Financial Accounting

Jun 04,2008 00:00 by admin

Financial Accounting

An understanding of balance sheet math is needed in order to proceed. For project managers not familiar with the balance sheet idea from the domain of financial accounting, here is a quick overview. First, the balance sheet is nothing more than a graphical or tabular way to show a numerical relationship: y = a + b. However, this relationship is not functional since all three of the variables are independent and, because of the equality sign, a relationship exists among the three that makes them interdependent as well. Thus, a change in one requires a change in another to maintain equality among the three. This equality is called "balance" in the accounting world, and the process by which if one variable changes then another must change in a compensating way to maintain balance is called "double entry accounting."

Second, accountants would understand the equation this way: assets ("y") = liabilities ("a") + equities ("b"). That is their "accounting equation." If assets increase, then so must either or both liabilities and equity increase in order to maintain balance. In fact, any change in the variables must be compensated by a change in one or two of the other two variables.

There is an important business concept to go along with the math: assets are property of the company put in the custody of the company managers to employ when they execute the business model. Assets are among the resources to be used by project managers to execute on projects. Assets are paid for by liabilities (loans from outsiders) and capital, also called equity. Equity is the property of the owners and liabilities are the properties of the creditors of the company. Thus, some stakeholders in the project arise naturally from the accounting equation: the financiers of the assets! As noted, these are the suppliers (accounts payable liabilities), creditors (long-term and short-term notes), and owners or stockholders (equity owners).

An asset cannot be acquired — that is, its asset dollar value increased — without considering how its acquisition cost is to be paid (increase in liability or capital, or sale of another asset). An asset cannot be sold — that is, its dollar value decreased — without accounting for the proceeds. Typical assets, liabilities, and equity accounts are shown in Table 1-2. A balance sheet for a small company is shown in Table 1-3.

Table 1-2: Balance Sheet Example

Assets

Liabilities and Capital Employed

Current Assets

Current Liabilities

Cash on hand

$10,000

Vendor payables

$3,000

Receivables

$40,000

Short-term notes

$35,000

Finished inventory

$15,500

Work in process

$5,500

Long-Term Assets

Long-Term Liabilities

Buildings

$550,000

Mortgages

$200,000

Software and equipment

$250,000

Supplier loan

$35,000

Equities or Capital Employed

Capital paid in

$400,000

Retained earnings

$170,000

Stock ($1 par)

$98,000

Total Assets

Total Liabilities and Equities

$906,000

Notes

Cash on hand is money in the bank.
Receivables are monies owed to the business on invoices.
Finished inventory is tangible product ready to sell.
Work in process is incomplete inventory that could be made available to sell within one year.
Buildings, equipment, and software are fixed assets that are less liquid than current assets. Software is usually considered an asset when the capitalized development, purchasing, or licensing cost exceeds certain predetermined thresholds.
The supplier loan is money loaned to a supplier to finance its operations.

Notes

Vendor payables are invoices from vendors that must be paid by the business, in effect short-term loans to the business.
Short-term notes are loans due in less than a year.
Mortgages are long-term loans against the long-term assets.
Capital paid in is cash paid into the business by the stockholders in excess of the par value of the stock.
Retained earnings are cumulative earnings of the business, less any dividends to the stockholders.
Stock is the paid-in par value, usually taken to be $1 per share, of the outstanding stock. In this case, there would be 98,000 shares in the hands of owners.

Table 1-3: Balance Sheet Accounts

Assets

Liabilities and Capital Employed

Current Assets

Current Liabilities

Cash in checking and savings accounts

Monies owed to suppliers

Monies owned by customers (receivables)

Short-term bonds or other short-term debt

Inventory that can be sold immediately

Long-Term Assets

Long-Term Liabilities

Overdue receivables

Mortgages

Loans to suppliers

Long-term bonds

Investments in notes, real estate, other companies

Overdue payables

Plant and equipment

Equity

Software (large value)

Cash paid in by investors for stock

Retained earnings from operations and investments

Notes

Current assets are generally those assets that can be turned into cash within one year. Some companies may assign a shorter period.
Long-term assets are less liquid than current assets, but nevertheless have a cash value in the marketplace.
The dollar value of all accounts on the left side must equal the dollar value of the accounts on the right side.

Notes

Current liabilities are generally those due and payable within one year. Some companies may assign a shorter period.
Long-term liabilities are less liquid than current liabilities, but nevertheless have a cash value in the marketplace.
Equity is the monies paid in by owners or monies earned from operations and investments. These funds finance the assets of the business, along with the liabilities.