Accounting Chapter 9 Teacher Notes

Financial Statments for a Proprietorship

Businesses create financial statements, or reports, to simplify information contained in the General Ledger they use to make business decisions.

Terms and Concepts:

  1. Adequate Disclosure: financial statements contain all the information needed to understand the business's financial condition (where they are at).
  2. Comparative financial statements: provide info for multiple fiscal periods to compare performance from year to year
  3. Interim financial statements allow businesses to evaluate progress every three months instead of waiting until the end of the fiscal year.
  4. Component percentage: relationship between a financial statement item and total sales.
    • Component percentages can be used to compare one reporting period or fiscal period to another, or they can used to compare one company with another
    • Detailed information on PowerPoint file

It is important that information transfers from one document to another accurately.

Recording dates on Financial Statements:

Income Statements compare REVENUE and EXPENSES in the same reporting period (Matching Expenses with Revenue).

There are four sections:

  1. Heading (Company Name, Income Statement, For Month Ended Month Day Year)
  2. Revenue
  3. Expenses
  4. Net income or loss

Balance Sheets report financial information on a specific date; show the current financial condition, or strength. Include ASSETS, LIABILITIES, AND OWNER'S EQUITY, all of the permanent accounts in the general ledger.

There are four sections:

  1. Heading (Company Name, Balance Sheet, Month Day Year)
  2. Assets
  3. Liabilities
  4. Owner's Equity

Statement of Cash Flows

This report shows changes in cash during the accounting cycle; the amount of cash that came in and the amount of cash that was paid out.

Calculating Current Capital:

Current Capital is the adjusted amount that goes on the Balance Sheet. The amount is adjusted to reflect changes in Owner's Equity during an accounting cycle.

When there is a Net Income:

Capital Account Balance + Net Income - Drawing Account Balance = Current Capital

When there is a Net Loss:

Capital Account Balance - Net Loss - Drawing Account Balance = Current Capital

Ratio Analysis is used to measure a business's financial performance during an accounting cycle; the information is often used to make management decisions and also to attract investors.

Profitablility ratios evaluate the earnings performance of a business during an accouonting period. From Investopedia:

A class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. For most of these ratios, having a higher value relative to a competitor's ratio or the same ratio from a previous period is indicative that the company is doing well.

Return on Sales measures the portion of each sales dolllar that represents profit for the business.

Net income ÷ Total Revenue (Sales)

Liquidity Measures show how easily an asset can be converted to cash. Cash is 100% liquid; buildings and equipment are a lot less liquid because it will take some time and effort to convert them to cash.

Liquity ratios measure a business's ability to pay its current debts.

Current Ratio compares assets and liabilities to determine a business's ability to pay its current debts. Investors looks for a current ratio of 2:1 (current assets is at least twice current liabilities) or higher.

Current Assets ÷ Current Liabilities = Current Ratio where Current Assets includes cash, receivables, and supplies.

Quick ratio measures a business's liquidity. 1:1 is considered adequate for most businesses.

Cash and Receivables ÷ Current Liabilities = Quick Ratio