or ROI• ROI measures the profit that is generated on
the owners investment• Bigger is better
Calculating ROI(Net Profit / # months in period x 12) / Equity
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Help is Available
• Your Accountant
• Local colleges
• School District extension services
• Profit Point LLC– Kevin Nott– 850-1716– [email protected]