Using Financial Information

Chapter and Accounting

Chapter 18
 Learning Goals

In this chapter students will be able to understand:

1. The concept of accounting and finance
2. The different transactions & their effects in business
3. The financial reports and their types of reports
4. The importance of income statement in business
5. The importance of balance sheet in business
Chapter 18

Management Quality Circle

Superior University Lahore
 Sources of Finance
• Owner’s Equity
– Ploughing back of profit
– Shares
– Initial investment
• Debt Financing
– Debenture
– Financial institution
– Customer advances
Chapter 18

Copyright ©2005 by South-Western, a

division of Thomson Learning. All rights 3
reserved
 Difference
• Principle of Accounting
• Cost Accounting
• Financial management
Chapter 18

Copyright ©2005 by South-Western, a

division of Thomson Learning. All rights 4
reserved
 Principles of Accounting

The process of collecting,

recording, classifying,
Accounting
summarizing, reporting,
and analyzing
financial activities.
Chapter 18

Management Quality Circle

Superior University Lahore
 The Accounting System
Chapter 18

Management Quality Circle

Superior University Lahore
 Types of Accounting system
Financial Accounting
Financial accounting focuses
on preparing external
Financial reports data used by
others, people who have any
interest in business but are
not part of management.

Accounting that provides

Managerial financial information that
Accounting managers inside the
organization can use to
evaluate and make decisions.
Chapter 18

Copyright ©2005 by South-Western, a

division of Thomson Learning. All rights 7
reserved
 Primary Financial Statements

Balance Sheet
Income Statement
Chapter 18

Management Quality Circle

Superior University Lahore
 The Accounting Equation
__ __
__ Owners’
Assets Liabilities
Equity

Things of value What a firm owes Investment in the

owned by a firm to its creditors firm minus
liabilities;
Net Worth
Chapter 18

Management Quality Circle

Superior University Lahore
 Balance
Sheet
Chapter 18

Management Quality Circle

Superior University Lahore
 The Balance Sheet

Resources of a company
(Assets)

Company’s obligations
Categories
(Liabilities)

Owners’ Equity
Chapter 18

Management Quality Circle

Superior University Lahore
 Assets
Cash
Marketable securities
Current assets Accounts receivable
Inventory

Land and buildings

Machinery and equipment
Fixed assets Furniture
Fixtures

Patents,
Copyrights
Intangible assets Trademarks
Chapter 18

Goodwill
Management Quality Circle
Superior University Lahore
 Liabilities
Accounts payable
Notes payable
Current liabilities Accrued expenses
Income taxes payable
Current portion of long-term debt

Long-term Bank loans

Mortgages on buildings
liabilities Company’s bonds sold to others
Chapter 18

Management Quality Circle

Superior University Lahore
 Owners’ Equity

 Owners’ total investment after

Owners’ Equity all liabilities have been paid
Chapter 18

Management Quality Circle

Superior University Lahore
 Income
Statement
Chapter 18

Management Quality Circle

Superior University Lahore
 The Income Statement

Revenues

Categories Expenses

Net Profit or Loss

Chapter 18

Management Quality Circle

Superior University Lahore
 Revenues
Gross sales:
The total dollar amount of a
company’s sales

Revenues
Net sales:
The amount left after
deducting sales discounts
and returns and allowances
from gross sales
Chapter 18

Management Quality Circle

Superior University Lahore
 Expenses
Cost of goods sold:
The total expense of buying
or producing the firm’s
goods or services

Expenses
Operating expenses:
The expenses of running a
business that are not directly
related to producing or
buying its products.
Chapter 18

Management Quality Circle

Superior University Lahore
 Net Profit or Loss
Obtained by subtracting a
firm’s expenses from
Net Income revenues (when revenues are
more than expenses)

Obtained by subtracting a
firm’s expenses from
Net Loss revenues (when expenses are
more than revenues)
Chapter 18

Management Quality Circle

Superior University Lahore
 Pay back period
• The length of time required to recover the cost of an
investment. The payback period of a given investment
or project is an important determinant of whether to
undertake the position or project, as longer payback
periods are typically not desirable for investment
positions.
• Calculated as:
• Payback Period = Cost of Project / Annual Cash
Inflows
•
source: investopedia.com dated: 11/02/13
Chapter 18

Copyright ©2005 by South-Western, a

division of Thomson Learning. All rights 20
reserved
 Break even point
• It is the point in business cycle where net cost
is equal to its net revenue. This point is called
“no profit no loss” situation.
• Break Even Sales in Rs. = Fixed Cost / 1 –
(Variable Cost / Sales)
• Source: accounting4management.com dated:
11/2/13
Chapter 18

Copyright ©2005 by South-Western, a

division of Thomson Learning. All rights 21
reserved
 Benefits / Advantages of Break Even Analysis:

• The main advantages of break even point

analysis is that it explains the relationship
between cost, production, volume and returns. It
can be extended to show how changes in fixed
cost, variable cost, commodity prices, revenues
will effect profit levels and break even points.
Break even analysis is most useful when used
with partial budgeting, capital budgeting
techniques. The major benefits to use break even
analysis is that it indicates the lowest amount of
business activity necessary to prevent losses.
Chapter 18

Copyright ©2005 by South-Western, a

division of Thomson Learning. All rights 22
reserved