Accounting Basics - Kevin Nott

Accounting Basics for Non-Financial Individuals

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

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

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 Analysis Making 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 Expenses Revenue = Fixed Expenses / Gross Margin %

Working Capital Measures the amount of Cash that is available to fund operations Calculating Working Capital Current Assets – Current Liabilities

Current Ratio Measures the organizations ability to pay it’s current obligations Should be greater than 1 Calculating Current Ratio Current 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 Equity Total 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_address]

Accounting Basics - Kevin Nott

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Accounting Basics - Kevin Nott