Introduction

Accounting

What is Accounting?

Referring to the Introduction to Accounting - Year 1, Accounting is the systematic process of:

Recording
Summarizing
Analyzing
Reporting financial transactions and information

Why Accounting?

The primary purpose of accounting is to provide RELEVANT and RELIABLE financial information about the economic activites of an organization to the various stakeholders.

Stakeholders include (but not limited to):

Management (owners, directors, managers)
Investors
Creditors
Regulators
Public

Flavors of Accounting

Bookkeeping: Recording of financial transactions
Financial Accounting: FOR EXTERNAL USERS
Management Accounting: FOR INTERNAL USERS
Income Taxes Accounting

General / Financial Accounting

Process

Limits

Historical Focus: only records past transactions
Subjectivity: analysis relies on judgements
No Non-Financial Information: only records financial transactions
Lack of Forward Looking Information: only records past transactions and not future transactions
Complexity: accounting standards are complex
Aggregation: information is aggregated and not detailed
Lack of Timeliness: information is not available in real-time
Ignoring Intangibles: information only includes numbers and not intangibles
Manipulation & Fraud: information can be manipulated and fraudulent
Globalization Challenges: information is not standardized across the globe (GAAP vs IFRS)

Why ?

Performance Evaluation: to evaluate the performance of the organization, how well it is doing, how profitable, how efficient, etc.
Comparative Analysis: to compare the performance of the organization with other organizations in the same industry
Risk Assessment: to assess the risk of the organization, how risky it is to invest, how likely it is to go bankrupt, how reliable it is, etc.
Creditworthiness: to assess the creditworthiness of the organization, how likely it is to pay back its debts, how likely it is to default, etc.
Strategic Planning: to plan the strategy of the organization, how to grow, how to expand, how to invest, etc.
Investors Decisions: to help investors make decisions, whether to invest, how much to invest, etc.
Valuation, Investment Decision, And Capital Budgeting: to help investors value the organization, how much it is worth, how much it is expected to grow, etc.
Management Performance: to evaluate the performance of the management, how well they are doing, how well are they managing, how efficiently, etc.
Early Warning Signs: to identify early warning signs of the organization, how likely it is to go bankrupt, how likely it is to default, etc.
Regulatory Compliance: to comply with regulatory requirements, to comply with accounting standards, etc.

Account & Finance

Accounting = recording, summarizing and reporting the transactions.
Finance = planning, managing and controlling the resources using the accounting information.

Accounting vs Finance Image

Financial Analysis

What is Financial Analysis?

Financial Analysis is the process of evaluating the financial performance of an organization using the financial information.

It is used to assess the financial health of an organization, the financial strength, profitability, and efficiency of an organization.

Why?

Assessing financial performance: to assess the financial performance of the organization, how well it is doing, how profitable, how efficient, etc.
Evaluation financial health: to evaluate the financial health of the organization, how healthy it is, how strong it is, how likely it is to go bankrupt, etc.
Identifying financial trends: to identify financial trends of the organization, how it is doing, how it is growing, how it is performing in specific periods of time, etc.
Comparing performances: to compare the performance of the organization with other organizations in the same industry
Supporting investment decisions: to support investment decisions, whether to invest, how much to invest, etc.
Assisting credit decisions: to assist credit decisions, whether to lend, how much to lend, etc.
Facilitating strategic planning: to facilitate strategic planning, how to grow, how to expand, how to invest, etc.
Forecasting future performance: to forecast the future performance of the organization, how it is expected to grow, how it is expected to perform, etc.
Detecting financial distress: to detect financial distress of the organization, how likely it is to go bankrupt, how likely it is to default, etc.
Communication and reporting: to communicate and report the financial performance of the organization to the various stakeholders in a decision-making way

Types

Types of Analysis Image

Financial Statements

Income Statement

Revenues: the amount of money earned from selling goods or services
Cost: the amount of money spent to produce goods or services
Expenses: the amount of money spent to generate revenues

It is used to calculate the NET PROFIT AFTER TAXES of an organization. (metric of profitability)

The Income Statement is done over a period of time (usually a year or quaterly).

Income Statement Image

Balance Sheet

Assets: the resources owned by the organization
Liabilities: the debts owed by the organization
Equity: the amount of money invested in the organization

It is used to evaluate the position of an organization. (metric of financial strength)

The Balance Sheet is done at a specific point in time (usually at the end of the year or quaterly).

Balance Sheet Image

Cash Flow Statement

Cash Flow From Operating Activities: the amount of money generated from the operations of the organization
Cash Flow From Investing Activities: the amount of money generated from the investments of the organization
Cash Flow From Financing Activities: the amount of money generated from the financing of the organization

It shows how changes in the balance sheet and income statement affect cash and cash equivalents. (metric of liquidity)

It is used to evaluate the liquidity of an organization. (metric of financial health)

The Cash Flow Statement is done over a period of time (usually a year or quaterly).

Cash Flow Image

Classic