Chapter Outline

LO 8.1  Discuss the importance and uses of financial records in a small business.

You need financial records so you can make managerial decisions on topics concerning how much money is owed to your business, how much money you owe, and how to identify financial problems before they become serious dilemmas. Financial records are also needed to prepare your tax returns and to inform your banker and investors about your business’s financial status. Without accurate financial records, you cannot exercise the kind of clear-sighted management control needed to survive in a competitive marketplace.

LO 8.2 Itemize the accounting records needed for a small business.

The accounting records of your small business need to follow the standards of generally accepted accounting principles (GAAP). From your source documents, such as sales slips, purchase invoices, and check stubs, you should record all the transactions in journals. Information from your journals should then be posted in (transferred into) a general ledger. Financial statements like your balance sheet, income statement, and statement of cash flow are produced from the transactions in your general ledger.

LO 8.3 Explain the 11 ratios used to analyze financial statements.

Ratio analysis enables you to compare the financial condition of your business to its performance in previous time periods or to the performance of similarly sized businesses’ performance within your industry. Four important types of financial ratios discussed in this chapter are liquidity (current and quick, or acid-test, ratios), asset utilization (inventory turnover, average collection period, fixed asset turnover, and total asset turnover), leverage (debt and times interest earned), and profitability ratios (net profit margin, return on assets, and return on equity).

LO 8.4 Illustrate the importance of and procedures for managing cash flow.

Cash flow is the difference between the amount of cash actually brought into your business and the amount paid out in a given period of time. Cash flow represents the lifeblood of your business because if you do not have enough money to pay for your operating expenses, you are out of business.