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Book Notes: The Accounting Game

Read On: Feb 19, 2014
Reading Time: 5 hours
Rating: 8/10

Summary

The Accounting Game presents financial information in a simple format. Using the world of a child’s lemonade stand to teach the basics of managing your finances, this book makes a dry subject fun and understandable. As you run your stand, you’ll begin to understand and apply financial terms and concepts like assets, liabilities, earnings, inventory and notes payable.

Notes

  • Assets = Liabilities + Owner’s Equity
  • A Balance Sheet is a snapshot in time. It connects things to people.
    • Inventory is considered as an asset. It can include raw materials, goods in progress as well as finished goods.
    • Gross Profit = Sales - Cost of Goods Sold (COGS).
      Gross Profit goes under “Earnings Week To Date” under Owner’s Equity.
    • Net Profit (Bottom Line/ Net Income/ Earnings) = Gross Profit - Expenses.
    • “Expenses” are the costs of doing business other than those related to producing the product. They come out of “Earnings Week to Date”.
    • In Liabilities, Notes Payable should be long term and have interest associated with them. Accounts Payable should be short term. Interest expense shows up in the Income Statement as a cost of doing business.
    • Accounts Receivables refers to money we are going to get soon. If something goes wrong and we do not receive it, it should be taken out of Earnings.
    • An expense is an Asset when we pay it in advance and it has value in future accounting periods (e.g prepaying for insurance).
  • Income Statement (Operating Statement/ Profit & Loss Statement) looks at a record of events happening over a period of time. It is a detailed view of the Earnings Week to Date on the Balance Sheet.
  • 2 methods of Accounting
    • Accrual Method: We account for everything as it accrues/happens (whether or not we paid any cash). Creates an accurate measure of a company’s financial position even though the cash has not been settled. It is more favorable to show this to banks/investors since it has more profit.
    • Cash Method: You account for things ony when they happen in cash. Can be benefical since you can defer some tax to next year when you pay it with inflated dollars. A company with inventory can’t use the Cash Method.
    • One can do both kinds of accounting (Accrual for investors and Cash for IRS). This is known as Creative Accounting.
  • 2 methods of valuing inventory. A company declares the method it uses in the footnotes of its financials.
    • FIFO: First In First Out
    • LIFO: Last In First Out. This can result in low net profit on paper if the cost of raw products increases with time. This would allow one to defer some taxes.
  • Cash Flow Statement: Only records the movement of cash in a given period.
  • Fixed Asset: Property/Equipment acquired that is not intended for sale and is used over and over again in the course of doing business. These are added to Balance Sheet (capitalized) and not expensed on Income Statement.
    • Depreciation: Decrease in value of fixed assets over time due to wear and tear. You can’t depreciate land. It is a non-cash expense. The advantage is that it reduces earnings and taxes without reducing cash. 2 methods:
      • Straight Line: Used for buildings.
      • Accelerated: Can be used for equipment. Ends up saving current tax dollars in exchange for future tax.
  • Cash helps run the business on a daily basis. You cannot spend earnings, you can only spend cash. The earnings are tied up in assets/inventory/equipment. It is very important to keep cash around. Profits are theoretical and do not equal Cash. Profits are a good objective measure of efficiency, productivity and innovation.
  • Rather than looking at absolute numbers for different accounting periods, it is better to look at ratios (and do Trend Analysis) and see the cost/profit for each dollar of revenue. Sometimes you can find out your competitors ratios using record of Industry Ratios (Dunn & Bradstreet/ Robert Morris & Associates)

Thoughts

I have minimal knowedge about Accounting. This was a great 101 level book (small size, large fonts, lots of pictures and simple lemonade stand example used throughout) to familiarize myself with the basic vocabulary.

P.S More Book Notes here.

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