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Category: Business Activity

  • What is earnings per share


    Publicly traded companies must report earnings per share (EPS) below the net income line in their income statements. This is mandated by generally accepted accounting practices (GAAP). The EPS gives investors a means of determining the amount the business earned on its stock share investments. In other words, EPS tells investors how much net income the business earned for each stock share they own.

    It’s calculated by dividing net income by the total number of capital stock share. It’s important to the stockholders who want the net income of the business to be communicated to them on a per share basis so they can compare it with the market price of their shares. Private businesses don’t have to report EPS because stockholders focus more on the business’s total net income.

    Publicly-held companies actually report two EPS figures, unless they have what’s known as a simple capital structure. Most publicly-held companies though, have complex capital structures and have to report two EPS figures. One is called the basic EPS; the other is called the diluted EPS. Basic EPS is based on the number of stock shares that are outstanding. Diluted earnings are based on shares that are outstanding and shares that may be issued in the future in the form of stock options.

    Obviously this is a complicated process. An accountant has to adjust the EPS formula for any number of occurrences or changes in the business. A business might issue additional stock shares during the year and buy back some of its own shares. Or it might issue several classes of stock, which will cause net income to be divided into two or more pools – one pool for each class of stock. A merger, acquisition or divestiture will also impact the formula for EPS.

  • How to analyze a financial statement

    It’s obvious financial statement have a lot of numbers in them and at first glance it can seem unwieldy to read and understand. One way to interpret a financial report is to compute ratios, which means, divide a particular number in the financial report by another.

    Financial statement ratios are also useful because they enable the reader to compare a business’s current performance with its past performance or with another business’s performance, regardless of whether sales revenue or net income was bigger or smaller for the other years or the other business. In order words, using ratios can cancel out difference in company sizes.

    There aren’t many ratios in financial reports. Publicly owned businesses are required to report just one ratio (earnings per share, or EPS) and privately-owned businesses generally don’t report any ratios. Generally accepted accounting principles (GAAP) don’t require that any ratios be reported, except EPS for publicly owned companies.

    Ratios don’t provide definitive answers, however. They’re useful indicators, but aren’t the only factor in gauging the profitability and effectiveness of a company.

    One ratio that’s a useful indicator of a company’s profitability is the gross margin ratio. This is the gross margin divided by the sales revenue. Businesses don’t discose margin information in their external financial reports. This information is considered to be proprietary in nature and is kept confidential to shield it from competitors.

    The profit ratio is very important in analyzing the bottom-line of a company. It indicates how much net income was earned on each $100 of sales revenue. A profit ratio of 5 to 10 percent is common in most industries, although some highly price-competitive industries, such as retailers or grocery stores will show profit ratios of only 1 to 2 percent.




  • A Brief Description Of The Sole Proprietorship


    A sole proprietorship is the business or an individual who has decided not to carry his business as a separate legal entity, such as a corporation, partnership or limited liability company. The proprietorship business type is not a separate entity. Any time a person regularly provides services for a fee, sells things at a flea market or engage in any business activity whose primary purpose is to make a profit, that person is a sole proprietor.

    If they carry on business activity to make profit or income, the IRS requires that you file a separate Schedule C “Profit or Loss From a Business” with your annual individual income tax return. Schedule C summarizes your income and expenses from your sole proprietorship business activity.

    As the sole proprietor of a business, you have unlimited liability, meaning that if your business can’t pay all it is liable for, the creditors to whom your business owes money can come after your personal assets. Many part-time entrepreneurs may not know this, but it’s an enormous financial risk. If they are sued or can’t pay their bills, they are personally liable for the business incurred expenses and liabilities.

    A sole proprietorship has no other owners to prepare financial statements for, but the proprietor should still prepare these statements in order to keep abreast of how his business is doing. Banks usually require financial statements from sole proprietors who apply for loans. And a partnership needs to maintain a separate capital or ownership account for each of the partners.

    The total profit of the firm is allocated into these capital accounts, as spelled out in the partnership agreement. Although sole proprietors don’t have separate invested capital from retained earnings like corporations do, they still need to keep these two separate accounts for owners’ equity – not only to track the business, but for the benefit of any future buyers of the business.

    The question you should ask yourself when planning to start a business of your own is, which business type affords me the most protection under the law? And the answer to this question is most assuredly the general corporation; but along with the protection it provides to you, the business person (or CEO), comes the added responsibility of adherence to the law as well as your obligation to stock holders, if any. The decision could be an interesting one that may take some time to come to terms with.

  • Making Your Accounting Principles Acceptable




    It would be very easy for an employee to expect fair treatment from professionals within the company s/he’s employed with. To expect them to act within the precepts of the Golden Rule: “Do Unto Others as You Would Have Them do Unto You” which, if company management were to engage in such honorable behavior, workers would have little or nothing to worry about. But that’s not the case and therefore principles and systems must be employed.

    If everyone involved in the process of accounting followed their own system, or no system at all, there would be no way to truly tell whether a company was profitable or not. Most companies follow what is commonly referred to as GAAP (Generally Accepted Accounting Principles), and there are huge tomes in libraries and bookstores devoted to just this one topic.

    Unless a company states otherwise, anyone reading a financial statement can make the assumption that company has used GAAP. If GAAP is not the set of principles used for preparing financial statements, then a business needs to make clear which other form of accounting they have used and are bound to avoid using titles in its financial statements that could mislead the person examining it.

    GAAP is the gold standard for preparing financial statements and/or a financial report. Not disclosing that it has used principles other than GAAP makes a company legally liable for any misleading or misunderstood data. These principles have been fine-tuned over decades and have effectively governed accounting methods and the financial reporting systems of businesses.

    Different principles have been established for different types of business entities, such as for-profit and NFP (Not For Profit) companies/organizations, governments and other enterprises. GAAP is not cut and dried, however. They’re guidelines and, as such, are often open to interpretation. Estimates have to be made at times, and they require good faith efforts towards accuracy.

    You have probably heard the phrase “creative accounting,” which is when a company pushes the envelope a little (or a lot) too far to make their business look more profitable than it might actually be. This is also known as massaging the numbers, a practice that can spiral out of control and quickly turn into accounting fraud (or cooking the books). The results of these practices can be devastating and ruinous to hundreds and thousands of lives, as in the cases of Enron, Rite Aid and others.

  • Can Financial Window Dressing Help Your Business?


     

    Financial managers can do certain things to increase or decrease net income that’s recorded in the year. This is called profit smoothing, income smoothing or just plain old window dressing. This isn’t the same as fraud, or cooking the books, though, just in case that thought had crossed your mind.

    Most profit smoothing involves pushing some amount of revenue and/or expenses into other years than they would normally be recorded. A common technique for profit smoothing is to delay normal maintenance and repairs. This is referred to as deferred maintenance. Many routine and recurring maintenance costs required for autos, trucks, machines, equipment and buildings can be delayed, or deferred until later.

    A business that spends a significant amount of money for employee training and development may delay these programs until the next year so the expense in the current year is lower. A company can also cut back on its current year’s outlays for market research and product development.

    Some businesses might ease up on their rules regarding when slow-paying customers are written off to expense as bad debts or uncollectible accounts receivable. These businesses can put off recording some of their bad debts expense until the next reporting year.

    A fixed asset that is not being actively used may have very little current or future value to a business. Instead of writing off the un-depreciated cost of the impaired asset as a loss in the current year, the business might delay the write-off until the next year.

    You can see how manipulating the timing of certain expenses can make an impact on net income. This isn’t illegal although companies can go too far in massaging the numbers so that its financial statements are misleading. For the most part though, profit smoothing isn’t much more than robbing Peter to pay Paul.

    Accountants refer to these as compensatory effects. The effects next year offset and cancel out the effects in the current year. Less expense this year is balanced by more expense the next year. The important thing is knowing how far to push the envelope in these kinds of maneuvers and keep yourself and your company out of trouble with the IRS, ’cause that kind of a problem you just don’t need.

     

  • Is Disclosure Mandated to Complete Financial Reports?




    Financial statements are the backbone of a complete financial report. In fact, a financial report is not complete if the three primary financial statements are not included. but a financial report is much more than just those statements. A financial report requires disclosures. This term refers to additional information provided in a financial report.

    Therefore, any comprehensive and ethical financial report must include not only the primary financial statements, but disclosures as well.

    The chief executive of a business (usually the CEO in a publicly held corporation) has the primary responsibility to make sure that the financial statements have been prepared according to generally accepted accounting principles (GAAP) and the financial report provides adequate disclosures. He or she works with the chief financial officer or controller of the business to make sure that the financial report meets the standard of adequate disclosures.

    Some common methods of disclosures include:

    • Footnotes that provide information about the basic figures. Nearly all financial statements require footnotes to provide additional information for several of the account balances in the financial statements.
    • Supplementary financial schedules and tables that provide more details than can be included in the body of the financial statements.
    • Other information may be required if the business is a public corporation subject to federal regulations regarding financial reporting to its stockholders. Other information is voluntary and not strictly required legally or according to GAAP.

    Some disclosures are required by various governing boards and agencies. These include:

    • The financial Accounting Standards Board (FASB) has designated many standards. Its dictate regarding disclosure of the effects of stock options is one such standard.
    • The Securities and Exchange Commission (SEC) mandates disclosure of a broad range of information for publicly held companies.
    • International businesses have to abide by disclosure standards adopted by the International Accounting Standards Board.