Accounting and Finance

Basic Concepts
Prof. Eliseo A. Aurellado, CPA, MBA, PhD

Definitions
Accounting - financial information system for decisionmaking. Objective: Wealth measurement Finance - science of the management of cash and other assets Objective: Creation of wealth

Exploring Wealth
How do you define wealth? How rich are you?

Concept of Wealth
Assets things OF VALUE that we OWN
Liabilities things OF VALUE that we OWE OWN OWE = NET WORTH NET WORTH = WEALTH

Nature of Accounting
Definition: Process of identifying, measuring, and communicating economic information to perform informed judgments and decisions by users of the information Language of business As old as the merchants of Venice Governed by principles and conventions

Exh. 1-1

Accounting
Accounting System (accumulates financial and managerial accounting data)
Managerial Accounting Information for decision making, and control of an organizations operations. Internal Users Financial Accounting Published financial statements and other financial reports. External Users

Accounting Process Flow

Dual-entry bookkeeping process Economic Event or Transaction Journalizing (Accounting entry in journals )

Posting (T-accounts in Ledger)

Trial Balance

Financial Statements

USERS Stockholders Managers Regulatory agencies - BIR - SEC Investors Creditors Employees

FS INFORMATION NEEDED Equity value of the business Business performance/ Growth and sustainability Taxable income Financial reporting compliance Dividends and price appreciation Liquidity, solvency indicators Benefits and security of tenure

Accounting Equation = Liabilities + Equity or Assets - Liabilities = Equity Assets

The Business Equation

Revenues - Costs = Profit

Typical Balance Sheet

Assets Cash P 50,000 Receivables 600,000 Inventory 250,000
Current Assets 900,000

Liabilities & Equity Accts payable P600,000 Other payables 100,000

Current Liabilities 700,000

PPE Investments

2,300,000 700,000

Long-term Debt 2,000,000 Stockholders Equity

Common stock Retained earnings Total S/E Total Liab.& Equity 1,000,000 200,000 1,200,000 P 3,900,000 =========

Total Assets

P3,900,000 =========

Typical Income Statement

Sales Cost of Sales Gross profit Operating expenses
Selling Administrative

P 1,200,000 940,000 260,000

P60,000 100,000

160,000 100,000

Earnings before interest & taxes

Interest Taxes 30,000 21,000

Net income

51,000 P 49,000
==========

Typical Cash Flow Statement

Cash flow from operating activities
Net income Add (deduct): Depreciation Decrease in accounts recble Increase in inventories Increase in prepaid expenses Decrease in accrued wages P540,000 60,000 40,000 (240,000) ( 10,000) (50,000)

P 340,000

Cash flow from investing activities

Sale (purchase of plant and equipment) 2,400,000
1,000,000 ( 3,500,000) (1,000,000)

Cash flow from financing activities

Issuance of bonds payable Repayment of long-term debt Payment of dividends Net increase (decrease) in cash for the period (3,500,000) P (760,000) =========

Concepts
Operating Cycle

Operating Cycle
Cash (Alpha) Merchandise Inventory Accounts receivable Cash (Omega)

Operating Cycle
Inventory turnover (Days in inventory) Accounts receivable (Days in receivable) Operating cycle = Days in inventory + Days in receivable

Concepts
Liquidity

Typical Balance Sheet

Assets
Cash Receivables Inventory
Current Assets

Liabilities & Equity

Accts payable Other payables
Current Liabilities

P 50,000 600,000 250,000

900,000

P600,000 100,000
700,000

Current assets/ current liabilities = 900,000/ 700,000

= 1.28 : 1
= Current Ratio

Typical Balance Sheet

Assets
Cash Receivables Inventory
Current Assets

Liabilities & Equity

Accts payable Other payables
Current Liabilities

P 50,000 600,000 250,000

900,000

P600,000 100,000
700,000

Cash + receivables / current liabilities = 650,000/ 700,000

= 0.92 : 1
= Acid-test Ratio

Concepts
Solvency

Solvency -Typical Balance Sheet

Assets
Cash Receivables Inventory
Current Assets

Liabilities & Equity

Accts payable P600,000 Other payables 100,000
Current Liabilities 700,000

P 50,000 600,000 250,000

900,000

Long-term Debt 2,000,000 Capital stock

Common stock 1,000,000 Retained earnings 200,000 Total S/E 1,200,000 Total Liab.& Equity P 3,900,000 =========

PPE Investments

2,300,000 700,000

Total Assets

P3,900,000 =========

Solvency -Typical Balance Sheet

Assets
Cash Receivables Inventory P 50,000 600,000 250,000
900,000

Liabilities & Equity

Accts payable P600,000 Other payables 100,000
Current Liabilities 700,000

Current Assets

PPE Investments

2,300,000 700,000

Long-term Debt 3,600,000 Capital stock

Common stock Deficit Total S/E 1,000,000 (1,400,000) ( 400,000)

Total Assets

P3,900,000 =========

Total Liab.& Equity P 3,900,000 =========

Leverage
Sales

Debt Lever

Weight

Fulcrum

Equity

Management

Turnover

Concepts
Profitability

ROI

ROI
Return on Assets Net income/ Total Assets Return on Equity Net income/ StockholdersEquity

Du Pont Analysis
ROE = Net income X Sales
Sales Assets

Assets

Equity Equity multiplier

Profit margin Asset TO