Current vs. Long-Term Often, the assets and liabilities on a balance sheet will be broken down into current assets or liabilities and long-term assets or liabilities. Current assets are those that are expected to be converted into cash within 12 months or less. Typical current assets include Accounts Receivable, Cash, and Inventory. Sometimes, long-term assets are referred to, understandably, as non-current assets. Property, Plant, and Equipment is a long-term asset account.
Current liabilities are those that will need to be paid off within 12 months or less. The most common example of a current liability is Accounts Payable. One column shows the balances as of the end of the most recent accounting period, and the adjoining column shows the balances as of the prior period-end.
This is done so that a reader can see how the financial position of the company has changed over time. For example, looking at the balance sheet on the following page we can learn a few things about the health of the company.
Overall, it appears that things are going well. The only thing that might be of concern is an increase in Accounts Receivable. An increase in Accounts Receivable could be indicative of trouble with getting clients to pay on time.
Any asset that is not a current asset is a non-current a. By default, any liability that is not a current liability is a long-term liability. This is in contrast to the balance sheet, which shows financial position at a point in time. A frequently used analogy is that the balance sheet is like a photograph, while the income statement is more akin to a video. Cost of Goods Sold CoGS is the amount that the company paid for the goods that it sold over the course of the period.
All of his costs are overhead— that is, each additional return he prepares adds nothing to his total costs—so he has no Cost of Goods Sold. His Gross Profit is simply equal to his revenues.
Operating Income vs. Non-Operating Expenses are those that are unrelated to the regular operation of the business and, as a result, are unlikely to be incurred again in the following year. A typical example of a Non-Operating Expense would be a lawsuit. The effect of this focus on Operating Income as opposed to Net Income has been to cause many companies to make efforts to classify as many expenses as possible as Non-Operating with the intention of making their Operating Income look more impressive to investors.
See example on following page. Its retained earnings statement for the year would look as follows. It takes information from the income statement, and it provides information to the balance sheet. When first learning accounting, many people are tempted to classify dividend payments as an expense. Unlike many other cash payments, however, dividends are simply a distribution of profits as opposed to expenses, which reduce profits. Because they are not a part of the calculation of net income, dividend payments do not show up on the income statement.
Instead, they appear on the statement of retained earnings. For instance, profits are frequently reinvested in growing the company by purchasing more inventory for sale or purchasing more equipment for production. They are a distribution of profits. Cash Flow Statement vs. Income Statement At first, it may sound as if a cash flow statement fulfills the same purpose as an income statement. There are, however, some important differences between the two.
First, there are often differences in timing between when an income or expense item is recorded and when the cash actually comes in or goes out the door. In September, this sale would be recorded as an increase in both Sales and Accounts Receivable. And the sale would show up on a September income statement. The second major difference between the income statement and the cash flow statement is that the cash flow statement includes several types of transactions that are not included in the income statement.
The loan will not appear on the income statement, as the transaction is neither a revenue item nor an expense item. It is simply an increase of an asset Cash and a liability Notes Payable. As discussed in Chapter 4, dividends are not an expense.
Therefore, the dividend will not appear on the income statement. It will, however, appear on the cash flow statement as a cash outflow. Categories of Cash Flow On a cash flow statement such as the example on page 39 all cash inflows or outflows are separated into one of three categories: 1. Cash flow from operating activities, 2. Cash flow from investing activities, and 3. Cash flow from financing activities. Cash Flow from Operating Activities The concept of cash flow from operating activities is quite similar to that of Operating Income.
The goal is to measure the cash flow that is the result of activities directly related to normal business operations i. Cash Flow from Investing Activities Cash flow from investing activities includes cash spent on—or received from—investments in financial securities stocks, bonds, etc. For the most part, this work is done by calculating and comparing several different ratios. Liquidity Ratios Liquidity ratios are used to determine how easily a company will be able to meet its short-term financial obligations.
Generally speaking, with liquidity ratios, higher is better. The difference between quick ratio and current ratio is that the calculation of quick ratio excludes inventory balances. This is done in order to provide a worst-case-scenario assessment: How well will the company be able to fulfill its current liabilities if sales are slow that is, if inventories are not converted to cash? However, a quick ratio of only 0. But the two businesses are of such different sizes that the comparison is rather meaningless, right?
For example, comparing the gross profit margin of two different grocery stores can give you an idea of which one does a better job of keeping inventory costs down. Gross profit margin comparisons across different industries can be rather meaningless.
For instance, a grocery store is going to have a lower profit margin than a software company, regardless of which company is run in a more cost-effective manner. Financial Leverage Ratios Financial leverage ratios attempt to show to what extent a company has used debt as opposed to capital from investors to finance its operations. There is, however, something to be gained from using leverage. The more highly leveraged a company is, the greater its return on equity will be for a given amount of net income.
In short, the question of leverage is a question of balance. Being more highly leveraged i. On the other hand, financing a company primarily with loans is obviously a risky way to run a business. Asset Turnover Ratios Asset turnover ratios seek to show how efficiently a company uses its assets. The two most commonly used turnover ratios are inventory turnover and accounts receivables turnover.
Average collection period is exactly what it sounds like: the average length of time that a receivable from a customer is outstanding prior to collection. Obviously, higher receivables turnover and lower average collection period is generally the goal. The two most frequently used liquidity ratios are current ratio and quick ratio. Return on assets and return on equity are the most important profitability ratios.
Inventory turnover and receivables turnover are the most important turnover ratios. The goal of GAAP is to make it so that potential investors can compare financial statements of various companies in order to determine which one s they want to invest in, without having to worry that one company appears more profitable on paper simply because it is using a different set of accounting rules. All publicly traded companies are required by the Securities and Exchange Commission to follow GAAP procedures when preparing their financial statements.
Governmental entities are required to follow GAAP as well. That said, there are a different set of GAAP guidelines created by a different regulatory body for government organizations. So, while they are following GAAP, their financial statements are quite different from those of public companies. For each transaction, one entry is made either an increase or decrease in the balance of cash in the account.
Likely the single most important aspect of GAAP is the use of double-entry accounting, and the accompanying system of debits and credits. With double-entry accounting, each transaction results in two entries being made. Like this duology has totally filled my creative well. I am heart eyes and my heart so so full and!!!! It honestly feels like my heart is going to explode.
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