Question

1. What is the difference between accounting and bookkeeping?

Part 1 -Balance Statement

2. What is the basic accounting equation? What is the purpose of a balance sheet (what does it show a business person; how is it used)?

3. Why is it that the assets always equals the total of liabilities and owner's equity? Explain this in your own words

. 4. Use an example of a person who is buying a house to illustrate why assets always equals owner's equity plus liabilities.

Part 2 - Income Statement

5. Explain what an income statement is and how it is used by a business person. Is this something prepared once a year, every month, every week? Explain.

6. What is a Statement of Cash Flows?

Part 3 - Using Ratios It’s important to use ratios to understand a business's financial health. Examples include liquidity ratios, leverage ratios, profitability ratios and activity ratios

. 7. Which of the four types of ratios do you believe is the most insightful to really understanding the financial health of a business? Explain why you believe the ratio you picked is more useful than the other ratios discussed. For example, if you state you believe leverage (debt) ratios are most important to really seeing how financially healthy a business is, why are these ratios more important than the liquidity, profitability, or activity ratios?

Explain your answer. Explain your reasoning. To support your answer, find a source online that provides additional information to help you answer this question. Properly cite to the source. Remember, pasting in a URL is not a proper citation for a source.

Answer 1

1. Difference between accounting and bookkeeping

Definition	Bookkeeping is mainly related to identifying, measuring, and recording, financial transactions	Accounting is the process of summarizing, interpreting, and communicating financial transactions which were classified in the ledger account
Decision Making	Management can't take a decision based on the data provided by bookkeeping	Depending on the data provided by the accountants, the management can take critical business decisions
Objective	The objective of bookkeeping is to keep the records of all financial transactions proper and systematic	The objective of accounting is to gauge the financial situation and further communicate the information to the relevant authorities
Preparation of Financial Statements	Financial statements are not prepared as a part of this process	Financial statements are prepared during the accounting process
Skills Required	Bookkeeping doesn't require any special skill sets	Accounting requires special skills due to its analytical and complex nature
Analysis	The process of bookkeeping does not require any analysis	Accounting uses bookkeeping information to analyze and interpret the data and then compiles it into reports
Types	Basically there are two types of bookkeeping - Single entry and double entry bookkeeping	The accounting department does preparations of a company's budgets and plans loan proposals
Bookkeepers and Accountants	Bookkeepers are required to be accurate in their work and knowledgeable about financial topics. Bookkeepers work is usually overseen by an accountant	Accountants with sufficient experience and education can obtain the title of Certified Public Accountant (CPA)

basic accounting equation

From the large, multi-national corporation down to the corner beauty salon, every business transaction will have an effect on a company's financial position. The financial position of a company is measured by the following items:

1. Assets (what it owns)
2. Liabilities (what it owes to others)
3. Owner's Equity (the difference between assets and liabilities)

The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a sole proprietorship is:

ASSET = LIABILITIES + OWNERS EQUITY

The accounting equation for a corporation is:

ASSET = LIABILITIES + STOCK HOLDERS EQUITY

Assets are a company's resources—things the company owns. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill. From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner's (or stockholders') equity. Liabilities are a company's obligations—amounts the company owes. Examples of liabilities include notes or loans payable, accounts payable, salaries and wages payable, interest payable, and income taxes payable (if the company is a regular corporation). Liabilities can be viewed in two ways: (1) as claims by creditors against the company's assets, and (2) a source—along with owner or stockholder equity—of the company's assets. Owner's equity or stockholders' equity is the amount left over after liabilities are deducted from assets:

Assets - Liabilities = Owner's (or Stockholders') Equity.

The purpose of a balance sheet

A balance sheet shows your business’s assets, liabilities and shareholder equity at a specific moment. An asset is anything that has value, such as equipment, real estate or cash in your bank account. Liabilities are money you owe others, such as a mortgage on property and the balance of loans and debts to suppliers. Accrued taxes and payroll that you owe are also liabilities. Equity is the difference between the assets and liabilities – what would be leftover to repay original investors. In the case of a sole proprietorship, the equity would be the amount you, the owner, would receive if you sold all your assets and paid all your liabilities.

Banks want to see balance sheets and income statements to determine if you’re earning enough to repay the loan you’re requesting. If you want to open an account with a vendor, they may ask to see these financial statements to verify that you’re making a profit, so the vendor is less likely to stuck with unpaid bills. Balance sheets and income statements can highlight trouble areas, such as chronic late payment fees for bills, or back taxes that you owe. If the income statement shows a high rate of returns, this could point to problems with your product that need to be addressed. While an occasional loss, especially in the early days of a business, may not be a concern, a string of losses after a period of profitability may mean you’re digging a financial hole you can’t climb out of without making drastic changes. A financial adviser or business mentor can review your financial statements with you and help you make wise decisions for your business.

Why is it that the assets always equals the total of liabilities and owner's equity

The primary reason that the balance sheet balances is the double-entry accounting system, which has evolved over hundreds of years from simple T accounts used in medieval Italy. For every entry, a balancing entry is made, preserving the balance. The basis for this system is that assets are recorded at their historical cost basis -- the price for which they were purchased -- meaning increases in market value are not reflected on the balance sheet. Besides financing activities, only earnings or losses affect shareholders' equity, and earnings or losses are balanced by the increases or decreases in assets and liabilities that generated them.

Understanding the nature of cash inflows and outflows helps to shed light on the perpetually balanced nature of the balance sheet. An increase in assets represents an outflow of cash. For example, if inventory increases, it is because a cash expenditure is made to purchase the inventory. The increase in inventory is offset by the decrease in cash. Both inventory and cash are assets, so the two wash out, having no impact on the balance with liabilities and equity. Similarly, an increase in liabilities reflects an inflow of cash. For example, debt is a liability. If you record new debt to the balance sheet, this reflects a corresponding increase in borrowed cash. In this case, assets (cash) increase the same amount as liabilities (debt).

what an income statement

The income statement presents the financial results of a business for a stated period of time. The statement quantifies the amount of revenue generated and expenses incurred by an organization during a reporting period, as well as any resulting net profit or loss. The income statement is an essential part of the financial statements that an organization releases. The other parts of the financial statements are the balance sheet and statement of cash flows.

The income statement may be presented by itself on a single page, or it may be combined with other comprehensive income information. In the latter case, the report format is called a statement of comprehensive income.

There is no required template in the accounting standards for how the income statement is to be presented. Instead, common usage dictates several possible formats, which typically include some or all of the following line items:

• Revenue

• Tax expense

• Post-tax profit or loss for discontinued operations and for the disposal of these operations

• Profit or loss

• Other comprehensive income, subdivided into each component thereof

• Total comprehensive income

What is a Statement of Cash Flows

What is the Statement of Cash Flows?

The Statement of Cash Flows (also referred to as the cash flow statement) is one of the three key financial statements that report the cash generated and spent during a specific period of time (e.g., a month, quarter, or year). The statement of cash flows acts as a bridge between the income statement and balance sheet by showing how money moved in and out of the business.

Three Sections of the Statement of Cash Flows:

1. Operating Activities: The principal revenue-generating activities of an organization and other activities that are not investing or financing; any cash flows from current assets and current liabilities
2. Investing Activities: Any cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents
3. Financing Activities: Any cash flows that result in changes in the size and composition of the contributed equity capital or borrowings of the entity (i.e., bonds, stock, dividends)

Cash Flow: Inflows and outflows of cash and cash equivalents (learn more in CFI’s Ultimate Cash Flow Guide)

Cash Balance: Cash on hand and demand deposits (cash balance on the balance sheet)

Cash Equivalents: Cash equivalents include cash held as bank deposits, short-term investments, and any very easily cash-convertible assets – includes overdrafts and cash equivalents with short-term maturities (less than three months).

1. Operating Cash Flow

Operating activities are the principal revenue-producing activities of the entity. Cash Flow from Operations typically includes the cash flows associated with sales, purchases, and other expenses.

The company’s chief financial officer (CFO) chooses between the direct and indirect presentation of operating cash flow:

• Direct Presentation: Operating cash flows are presented as a list of cash flows; cash in from sales, cash out for capital expenditures, etc. This is a simple but rarely used method, as the indirect presentation is more common.
• Indirect Presentation: Operating cash flows are presented as a reconciliation from profit to cash flow:

  The items in the cash flow statement are not all actual cash flows, but “reasons why cash flow is different from profit.”

  Depreciation expense reduces profit but does not impact cash flow (it is a non-cash expense). Hence, it is added back. Similarly, if the starting point profit is above interest and tax in the income statement, then interest and tax cash flows will need to be deducted if they are to be treated as operating cash flows.

  There is no specific guidance on which profit amount should be used in the reconciliation. Different companies use operating profit, profit before tax, profit after tax, or net income. Clearly, the exact starting point for the reconciliation will determine the exact adjustments made to get down to an operating cash flow number.

2. Investing Cash Flow

Cash Flow from Investing Activities includes the acquisition and disposal of non-current assets and other investments not included in cash equivalents. Investing cash flows typically include the cash flows associated with buying or selling property, plant, and equipment (PP&E), other non-current assets, and other financial assets.

Cash spent on purchasing PP&E is called capital expenditures (or CapEx for short).

3. Financing Cash Flow

Cash Flow from Financing Activities are activities that result in changes in the size and composition of the equity capital or borrowings of the entity. Financing cash flows typically include cash flows associated with borrowing and repaying bank loans, and issuing and buying back shares. The payment of a dividend is also treated as a financing cash flow.

Accounting Ratios

Accounting ratio is the comparison of two or more financial data which are used for analyzing the financial statements of companies. It is an effective tool used by the shareholders, creditors and all kinds of stakeholders to understand the profitability, strength and financial status of companies.

This is also widely known as financial ratios based on which business performance can be monitored and important business decisions are made.

1. Liquidity Ratio

Liquidity ratio helps in measuring the cash sufficiency of an enterprise to pay off its short-term liabilities. A High liquidity ratio ensures the company is in a good position to pay its creditors. The liquid ratio of 2 or more is considered acceptable. Listed below are some of the commonly used liquidity ratios:

Sl.No	Ratio Name	Formula	Used for	Detail
1	Current Ratio	{(Current Assets)/(Current Liabilities)}	1. One of the commonly used liquidity ratios is the current ratio which compares the current assets to current liabilities held by the business	Current assets include cash, inventory, accounts receivable etc
			2. This ratio is used to check if the company will be able to pay its debts which are due in next 12 months	Current liabilities include accounts payable, income tax payable and any other current liabilities
2	Quick Ratio	{(Quick Assets)/(Current Liabilities)}	1. It is similar to current ratio except that this uses only quick assets which are easy to liquidate.	To calculate the Quick assets, inventory and prepaid expenses which are difficult to liquidate are to be removed from the current assets.
			2. This is also known as Acid test
3	Cash Ratio	{(Cash + Marketable securities )/(Current Liabilities)}	1. This ratio considers only those current assets which are immediately available to the company to pay its debts.	1. This ratio considers only those current assets which are immediately available to the company to pay its debts.
			2. Business is considered as financially sound if it has a cash ratio of 1 or more.

2. Profitability Ratio

Profitability ratio is generally used to determine how well the business is generating profits from its operations. Profit is the balance of income earned after deducting all related expenses. Given below are some of the commonly used profitability ratios:

Sl.No	Ratio Name	Formula	Used for	Detail
	Gross Profit Margin	{(Revenue – Cost of Goods Sold (COGS))/(Revenue)}	1. Higher the gross profit margin, more efficient is the business operation.	Revenue is the sales income and COGS includes raw material, labour, and other production expenses
			2. Gross Profit ratio is used to compare the business performance with its previous period or even with its competitors
	Operating Margin	{(Gross Profits- Operating Expense)/(Revenue)}	1. Unlike Gross profit ratio, this includes more expenses and hence it is used to ascertain companies profitability more efficiently	From the gross profits, operating expenses such as selling and distribution cost, administration cost etc are deducted to arrive at operating margin
	Profit Margin	{(Revenue – Operating expense + non-operating income-Interest Expense- Income taxes)/(Revenue)}	1. This ratio helps an investor to know how much profit is generated from the total revenue of the business	As the formula itself explains, the profit margin is arrived from the revenue after adjusting all operating and non-operating expense and income
			2. The overall functional efficiency of an enterprise can be ascertained apart from its core business
	Earnings per Share (EPS)	{(Net Income – Preferred Dividend)/(Weighted Average Outstanding Shares)}	EPS is more important to shareholders since it helps in determining the return on investment	Generally weighted average Outstanding shares are used since outstanding shares can change over time
			Higher the EPS, higher is the stock price of the company	Sometime Diluted EPS are used which includes options, convertible securities and warrants outstanding which affects outstanding shares

3. Leverage Ratio

Leverage ratio measures the utilization of borrowed money by the business. It helps to identify the financial stability of the business by analyzing the total debt of the company.

Sl.No	Ratio Name	Formula	Used for	Detail
	Debt to Equity Ratio	{(Total Debt)/(Total Equity)}	1. Business with high debt Equity ratio indicates that it is more dependent on debts for operation	Total Debt includes both long term and short term debts held by the company.
			2. This is also known as Gearing ratio which is used by Investors and Creditors to analyze the company’s financial leverage
	Debt to Asset Ratio	{(Total Debt)/(Total Asset)}	1. Debt to Asset ratio can be used to determine if the business will be able to pay all of its debts if the business is closed immediately	It includes all the debt and assets of the company but there are different variations of this formula where only certain assets or specific liabilities are included
			2. A company having a debt to asset ratio of less than 1 is considered as good for investment. If the ratio is greater than 1, the company is considered as highly leveraged
	Debt Ratio	{(Total Liabilities)/(Total Asset)}	1. The liabilities to assets ratio is also known as solvency ratio indicates how much of a company’s assets are made of liabilities	Total long-term debt and total assets (tangible and intangible) are reported on the balance sheet are considered
			2. A high liability to assets ratio indicates the business might face potential solvency issues
	Interest Coverage Ratio	{(Earnings before interest and taxes (EBIT))/(Interest Expense)}	1. This ratio is used to measure the company’s ability to meet its interest –payment obligation	Net Income before deducting interest and taxes by the company’s interest expense and taxes are considered as a percentage on interest expense
			2. A higher ratio indicates a better financial position of the business

4. Activity Ratio / Efficiency Ratio

Activity ratio indicates the return generated from a particular type of asset using the sales, cost and asset data. This ratio helps the business to identify effective utilization of the assets and thereby facilitates efficient management:

Sl.No	Ratio Name	Formula	Used for	Detail
	Receivable Ratio	{(Annual Sales Credit)/(Accounts Receivable)}	1. Receivables Turnover ratio measures how soon the firms collect its receivables	For the ratio calculation, monthly average receivables and sales on credit terms are used generally
			2. A high receivable ratio indicates that the business sales collection process is working well	Average collection period can be determined using this ratio
	Inventory Turnover Ratio	{(Cost of Goods Sold)/(Average Inventory)}	1. It is used to ascertain the rate at which the company’s inventory is converted to cash	It is generally measured using inventory period which is the average inventory divided by average cost of goods is sold
			2. A company with higher inventory ratio is considered to have an effective sales strategy
	Asset Turnover Ratio	{(Net Revenue)/(Assets)}	1. This ratio indicates the value of revenue as a percentage of the value of investment	This can have different variants depending upon the asset category used for the calculation
			2. A higher ratio indicates better asset management and utilization by the business