MODULE 6 Financial Statements
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1 Introduction. 102 Projected Outcomes 103 Facilitators Notes. 104 What is Accounting. 104 The Accounting Equation Accounting Terminology 106 Assets 106 Liabilities. 106 Owner s Equity, Partner s Equity, Retained Earnings Revenue 106 Cost of Goods Sold Expenses Start-up Expenses Schedule Income Statement Balance Sheet. 109 Cash-Flow Basics
2 Introduction: Financial statements usually invoke feelings of fear and trepidation for the neophyte entrepreneur. This should not be the case; the majority of the work has already been completed in the previous modules. Research on how much rent will cost, what is the office supplies and equipment going to cost, and what will the labour cost. The importance of accounting in business cannot be overstated. Lenders, investors, and other stakeholders in your business will examine your financial statements and accounting procedures very carefully before getting involved with your business. Your financial plan will be highly scrutinized by the E-Spirit Team and Judges. The concepts and strategies you discussed throughout your entire business plan form the basis for, and should flow into, your financial statements and projections in some manner. When all is said and done it is all about if your business makes financial sense, will it make money and support any debt and growth? Team participants are in no way expected to provide professionally developed financial statements. This module was designed to increase participants awareness of accounting fundamentals, the role of financial statements in business planning, and basic financial statement preparation and presentation. Taxation issues will only be briefly discussed due to the complexity of the Revenue Canada Tax Code in relation to the Indian Act. Some Aboriginal businesses located onreserve may be tax-free. But no business located on reserve should consider itself taxation free until they are provided with a ruling from Revenue Canada. Basic accounting theory and practices have been included with this module to provide team members an accounting foundation. As with previous modules overhead transparencies have been provided. 102
3 Projected Outcomes: Upon completion of Module 6, participants will: Increase awareness of accounting role and importance in small business Understand the accounting equation Increase awareness of basic financial statements; Start-up Schedule, Income Statement, Balance Sheet, and Cash projections Increase awareness of accounting terminology Increase awareness of financial statement preparation 103
4 Facilitators Notes: Accounting is at the heart of almost every business decision. In fact, you must understand the basics of accounting if you want to understand business. Accounting is not difficult though, you must understand some terminology and understand bookkeeping basics; from the information gathered from keeping your books, financial statements can be prepared. Very few examples have been provided in this module. Excellent examples of the required financial statements have been provided on the E-Spirit website. What is Accounting: Have fun!!! Accounting is the process of recording, processing, classifying, summarizing, and interpreting financial transactions. These transactions include buying and selling of products or services, purchasing equipment/supplies, and receiving and paying out cash for expenses, wages, and income taxes. Transactions are grouped or classified by common characteristics such all purchases or sales. By classifying transactions, management or entrepreneur can extract information about different areas of their business over a given period of time. Information can be utilized to make decisions about the business. The methods for recording and summarizing accounting data are referred to as the Accounting System. Recording or journalizing accounting information can be done manually or by computer. But regardless of the method, understanding some accounting basics is a must!! Module 6 will only cover aspects of financial accounting. Financial accounting differs from managerial accounting in that financial accounting is done for people outside the business such as lenders, creditors, employee unions, customers, and investors. 104
5 Financial accounting and statement reports answer the following questions: Is the businesses income sufficient to carry debt, pay creditors, etc? Should we, Bank or other lender, lend this business money? Can the business afford employees? Can the business afford to pay rent? How much money will you require 6 months from now? Should we, suppliers, sell to your business? Financial statements provide a recorded history of how well your performed over a given period of time. Financial statements can be prepared monthly, quarterly, bi-annually, or annually. The majority of small business owners in Canada hire an accountant either full-time or on a casual basis to provide accounting expertise to their business. Financial statements will show sales increases/decreases, cost increases, overhead fluctuations, effectiveness of marketing, and changes in profit. Overhead transparencies and activities have been included. Some material may be not be relevant to your class in terms of accounting understanding. This module has been designed for the novice entrepreneur who has little or no accounting background. The Accounting Equation : At the core of all accounting transactions and records is a fundamental accounting equation: ASSETS = LIABILITIES + OWNERS EQUITY The basic accounting equation is derived from the double-entry accounting system. This is a standardized system around the world. 105
6 Accounting Terminology: Assets: Things of value owned by the business. Assets may include cash on hand or in the bank, accounts receivable, inventory, land, buildings, vehicles, patents, copyrights, etc. Current assets are items that can be converted into cash within one year. Fixed Assets are items required to produce the ventures products or services. Examples of fixed assets include buildings, land, equipment, etc. Liabilities: Liabilities simply stated are those de bts the business owes others. Liabilities may include accounts payable, bonds payable, notes payable, etc. Owners Equity, Partners Equity, and Retained Earnings: Owners equity includes all of the monies invested by the owners plus all profits accumulated since the business started but may not have been paid for. Owners equity refers to a sole proprietorship. In a partnership owners equity is referred to as Partners Equity or Capital. In a corporation owners equity is referred to as Shareholders Equity. Profit is distributed to shareholders by paying them dividends from any profits made. Any monies reinvested into the business are referred to as Retained Earnings. Revenue : Revenue accounts are where all income is recorded. Sources of revenue may include sales, rentals, commissions, royalties, interest earned, etc. 106
7 Cost of Goods Sold: The Cost of Goods Sold is used when a business venture sells products. This account shows all of the costs associated with selling the product. Costs may include inventory, transportation, purchases, purchase discounts, packaging, and marketing. Expenses: An expense refers to the costs incurred of running the business. Expenses may include rent, insurance, utilities, advertising, other? 107
8 Start-Up Expense Schedule: This section should prove to be very simple, as most of the legwork has been completed in previous modules. Start-up Schedules include all costs incurred, or projected to be incurred, to open your business venture. It is important not to underestimate start-up costs. If you are under capitalized in the beginning it will be very difficult to go back to your lender and ask for additional money to operate your business. Income Statement: E-Spirit requires pro forma statements for this section. Pro forma is just the term used to indicate these statements are projections of what is expected to take place. Income Statements demonstrate whether the business has earned any revenue or profit from operations. A business is said to have earned a Net Profit if revenue exceeds expenses, and if the business expenses exceed revenue the business would be in a Net Loss position. Income statements indicate business performance over a given period of time. For example, income statement titles will indicate that the Income Statement is for Year/Month Ending January 30, XXXX. 108
9 Balance Sheet: The Balance Sheet provides readers financial information as of a given date, not over a given time period, for the business venture in question. The balance sheet is also known as Statement of Financial Position. The balance sheet is frequently used by financial institutions to assist in ascertaining whether to loan money to a business. Comparisons can be made between the businesses assets and liabilities for the purpose of risk assessment, assessing business performance, and planning. Cash Flow Basics: Cash flow shows the movement of cash through your business. A Cash Flow Statement will de scribe the financial situation of a business. Poor cash flow management may lead to disaster. Planning your cash flow requires projecting : How much money you require over a given period of time When you will need the money How the money will be generated Where will you spend the money When will you spend the money Now make your dreams a reality, because you know how to plan, set goals and objectives, and what you are doing!!!!!!!!! 109
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