Accounting Basics - Kevin Nott

Profit Point LLC 2008

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


A Crash Course in Accounting


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


The Chart of Accounts

• Systematic listing of all accounts

• Accounts are named and usually numbered

• Called General Ledger accounts or GL accounts


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


Assets

• Assets are a use of financial resources

• Owned property -- tangible and intangible with market value

• Classified as Current or Fixed


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


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


Liabilities

• Liabilities are a source of financial resources

• Debts of the organization

• Classified as Current or Long-Term


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


Long-Term Liabilities

• Obligations that will not be paid or converted to revenue within the next 12 months

• Examples: Mortgages, Long-term Bank Loans


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)


Revenue

• Revenue is a source of financial resources

• Sales of goods and services

• Amount the customer is charged


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)


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)


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


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


Introducing:Debits and Credits

The accounting terms used to describe the two sides of the transaction are debits and credits.


Debit

• The side of the transaction that records the use of the financial resource

• Abbreviated as DR


Credit

• The side of the transaction that records the source of the financial resource

• Abbreviated as CR


All Things Must Be Equal

• Uses = Sources

• Debits = Credits


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


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


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


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


The Accounting Equation

Assets = Liabilities + Owners’ Equity

where

Owners’ Equity includes accumulated profits (losses)

and

Revenue - expenses = profit (loss)


Making Sense of it all with Financial Reports

Reports that show the financial situation of an organization

• Balance Sheet

• Income Statement


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


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


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


The Reporting Year

• Calendar Year -- Jan 1 to Dec 31

• Fiscal Year -- Any other annual period


Reporting Frequency

• Depends upon the needs of the organization

• Shorter periods provide more timely information

• Longer periods smooth out aberrations

• Most organizations employ both


Cash versus Accrual

• Cash Basis Accounting: Recognize revenue and expenses when cash is exchanged

• Accrual Basis: Recognize revenue and expenses when earned or incurred


The Matching Principle

Expenses must be recognized in the same accounting period as the revenue they generate


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


Best Practices

• The theoretic “Best” way to do something

• The most efficient and effective method of accomplish a task

• A benchmark for performance


Gross Profit

• Variable profit

• Sales less cost of sales

• Measured in dollars and percentage (margin)


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


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 %


Working Capital

• Measures the amount of Cash that is available to fund operations

Calculating Working CapitalCurrent Assets – Current Liabilities


Current Ratio

• Measures the organizations ability to pay it’s current obligations

• Should be greater than 1

Calculating Current RatioCurrent Assets / Current Liabilities


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


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


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


Help is Available

• Your Accountant

• Local colleges

• School District extension services

• Profit Point LLC– Kevin Nott– 850-1716– [email protected]

Date post:	07-Nov-2014
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Accounting Basics - Kevin Nott

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