you build your skills. You might want to keep it nearby. I t will come
i n handy whenever you are called on to analyze why your department
is over budget or when you want to know how well your company is
performing financially.
This book is divided into two sections. The first deals with basic
accounting concepts and financial statements. The second half cov-
ers the budgeting process.
Although you don't need to read the book in chronological
order, it might be helpful to do so, especially i f you are unfamiliar
with finance and accounting. Although each chapter is designed to
stand on its own, certain terms and phrases are introduced in one
chapter with subsequent chapters expanding on the topic.
After you read this book, you may find that there are certain top-
ics about which you're interested i n learning more. I f that's the case,
many resources are available. You can buy a book that discusses the
topic i n more depth or take an evening class at a nearby college.
Remember that this book is the starting point i n your journey to
I f numbers are the alphabet of the business world, then financial
evaluating and understanding financial health, not the end point.
statements and budgets are the books.
To be competitive i n today's marketplace requires a rudimentary
understanding of key finance and accounting concepts. This book
will help give you the financial knowledge you need to succeed at
yourjob.
For many managers, financial statements and budgets are a mys-
tery. I f you normally spend your workday planning marketing cam-
paigns or recruiting new employees, you probably don't look for-
ward to preparing your annual budget—or reading through your
company's financial statements.
But i t doesn't have to be that way.
With just a little effort on your part, you can become financially
literate. You may not be able to speak the language of finance fluent-
ly, but you can learn i t well enough to manage your way around.
The secret to success is that you don't have to learn everything
there is to know about finance and accounting. You only need to
learn enough to know the right questions to ask.
This book isn't designed to make you into a finance manager or
an accountant. Instead, it presents basic information that will help
, you b u i l d your skills. You might want to keep i t nearby. It will come
in handy whenever you are called on to analyze why your department
is over budget or when you want to know how well your company is
p e r f o r m i n g financially.
This book is divided into two sections. The first deals with basic
accounting concepts and financial statements. The second half cov-
ers the budgeting process.
Although you don't need to read the book in chronological
order, i t might be h e l p f u l to do so, especially i f you are unfamiliar
with finance and accounting. Although each chapter is designed to
stand on its own, certain terms and phrases are introduced i n one
chapter with subsequent chapters expanding on the topic.
After you read this book, you may find that there are certain top-
ics about which you're interested i n learning more. I f that's the case,
many resources are available. You can buy a book that discusses the
topic i n more depth or take an evening class at a nearby college.
Remember that this book is the starting point i n your journey to
If numbers are the alphabet of the business world, then financial evaluating and understanding financial health, not the end point.
statements and budgets are the books.
To be competitive i n today's marketplace requires a rudimentary
understanding of key finance and accounting concepts. This book
will help give you the financial knowledge you need to succeed at
yourjob.
For many managers, financial statements and budgets are a mys-
tery. I f you normally spend your workday planning marketing cam-
paigns or recruiting new employees, you probably don't look for-
ward to preparing your annual budget—or reading through your
company's financial statements.
But i t doesn't have to be that way.
With just a little effort on your part, you can become financially
literate. You may not be able to speak the language of finance fluent-
ly, but you can learn i t well enough to manage your way around.
The secret to success is that you don't have to learn everything
there is to know about finance and accounting. You only need to
learn enough to know the right questions to ask.
This book isn't designed to make you into a finance manager or
an accountant. Instead, i t presents basic information that will help
, • Depreciation/amortization: Depreciation is a system that spreads the
cost of a tangible asset, such as machinery, over the useful life of
the asset. Amortization is a system that spreads the cost of an intan-
gible asset, such as a patent, over the useful life of the asset.
• Fiscal year: A company's fmancial reporting year—for example,
July 1 to June 30. I n most cases the fiscal year is not the same as
the calendar year—that is, January 1 to December 31.
• Profit margin: This is profit—^what the company's owners keep
after paying all the bills—as a percentage of sales or revenue.
• Receivables/payables: Receivables are money owed to the company,
usually f o r goods and services. Payables are money the company
owes to others, including suppliers.
f or most people, the word credit brings to mind a line of credit that • Revenue/expenses: Revenue is income that flows into a company.
you can tap into at some future date or the amount that appears on Revenue includes sales, interest, and rents. The terms revenue,
your bank statement when you make a deposit. sales, and income are often used interchangeably. Expenses are
But to accountants, credit has another definition. It's a designa- costs that are matched to a specific time period, such as by
tion f o r the right-hand column of the double-ledger accounting sys- month. Cost is the price paid to acquire an asset.
tem. The left-hand side is known as the debit column. I n the double- The preceding list is only a starting point. Follow these sugges-
ledger system, debits and credits must be equal. tions to continue learning:
It's certainly not necessary—or even recommended—that you
Ask questions: I f you hear people use a term you're not sure
learn about or understand the double-ledger system. But it's useful
about, ask them what it means.
to know that when accountants use a term such as debit or credit
they may not be saying what you think they are. Keep educating yourself: The more you know, the easier it gets.
To make sure you're speaking the same language as finance people, Read business books and pubhcations.
here's a list of some commonly used finance and accounting terms: Uake four own list: As you come across other terms, j o t them i n
• Asset/liability: A n asset is an economic resource that a company the margins of this chapter so you can refer to them as needed.
owns. A liability is a resource that the company owes. Land and
machinery held by the company are assets, while debt is a liability.
• Book value/market value: Book value is, the amount of an asset or lia-
bility shown on the companies' official financial statements
based on the historical, or original, cost. Market value is the cur-
rent value of the asset or liability. I n most cases, book value does-
n't equal market value.
• Capital goods: These are machines and tools used to produce
other goods. For many companies, the purchase of capital goods
represents a major investment.
, As an example, imagine that you've inherited a httle money and
want to invest it i n a magazine publisher. You send f o r the company's
annual report and start reading the fmancial statements.
As you look at the balance sheet—one of the company's official
financial statements—you start to have misgivings about investing i n
the pubhsher because you notice a large liability balance. Most of
this, you note, is caused by deferred income, a term you've never
heard before. You're nof certain what i t is exactly but you assume i t
can't be good because habihties are always bad.
As it turns out, however, your assumption about deferred income
is wrong. I t actually represents prepaid magazine subscriptions and
is a source of revenue. Deferred income is common on financial
people with limited fmancial background, it's easy to make snap statements i n the publishing industry. I t appears as a liabihty because
judgments about the information presented i n fmancial statements. I n the publisher hasn't earned the income yet by putting out magazines
some cases, people make these judgments after only a cursory glance scheduled into the future.
at the numbers and the calculation of a few profit measures. Here are some sources you can contact i n your investigations o f
I f you really want to understand financial statements, however, financial statement information:
you must be willing to dig deeper than the numbers that appear on
Trade associations: Check to see i f your local public library has
the page. While learning some basic accounting concepts will help,
Gale's Encyclopedia of Associations. I n addition, many trade associations
just having this knowledge won't make you a sawy financial state-
have Web sites.
ment user. To become that, you'll need to be curious and follow up
on the numbers you see. McCOUnting societies: They offer information about proposed
As you read financial statements you might notice an unusual accounting rule changes that affect a variety of different industry.
number or trend. Instead of just letting i t go at that, it's important to Business pul]lisliers: There are numerous books that give indus-
investigate f u r t h e r and ask questions such as the following: try statistics and standards.
Is this really a trend, or is this a result of some change i n account-
ing procedure? When d i d this condition start? What's causing it? Is
the condition unique to this one company, or is i t happening to com-
petitors as well? The Bottom Line
For a complete picture of what is going on, you'll need to investi-
gate the company and the industry i n which i t operates. There are a When in doubt, chssk It out.
number of resources to help you, with the most obvious being the
company's annual report, which includes all the financial statements
as well as additional information about the company's long-term goals.
You'h also want to read business and industry publications, as it's
extremely important to understand industry norms and how certain
accounting procedures are handled i n a given industry.
, salaries, and it has used inventory valued at $5,000 during the peri-
od, although it has only been obhgated to pay f o r $1,000 worth of
inventory.
I f Nicko Corporation operates on a cash basis, i t might look hke
the example below.
Cash receipts $10,000
Cash disbursements
Inventory 1,000
Salaries 4,000
Total disbursements ($5,000)
Excess of receipts over disbursement $5,000
Now let's see how the same set of facts would look i f the compa-
ny used the accrual method of accounting.
Revenue $20,000
Expenses
Inventory 5,000
ike most things i n life, when i t comes to accounting, timing is Salaries 4,000
everything. T i m i n g is especially important when it comes to business Total expenses ($9,000)
transactions and how they are recorded on the financial statements. Net income $ 11,000
Businesses use two types of methods to record transactions: cash This report gives us more information. For example, i t makes i t
and accrual. The cash accounting method records transactions only clear how much inventory it took to produce sales of $20,000.
when money exchanges hands. Accrual accounting, on the other Here are key points to remember about accrual accounting:
hand, records transactions when the transaction is complete,
Matching principle: The accrual method matches revenues with
whether or not the transaction has been paid f o r yet.
associated expenses.
Small businesses often use cash accounting because of its simplic-
ity. For these businesses, revenue is recorded when the customer Timing: The accrual method records revenue that has been
pays and expenses are recorded when the company pays f o r them. earned but not paid and expenses owed but not paid.
However, most large businesses use accrual accounting, which is
Cash flow: The accrual method does not track cash inflows and
more complex than the cash basis. The purpose of the accrual
outflows.
method is to match revenues with the expenses that were used to
earn them. To accomplish this, transactions are recorded when an
economic event has occurred, such as a product being shipped or a
machine being repaired, rather than when they are paid. The B sitam Line
For example, let's say f o r the current accounting period Nicko
Corporation has booked orders worth $20,000 but actually has col-
mting reeords tmmaefioas wlien ihef tiappen; cash
lected $10,000 i n revenues. The company has expenses of $4,000 f o r
1na records transactioas wlien essh eliaages hands.
, For example, management may require accounts payable clerks
to match a supplier invoice with the receiving record and purchase
order so that the company only pays valid supplier invoices. The
auditor does testing to determine i f accounts payable clerks actually
p e r f o r m the control procedure.
The auditor checks to see i f invoices were properly matched with
the required documents. The testing is done on a random sample of
invoices. Depending on the sample results, the auditor may decide to
perform further testing to make sure that any lapses of improperly
matching invoices haven't resulted i n a material misstatement of
accounts payable.
The question of materiahty is an important one f o r auditors.
Throughout the audit process, auditors are constantly assessing
whether any errors would mislead users of the financial statements.
For instance, i f during an audit an auditor uncovers a computer
program making rounding errors that end up charging customers a
few cents more or a few cents less, the auditor would probably con-
#1s you read a company's annual report, you'll notice that it
sider this to be immaterial—in other words, inconsequential to the
includes an auditor's opinion about the company's financial state-
users of fmancial statements. However, i f it turns out that the pro-
ments. In many cases, people are confused about the role of the
gram's rounding errors have a large cumulative effect, the auditor
independent auditor
may decide that the miscalculation is material and ask the company
People often think that it's the auditor's job to verify that the
to revise the financial statements.
fmancial statements are accurate. But this isn't the case. I t would be
Here is some additional information about auditors:
extremely difficult f o r an auditor to be certain that financial state-
ments are accurate unless the auditing f i r m was responsible f o r Audit opinion: Auditors can give a "clean" opinion or a "qualified"
recording the transactions and then preparing the reports. A n d i f opinion about financial statements.
that were to happen, the auditor would no longer be independent. Internal versus external: Internal auditors are employees of the
I n their capacity as objective outsiders, auditors evaluate whether f i r m , while external auditors are independent t h i r d parties.
the financial statements present fairly the company's financial posi-
Auditor change: A change i n auditors by a company could be a red
tion and the results of its operations and its cash flows. They do this
flag, and the situation requires f u r t h e r investigation.
in several ways, including sending out letters to customers, suppliers,
and other entities and asking them to confirm financial information
that's recorded on the company's books.
Auditors also test internal control procedures. Companies estab-
lish controls to minimize the possibility of error and fraud. From the
auditor's viewpoint, some of the most important controls are those
that involve accounts with access to cash, such as accounts payable.
i n handy whenever you are called on to analyze why your department
is over budget or when you want to know how well your company is
performing financially.
This book is divided into two sections. The first deals with basic
accounting concepts and financial statements. The second half cov-
ers the budgeting process.
Although you don't need to read the book in chronological
order, it might be helpful to do so, especially i f you are unfamiliar
with finance and accounting. Although each chapter is designed to
stand on its own, certain terms and phrases are introduced in one
chapter with subsequent chapters expanding on the topic.
After you read this book, you may find that there are certain top-
ics about which you're interested i n learning more. I f that's the case,
many resources are available. You can buy a book that discusses the
topic i n more depth or take an evening class at a nearby college.
Remember that this book is the starting point i n your journey to
I f numbers are the alphabet of the business world, then financial
evaluating and understanding financial health, not the end point.
statements and budgets are the books.
To be competitive i n today's marketplace requires a rudimentary
understanding of key finance and accounting concepts. This book
will help give you the financial knowledge you need to succeed at
yourjob.
For many managers, financial statements and budgets are a mys-
tery. I f you normally spend your workday planning marketing cam-
paigns or recruiting new employees, you probably don't look for-
ward to preparing your annual budget—or reading through your
company's financial statements.
But i t doesn't have to be that way.
With just a little effort on your part, you can become financially
literate. You may not be able to speak the language of finance fluent-
ly, but you can learn i t well enough to manage your way around.
The secret to success is that you don't have to learn everything
there is to know about finance and accounting. You only need to
learn enough to know the right questions to ask.
This book isn't designed to make you into a finance manager or
an accountant. Instead, it presents basic information that will help
, you b u i l d your skills. You might want to keep i t nearby. It will come
in handy whenever you are called on to analyze why your department
is over budget or when you want to know how well your company is
p e r f o r m i n g financially.
This book is divided into two sections. The first deals with basic
accounting concepts and financial statements. The second half cov-
ers the budgeting process.
Although you don't need to read the book in chronological
order, i t might be h e l p f u l to do so, especially i f you are unfamiliar
with finance and accounting. Although each chapter is designed to
stand on its own, certain terms and phrases are introduced i n one
chapter with subsequent chapters expanding on the topic.
After you read this book, you may find that there are certain top-
ics about which you're interested i n learning more. I f that's the case,
many resources are available. You can buy a book that discusses the
topic i n more depth or take an evening class at a nearby college.
Remember that this book is the starting point i n your journey to
If numbers are the alphabet of the business world, then financial evaluating and understanding financial health, not the end point.
statements and budgets are the books.
To be competitive i n today's marketplace requires a rudimentary
understanding of key finance and accounting concepts. This book
will help give you the financial knowledge you need to succeed at
yourjob.
For many managers, financial statements and budgets are a mys-
tery. I f you normally spend your workday planning marketing cam-
paigns or recruiting new employees, you probably don't look for-
ward to preparing your annual budget—or reading through your
company's financial statements.
But i t doesn't have to be that way.
With just a little effort on your part, you can become financially
literate. You may not be able to speak the language of finance fluent-
ly, but you can learn i t well enough to manage your way around.
The secret to success is that you don't have to learn everything
there is to know about finance and accounting. You only need to
learn enough to know the right questions to ask.
This book isn't designed to make you into a finance manager or
an accountant. Instead, i t presents basic information that will help
, • Depreciation/amortization: Depreciation is a system that spreads the
cost of a tangible asset, such as machinery, over the useful life of
the asset. Amortization is a system that spreads the cost of an intan-
gible asset, such as a patent, over the useful life of the asset.
• Fiscal year: A company's fmancial reporting year—for example,
July 1 to June 30. I n most cases the fiscal year is not the same as
the calendar year—that is, January 1 to December 31.
• Profit margin: This is profit—^what the company's owners keep
after paying all the bills—as a percentage of sales or revenue.
• Receivables/payables: Receivables are money owed to the company,
usually f o r goods and services. Payables are money the company
owes to others, including suppliers.
f or most people, the word credit brings to mind a line of credit that • Revenue/expenses: Revenue is income that flows into a company.
you can tap into at some future date or the amount that appears on Revenue includes sales, interest, and rents. The terms revenue,
your bank statement when you make a deposit. sales, and income are often used interchangeably. Expenses are
But to accountants, credit has another definition. It's a designa- costs that are matched to a specific time period, such as by
tion f o r the right-hand column of the double-ledger accounting sys- month. Cost is the price paid to acquire an asset.
tem. The left-hand side is known as the debit column. I n the double- The preceding list is only a starting point. Follow these sugges-
ledger system, debits and credits must be equal. tions to continue learning:
It's certainly not necessary—or even recommended—that you
Ask questions: I f you hear people use a term you're not sure
learn about or understand the double-ledger system. But it's useful
about, ask them what it means.
to know that when accountants use a term such as debit or credit
they may not be saying what you think they are. Keep educating yourself: The more you know, the easier it gets.
To make sure you're speaking the same language as finance people, Read business books and pubhcations.
here's a list of some commonly used finance and accounting terms: Uake four own list: As you come across other terms, j o t them i n
• Asset/liability: A n asset is an economic resource that a company the margins of this chapter so you can refer to them as needed.
owns. A liability is a resource that the company owes. Land and
machinery held by the company are assets, while debt is a liability.
• Book value/market value: Book value is, the amount of an asset or lia-
bility shown on the companies' official financial statements
based on the historical, or original, cost. Market value is the cur-
rent value of the asset or liability. I n most cases, book value does-
n't equal market value.
• Capital goods: These are machines and tools used to produce
other goods. For many companies, the purchase of capital goods
represents a major investment.
, As an example, imagine that you've inherited a httle money and
want to invest it i n a magazine publisher. You send f o r the company's
annual report and start reading the fmancial statements.
As you look at the balance sheet—one of the company's official
financial statements—you start to have misgivings about investing i n
the pubhsher because you notice a large liability balance. Most of
this, you note, is caused by deferred income, a term you've never
heard before. You're nof certain what i t is exactly but you assume i t
can't be good because habihties are always bad.
As it turns out, however, your assumption about deferred income
is wrong. I t actually represents prepaid magazine subscriptions and
is a source of revenue. Deferred income is common on financial
people with limited fmancial background, it's easy to make snap statements i n the publishing industry. I t appears as a liabihty because
judgments about the information presented i n fmancial statements. I n the publisher hasn't earned the income yet by putting out magazines
some cases, people make these judgments after only a cursory glance scheduled into the future.
at the numbers and the calculation of a few profit measures. Here are some sources you can contact i n your investigations o f
I f you really want to understand financial statements, however, financial statement information:
you must be willing to dig deeper than the numbers that appear on
Trade associations: Check to see i f your local public library has
the page. While learning some basic accounting concepts will help,
Gale's Encyclopedia of Associations. I n addition, many trade associations
just having this knowledge won't make you a sawy financial state-
have Web sites.
ment user. To become that, you'll need to be curious and follow up
on the numbers you see. McCOUnting societies: They offer information about proposed
As you read financial statements you might notice an unusual accounting rule changes that affect a variety of different industry.
number or trend. Instead of just letting i t go at that, it's important to Business pul]lisliers: There are numerous books that give indus-
investigate f u r t h e r and ask questions such as the following: try statistics and standards.
Is this really a trend, or is this a result of some change i n account-
ing procedure? When d i d this condition start? What's causing it? Is
the condition unique to this one company, or is i t happening to com-
petitors as well? The Bottom Line
For a complete picture of what is going on, you'll need to investi-
gate the company and the industry i n which i t operates. There are a When in doubt, chssk It out.
number of resources to help you, with the most obvious being the
company's annual report, which includes all the financial statements
as well as additional information about the company's long-term goals.
You'h also want to read business and industry publications, as it's
extremely important to understand industry norms and how certain
accounting procedures are handled i n a given industry.
, salaries, and it has used inventory valued at $5,000 during the peri-
od, although it has only been obhgated to pay f o r $1,000 worth of
inventory.
I f Nicko Corporation operates on a cash basis, i t might look hke
the example below.
Cash receipts $10,000
Cash disbursements
Inventory 1,000
Salaries 4,000
Total disbursements ($5,000)
Excess of receipts over disbursement $5,000
Now let's see how the same set of facts would look i f the compa-
ny used the accrual method of accounting.
Revenue $20,000
Expenses
Inventory 5,000
ike most things i n life, when i t comes to accounting, timing is Salaries 4,000
everything. T i m i n g is especially important when it comes to business Total expenses ($9,000)
transactions and how they are recorded on the financial statements. Net income $ 11,000
Businesses use two types of methods to record transactions: cash This report gives us more information. For example, i t makes i t
and accrual. The cash accounting method records transactions only clear how much inventory it took to produce sales of $20,000.
when money exchanges hands. Accrual accounting, on the other Here are key points to remember about accrual accounting:
hand, records transactions when the transaction is complete,
Matching principle: The accrual method matches revenues with
whether or not the transaction has been paid f o r yet.
associated expenses.
Small businesses often use cash accounting because of its simplic-
ity. For these businesses, revenue is recorded when the customer Timing: The accrual method records revenue that has been
pays and expenses are recorded when the company pays f o r them. earned but not paid and expenses owed but not paid.
However, most large businesses use accrual accounting, which is
Cash flow: The accrual method does not track cash inflows and
more complex than the cash basis. The purpose of the accrual
outflows.
method is to match revenues with the expenses that were used to
earn them. To accomplish this, transactions are recorded when an
economic event has occurred, such as a product being shipped or a
machine being repaired, rather than when they are paid. The B sitam Line
For example, let's say f o r the current accounting period Nicko
Corporation has booked orders worth $20,000 but actually has col-
mting reeords tmmaefioas wlien ihef tiappen; cash
lected $10,000 i n revenues. The company has expenses of $4,000 f o r
1na records transactioas wlien essh eliaages hands.
, For example, management may require accounts payable clerks
to match a supplier invoice with the receiving record and purchase
order so that the company only pays valid supplier invoices. The
auditor does testing to determine i f accounts payable clerks actually
p e r f o r m the control procedure.
The auditor checks to see i f invoices were properly matched with
the required documents. The testing is done on a random sample of
invoices. Depending on the sample results, the auditor may decide to
perform further testing to make sure that any lapses of improperly
matching invoices haven't resulted i n a material misstatement of
accounts payable.
The question of materiahty is an important one f o r auditors.
Throughout the audit process, auditors are constantly assessing
whether any errors would mislead users of the financial statements.
For instance, i f during an audit an auditor uncovers a computer
program making rounding errors that end up charging customers a
few cents more or a few cents less, the auditor would probably con-
#1s you read a company's annual report, you'll notice that it
sider this to be immaterial—in other words, inconsequential to the
includes an auditor's opinion about the company's financial state-
users of fmancial statements. However, i f it turns out that the pro-
ments. In many cases, people are confused about the role of the
gram's rounding errors have a large cumulative effect, the auditor
independent auditor
may decide that the miscalculation is material and ask the company
People often think that it's the auditor's job to verify that the
to revise the financial statements.
fmancial statements are accurate. But this isn't the case. I t would be
Here is some additional information about auditors:
extremely difficult f o r an auditor to be certain that financial state-
ments are accurate unless the auditing f i r m was responsible f o r Audit opinion: Auditors can give a "clean" opinion or a "qualified"
recording the transactions and then preparing the reports. A n d i f opinion about financial statements.
that were to happen, the auditor would no longer be independent. Internal versus external: Internal auditors are employees of the
I n their capacity as objective outsiders, auditors evaluate whether f i r m , while external auditors are independent t h i r d parties.
the financial statements present fairly the company's financial posi-
Auditor change: A change i n auditors by a company could be a red
tion and the results of its operations and its cash flows. They do this
flag, and the situation requires f u r t h e r investigation.
in several ways, including sending out letters to customers, suppliers,
and other entities and asking them to confirm financial information
that's recorded on the company's books.
Auditors also test internal control procedures. Companies estab-
lish controls to minimize the possibility of error and fraud. From the
auditor's viewpoint, some of the most important controls are those
that involve accounts with access to cash, such as accounts payable.
