Depreciation reporting

In an accountant's reporting systems, depreciation of a business's fixed assets such as its buildings, equipment, computers, etc. is not recorded as a cash outlay. When an accountant measures profit on the accrual basis of accounting, he or she counts depreciation as an expense. Buildings, machinery, tools, vehicles and furniture all have a limited useful life. All fixed assets, except for actual land, have a limited lifetime of usefulness to a business. Depreciation is the method of accounting that allocates the total cost of fixed assets to each year of their use in helping the business generate revenue.

Part of the total sales revenue of a business includes recover of cost invested in its fixed assets. In a real sense a business sells some of its fixed assets in the sales prices that it charges it customers. For example, when you go to a grocery store, a small portion of the price you pay for eggs or bread goes toward the cost of the buildings, the machinery, bread ovens, etc. Each reporting period, a business recoups part of the cost invested in its fixed assets.

It's not enough for the accountant to add back depreciation for the year to bottom-line profit. The changes in other assets, as well as the changes in liabilities, also affect cash flow from profit. The competent accountant will factor in all the changes that determine cash flow from profit. Depreciation is only one of many adjustments to the net income of a business to determine cash flow from operating activities. Amortization of intangible assets is another expense that is recorded against a business's assets for year. It's different in that it doesn't require cash outlay in the year being charged with the expense. That occurred when the business invested in those tangible assets.

Revenue and receivables

In most businesses, what drives the balance sheet are sales and expenses. In other words, they cause the assets and liabilities in a business. One of the more complicated accounting items are the accounts receivable. As a hypothetical situation, imagine a business that offers all its customers a 30-day credit period, which is fairly common in transactions between businesses, (not transactions between a business and individual consumers).

An accounts receivable asset shows how much money customers who bought products on credit still owe the business. It's a promise of case that the business will receive. Basically, accounts receivable is the amount of uncollected sales revenue at the end of the accounting period. Cash does not increase until the business actually collects this money from its business customers. However, the amount of money in accounts receivable is included in the total sales revenue for that same period. The business did make the sales, even if it hasn't acquired all the money from the sales yet. Sales revenue, then isn't equal to the amount of cash that the business accumulated.

To get actual cash flow, the accountant must subtract the amount of credit sales not collected from the sales revenue in cash. Then add in the amount of cash that was collected for the credit sales that were made in the preceding reporting period. If the amount of credit sales a business made during the reporting period is greater than what was collected from customers, then the accounts receivable account increased over the period and the business has to subtract from net income that difference.

If the amount they collected during the reporting period is greater than the credit sales made, then the accounts receivable decreased over the reporting period, and the accountant needs to add to net income that difference between the receivables at the beginning of the reporting period and the receivables at the end of the same period.

Balance sheet

A balance sheet is a quick picture of the financial condition of a business at a specific period in time. The activities of a business fall into two separate groups that are reported by an accountant. They are profit-making activities, which includes sales and expenses. This can also be referred to as operating activities. There are also financing and investing activities that include securing money from debt and equity sources of capital, returning capital to these sources, making distributions from profit to the owners, making investments in assets and eventually disposing of the assets.

Profit making activities are reported in the income statement; financing and investing activities are found in the statement of cash flows. In other words, two different financial statements are prepared for the two different types of transactions. The statement of cash flows also reports the cash increase or decrease from profit during the year as opposed to the amount of profit that is reported in the income statement.

The balance sheet is different from the income and cash flow statements which report, as it says, income of cash and outgoing cash. The balance sheet represents the balances, or amounts, or a company's assets, liabilities and owners' equity at an instant in time. The word balance has different meanings at different times. As it's used in the term balance sheet, it refers to the balance of the two opposite sides of a business, total assets on one side and total liabilities on the other. However, the balance of an account, such as the asset, liability, revenue and expense accounts, refers to the amount in the account after recording increases and decreases in the account, just like the balance in your checking account. Accountants can prepare a balance sheet any time that a manager requests it. But they're generally prepared at the end of each month, quarter and year. It's always prepared at the close of business on the last day of the profit period.

Assets and Liabilities

Making a profit in a business is derived from several different areas. It can get a little complicated because just as in our personal lives, business is run on credit as well. Many businesses sell their products to their customers on credit. Accountants use an asset account called accounts receivable to record the total amount owed to the business by its customers who haven't paid the balance in full yet. Much of the time, a business hasn't collected its receivables in full by the end of the fiscal year, especially for such credit sales that could be transacted near the end of the accounting period.

The accountant records the sales revenue and the cost of goods sold for these sales in the year in which the sales were made and the products delivered to the customer. This is called accrual based accounting, which records revenue when sales are made and records expenses when they're incurred as well. When sales are made on credit, the accounts receivable asset account is increased. When cash is received from the customer, then the cash account is increased and the accounts receivable account is decreased.

The cost of goods sold is one of the major expenses of businesses that sell goods, products or services. Even a service involves expenses. It means exactly what it says in that it's the cost that a business pays for the products it sells to customers. A business makes its profit by selling its products at prices high enough to cover the cost of producing them, the costs of running the business, the interest on any money they've borrowed and income taxes, with money left over for profit.

When the business acquires products, the cost of them goes into what's called an inventory asset account. The cost is deducted from the cash account, or added to the accounts payable liability account, depending on whether the business has paid with cash or credit.

Making a Profit

Accountants are responsible for preparing three primary types of financial statements for a business. The income statement reports the profit-making activities of the business and the bottom-line profit or loss for a specified period. The balance sheets reports the financial position of the business at a specific point in time, often the last day of the period. and the statement of cash flows reports how much cash was generated from profit what the business did with this money.

Everyone knows profit is a good thing. It's what our economy is founded on. It doesn't sound like such a big deal. Make more money than you spend to sell or manufacture products. But of course nothing's ever really simple, is it? A profit report, or net income statement first identifies the business and the time period that is being summarized in the report.

You read an income statement from the top line to the bottom line. Every step of the income statement reports the deduction of an expense. The income statement also reports changes in assets and liabilities as well, so that if there's a revenue increase, it's either because there's been an increase in assets or a decrease in a company's liabilities. If there's been an increase in the expense line, it's because there's been either a decrease in assets or an increase in liabilities.

Net worth is also referred to as owners' equity in the business. They're not exactly interchangeable. Net worth expresses the total of assets less the liabilities. Owners' equity refers to who owns the assets after the liabilities are satisfied.

These shifts in assets and liabilities are important to owners and executives of a business because it's their responsibility to manage and control such changes. Making a profit in a business involves several variable, not just increasing the amount of cash that flows through a company, but management of other assets as well.

Profit and Loss

It might seem like a no-brainer to define just exactly what profit and loss are. But of course these have definitions like everything else. Profit can be called different things, for a start. It's sometimes called net income or net earnings. Businesses that sell products and services generate profit from the sales of those products or services and from controlling the attendant costs of running the business. Profit can also be referred to as Return on Investment, or ROI. While some definitions limit ROI to profit on investments in such securities as stocks or bonds, many companies use this term to refer to short-term and long-term business results. Profit is also sometimes called taxable income.

It's the job of the accounting and finance professionals to assess the profits and losses of a company. They have to know what created both and what the results of both sides of the business equation are. They determine what the net worth of a company is. Net worth is the resulting dollar amount from deducting a company's liabilities from its assets. In a privately held company, this is also called owner's equity, since anything that's left over after all the bills are paid, to put it simply, belongs to the owners. In a publicly held company, this profit is returned to the shareholders in the form of dividends. In other words, all liabilities have the first claim on any money the company makes. Anything that's left over is profit. It's not derived from one element or another. Net worth is determined after all the liabilities are deducted from all the assets, including cash and property.

Showing a profit, or a positive figure on the balance sheet, is of course the aim of every business. It's what our economy and society are built on. It doesn't always work out that way. Economic trends and consumer behaviors change and it's not always possible to predict these and what income they'll have on a company's performance.

Basic Accounting Principles

Accounting has been defined as, by Professor of Accounting at the University of Michigan William A Paton as having one basic function: "facilitating the administration of economic activity. This function has two closely related phases: 

1) measuring and arraying economic data; and 

2) communicating the results of this process to interested parties."

As an example, a company's accountants periodically measure the profit and loss for a month, a quarter or a fiscal year and publish these results in a statement of profit and loss that's called an income statement. These statements include elements such as accounts receivable (what's owed to the company) and accounts payable (what the company owes). It can also get pretty complicated with subjects like retained earnings and accelerated depreciation. This at the higher levels of accounting and in the organization.

Much of accounting though, is also concerned with basic bookkeeping. This is the process that records every transaction; every bill paid, every dime owed, every dollar and cent spent and accumulated.

But the owners of the company, which can be individual owners or millions of shareholders are most concerned with the summaries of these transactions, contained in the financial statement. The financial statement summarizes a company's assets. A value of an asset is what it cost when it was first acquired. The financial statement also records what the sources of the assets were. Some assets are in the form of loans that have to be paid back. Profits are also an asset of the business.

In what's called double-entry bookkeeping, the liabilities are also summarized. Obviously, a company wants to show a higher amount of assets to offset the liabilities and show a profit. The management of these two elements is the essence of accounting.

There is a system for doing this; not every company or individual can devise their own systems for accounting; the result would be chaos!