Financial Accounting For Dummies. Maire Loughran

assets and borrowing money can never be construed as continuing events the way bringing in cash from selling goods or services can be.

      

Financial accounting, which is done on the accrual basis (see Chapter 6), does not show the cash ins and outs of business operations. The statement of cash flows gives the user of the financial statements a better idea of cash payments and receipts during the year in two ways:

       By eliminating the effects of accounts receivable and payable

       By showing cash brought in by means other than the continuing operations of the business and cash paid out for items outside the scope of continuing operations — for example, for the purchase of fixed assets

      Studying sections of the cash flow statement

      There are three sections on a statement of cash flows: operating, investing, and financing. Each section addresses cash ins and outs that the business experiences under completely different circumstances:

       Operating: This section shows items reflecting on the income statement. The three big differences between the cash and accrual methods (see Chapter 6) will be accounts receivable, which is money owed to the company by its customers; accounts payable, which is money the company owes to its vendors; and inventory, which are goods held by the business for resale to customers.

       Investing: This section usually shows the sale and purchase of long-term assets. The purchase of long-term assets reflects on the balance sheet (see Chapter 7). The sale of long-term assets reflects both on the balance sheet and income statement (see Chapter 10): It reflects on the balance sheet as a reduction of the amount of assets the company owns, and on the income statement as a gain or loss from disposing of the asset.

       Financing: The financing section shows the cash effects of long-term liability items (paying or securing loans beyond a period of 12 months from the balance sheet date) and equity items (the sale of company stock and payment of dividends).

      Seeing a short statement of cash flows

I show you a full-blown statement of cash flows prepared in accordance with generally accepted accounting principles (GAAP — see Chapter 4) in Chapter 11. In Figure 2-3, I give you a very abbreviated version of what a statement of cash flows looks like.

      FIGURE 2-3: A very basic statement of cash flows.

      

There are two different ways to prepare a statement of cash flows: the direct method and the indirect method. I show you how to prepare a statement of cash flows using each method in Chapter 11. For now, here’s what to remember:

       The direct method reports cash receipts and disbursements.

       The indirect method starts with net income from the income statement and adjusts for noncash items reflecting on the income statement such as depreciation, which is allocating the cost of long-lived assets over their useful life. (See Chapter 12 for more info about depreciation.)

Chapter 3

      Running the Numbers for Success

      IN THIS CHAPTER

      

Finding out the difference between business entities

      

Learning about small business reporting

      

Managing cash and expenses

      Students approach me every session I teach financial accounting to pick my brains about accounting for a small business. I’ve come to find out that a lot of people have a small gig running on the side to make extra money. Sometimes it’s because they want to completely transition from working for “the man” to self-employment. Other reasons include increasing savings, paying off student debt or planning for a big purchase like a house.

      To address this occurrence, in this chapter, you learn the difference between the two most common types of business entities selected by small business owners: sole proprietorships and S corporations. Hint: It’s because both are easy to set up and operate! I also discuss the difference in recording revenue and expenses between the two. To round it all out, I offer a brief introduction to the tax applications of both, which is expanded on in Chapter 18.

      There’s more! This chapter provides an overview of how to prepare and analyze financial statement data. You discover the difference between costs and expenses and why the distinction is important. The chapter also provides a walk-through on managing cash and preparing a bank reconciliation, a topic you’ll definitely be tested on in your financial accounting course!

Even if you aren’t interesting in accounting for your own business, this chapter is loaded with information relevant to financial accounting homework and test questions. And since every financial accounting course includes at least one chapter about cost accounting, I also go through the necessary lingo to ace that part of your financial accounting class!

Identifying Accounting Issues and Solutions

      Your financial accounting course goes into great detail about classification, interpretation and decision-making. Classification deals with how to properly enter an accounting transaction. Interpretation addresses the assumptions that can be made by viewing that accounting transaction. Decision-making flows from the classification and interpretation.

      This chapter discusses how this information is relevant to the internal user of the financial statements, particularly management and owners. It supports the decision to change vendors, add product lines, increase advertising and a myriad number of other forward and backwards actions. The object is usually to increase or maintain steady profits.

      

If you are hungry for more information about internal users, check out Chapter 6. The flip side of this coin are the external users of the financial statements, a topic covered in Chapter 2. In a nutshell, external users are those not privy to the day-to-day operations of the business.

Selecting a Business Entity

      In this chapter, I discuss the sole proprietorship and S Corporation, which are the two most popular small business entities. As an owner of the business, how you choose to operate your business directly affects how you classify transactions.