Chapter 8

ACCOUNTING &

Learning Objectives: -determine the difference between financial accounting and managerial accounting - explain the sources of business finance in an organization - appreciate the need for effective financial management in business

Learning Outcome: After studying this chapter successful student should be able to; -Differentiate financial accounting and managerial accounting. - State the various financial statements and its importance. -Understand purpose of budget -Identify five types of short-term and five types of longterm financial sources

Chapter Outline
8.1 Define accounting and finance 8.2 Differentiate between financial accounting vs managerial accounting 8.3 Financial statements Balance sheet, Income Statement, Cash Flow Statement, Budget 8.4 Sources of funds Short term (operating expenditure) and long-term (capital expenditure)

8.1 What Is Accounting?

A comprehensive system for collecting, analyzing and communicating financial information Bookkeeping: the recording of transactions
Users of Accounting Information: Business managers Employees and unions Investors and creditors Tax authorities Government regulatory agencies

8.1 What Is Finance?

Relates with activities:
Determining firm's long-term investments Obtaining funds to pay for those investments Conducting the firm's everyday financial activities Helping to manage the risks the firm takes.

8.2 Financial Accounting VS Managerial Accounting

Financial Accountingfield of accounting that
informs external users of a companys financial information shareholders, banks and suppliers (reporting past information about a business)

- using balance sheet, profit & loss statement, cash flow report to cover certain financial period. Eg: Balance sheet for the year ending 2010 of the company is printed in the shareholders annual report.

8.2 Financial Accounting VS Managerial Accounting

Managerial Accountingfield of accounting that

serves internal users of a companys financial

information. - Detailed internal accounts cash flow monitoring monthly basis, setting financial targets (reporting on-going business performance for future decisions) done as of when needed, not following financial period. Eg: Purchasing dept using monthly material costs to negotiate price with supplier.

8.3 Financial Statements

Financial statements provide managers with essential information they need to evaluate the liquidity position of an organization its ability to meet current obligations and needs by converting assets into cash, the firms profitability, and its overall financial health.

8.3 Financial Statements

1. Balance sheet statement of a firms financial position - what it owns and the claims against its assets - at a particular point in time. o Similar to a photograph of the firms assets together with its liabilities and owners equity at a specific moment in time

1. Balance sheet
Supply detailed information about:
Assets Current assets: Cash/assets that can be converted into cash within a year Fixed assets: Capital that has long-term use or value Intangible assets: Patents, trademarks, copyrights, etc. Liabilities Current liabilities: Debts that must be paid within one year, including accounts payable Long-term liabilities: Debts not due for at least a year Owners Equity Paid-in (invested) capital Retained earnings (net profits)

1. Balance sheet

8.3 Financial Statements

2. The Income Statement - Is a
financial record summarizing a firms financial performance in terms of revenues, expenses, and profits over a given time period. Reports the firms profit or loss results. Sometimes called a profit and loss, or P&L statement, begins with total sales or revenues generated during a year, quarter, or month

2. Income Statement (Profit and Loss Statement)

Supply detailed information about: Revenues: The funds that flow into a business from the sale of goods or services Cost of revenues: Shows the costs of obtaining the revenues from other companies during the year Cost of goods sold: Costs of obtaining materials to make products sold during the year Gross profit: Considers revenues and cost of revenues from the income statement Operating expenses: Resources that must flow out of a company if it is to earn revenues

2. Income Statement (Profit and Loss Statement)

Income Statement

8.3 Financial Statements

3. Statement of Cash Flow - Provides
investors and creditors with relevant information about a firms cash receipts and cash payments for its operations, investments, and financing during an accounting period. presents information on its sources and uses of cash.

3. Statement of Cash Flow

Supply detailed information about: Cash Flows from Operations: Concerns main operating activities: cash transactions involved in buying and selling goods and services. [Cash from customers - cash paid in carrying out the firms operating activities] Cash Flows from Investing: Net cash used in or provided by investing. [Cash paid to acquire noncurrent assets cash from any sale of noncurrent assets] Cash Flows from Financing: Net cash from all financing activities. [Cash from issues of long-term debt or new capital dividends paid out]

Inflows and Outflows of Cash

3. Statement of Cash Flow

Microsofts Cashflow

Examine the cash flow of the company for each year. What information does this provide for the company?

8.3 Financial Statements

4. Budget -
A detailed internal report on estimated receipts and expenditures for a future period of time to facilitate financial control. - relating use of resources to achieve specific targets over a given period of time . Most companies use their budgets for internal planning, controlling, and decision-making Known as financial report or forecast of income & expenditure to measure performance against plan

Purpose of Budget:
-Predictions about the future enable an organization to

determine its objectives & make plans to achieve them

-To set targets which will enable objectives to be achieved e.g. sales volume, for revenue & spending limits to control costs, effective allocation of resources -Monitor performance to ensure that targets are being

achieved & to enable corrective action to be taken where

this is not happening (Eg: Advertising expenditure more than budget?)

4. Sales Budget

Examine the cash position of the company by month in terms of total cash receipts. What information does this provide for the company?

Financial StatementsBalance Sheet Assets Liabilities = Owners Equity

Basic Accounting Equation

Income Statement Revenues Expenses = Profit (or Loss)

Statement of Cash Flows Cash In and Cash Out from Operating, Investing and Financing Budget Estimate Actual = Variance

Rapid Review - True or False

The four principle business activities of a business firm are (a) establishing goals and strategies (c) making investments (b) obtaining financing (d) conducting operations

An income statement provides information about a firms cashgenerating ability.

An income statement provides information about a firms profitability. Cash-generating ability information is provided by the Statement of Cash Flows. Major purposes of a budget is to make predictions, To set targets and to control financial performance.

Group Discussion
Assume you and your friends have started your own business using the training that you have received at college and the experience you and your friends have gained while working part time in a small business organization. Now the business is doing well and you and your friends plan to expand the business. Find a suitable sources of funds to finance your business expansion.

8.4 Sources Of Funds

Categorized according to length of time it is required for...

Short term funds

Long term funds

8.4 Short Term Funds

Working capital Trade credit Bank Loan Bank Overdraft Commercial paper

8.4 Short term funds

a) Working Capital

- the difference between the firms current assets

(stocks/inventories in hand, cash balances) and current liabilities (loans, trade credit given by supplier) - indicates the firms ability to pay off short-term debts to outsiders (suppliers & banks)

- liquid fund to maintain short term cash flow

4.1 Short term funds

b) Trade Credit
- good-faith agreement - when a company buys products or supplies on credit from its suppliers (postponing payment) E.g: Open-Book Credit - form of trade credit in which sellers ship merchandise on faith that payment will be forthcoming. Other documented agreement- promissory notes (legal doc stating amt to be paid before shipment) & trade draft (doc stating date & amt due, signed by the owner)

Example

8.4 Short term funds

c) Bank Loan - Fixed amount given for fixed period of time - If size & duration increase -collateral (form of securitylegal assets) required by lender - In case non-payment occur, banks earn outstanding loan value by selling asset (secured for loan) d) Bank overdraft - Business takes out more than it has banked - Withdraw limits set with interest payment for each amount - Used when business face short term cash flow problems

8.4 Short term funds

e) Commercial Paper

short-term securities, or notes, containing a borrower's promise to pay.

Buying companies pays less than face value

After maturity, issuing company buys back at face value

Matures in 270 days or less.
Eg: Co A issue comm paper at face value RM100,000. Co B buy & pay less (RM90,000). End of 90days, Co A buy back at face value (RM100,000). Co B gets profit (buy amt less than sell= RM10,000) and Co A gets lower interest rate than borrowing fm bank.

8.4 Long term funds

Venture capital Debt Financing - Corporate Bonds Debt Financing - Long term loans Equity Financing/Investment Capital Hybrid Financing

8.4 Long term funds

a) Venture Capitaloutside equity financing provided in return for part ownership of the borrowing firm. - Made available by venture capital companies - Usually for new small business undergoing rapid growth potential (difficulty to convince commercial banks on future prospect) - Due to high risk of investment, demand I/rates higher on returns

8.4 Long term funds

Debt Financing

- used to cover long-term expenses

such as assets (generally repaid in

more than one year). 2 types:

- Corporate Bonds

- Long term loans

8.4 Long term funds

b) Corporate Bonds - method of raising money - issuing organization borrows from an investor and issues a written pledge (IOU) to make regular interest payments & repay borrowed amount later. - Terms of a bond (in contract) - amount to be

paid, the interest rate, and the maturity date

*IOU= promise by issuer to pay buyer a certain amount of $$ by specific time in future with interest rate.

Examples- Bonds

8.4 Long term funds

c) Long-Term Loans

- usually issued by commercial banks. (Eg: CIMB, RHB etc) - financial managers try to time their borrowing to take advantage of drops in interest rates. - I/R is negotiated between borrower & lender. Some banks have fixed rate/ floating rate.

8.4 Long term funds

d) Investment Capital (Equity Financing)use of

common stock and/or retained earnings to raise

long-term funding (buy land, building and equipment) i. Common Stockselling ownership of company to raise money for investment/pay debt - stock owners get appreciation (increase in mkt value) or dividend( income after deduct taxes) Retained Earningsreinvesting profits in the company rather than issue a dividend

ii.

Example Common stock certificate

8.4 Long term funds

e) Hybrid Financing
- Preferred StockPreferred stock is a "hybrid" because it has some of the features of both corporate bonds and common stocks. - Like bonds, payment is fixed (e.g: $3 per share per year) but unlike bonds, it never matures (bonds have a maturity period) - Preferred Stockholders of have first right over common

stockholders to dividends (Preferred stockholders get

dividends first) - Corporate may withhold dividends during lean times

Example- Preferred stock certificate

THE END