Cash is different from profits, but it is blood of the business. It is necessary to maintain cash as one can run business without profits but not without cash. Profits do not indicate the cash. It is key for any business to have cash by selling the products and services. In relation to depreciation, straight line method is used for the buildings and even for the equipment. However, government frequently changes the formula of depreciation as one of the formulae is 2x. Another formula is known as one and one-half times the declining balance. The businesses can use either straight line method or accelerated depreciation. Depreciation is a non-cash expense that will be decreased from the earnings.
Sometimes, there are some materials in the inventory that are of no use due to their expiration. Hence, there is a need to throw them out. In other words, they are needed to write off. In turn, the earnings will be reduced. In addition, the written off materials affect the tax liabilities. Now instead of charging them to expense side, one can write them off to ending inventory. The ending inventory will be zero in this case that means higher cost of goods sold and lower gross profits. In case of overstated earnings and written off inventory, the earnings will also be overstated. To know the soundness of the business, one can review the accounts receivables, assets, prepaid expenses like insurance policy, and inventory, etc.
Inventory is the most critical part of the business as the presentation of the inventory involves creativity. In case of buying or selling the business, an expert should be hired to determine the true value of the inventory. The taxes and suppliers are needed to pay that can be done by the collection of accounts receivables and other modes like cash. But, insurance policy can also be canceled to get a refund if there is a need of cash. For instance, one has $5 of original investment and $40 earnings that means total equity of $45. However, the cash is only $18 that indicates $27 are tied up in the assets like building and wagon. These assets have last positions in the balance sheet because they are difficult to liquidate in case of selling of business. If fixed assets are sold for more than book value, it indicates the profits. On the other side, if they are sold for less than book value there will be a loss.
In relation to summary of lessons learned, three financial statements have been learned such as balance sheet, income statement, and cash statement. Profits have been discussed thoroughly that can be ascertained by the fact that all three financial statements provide the picture of profit. It is identified that cash is the most important asset in the business to run daily operations smoothly. Profit on the other side is also measurable like cash but it is not real, but a theory. It can be understood by the example of lemonade stand. For instance, lemonade was sold and profit was made. Suppose, one of the customers who owed the owner $4 moved away from town or faced bankruptcy. In turn, profit of worth $4 disappeared. Hence, if the business has profits they can vanish in the future. It has also been learned that old inventory needs to be written off. As the lemons of worth $10 spoiled due to which they were thrown out. In turn, another $ 10 of the profits disappeared.
Moreover, in case the business does not work and one sold the wagon of worth $20 that means loss of $20. It indicates that profits are measurable and are used by the business to measure efficiency, productivity, and innovation. The profits are in terms of assets, cash, inventory, and fixed assets, etc. Increase and decrease of the assets show profits/loss. It is the amount by which sales of a business exceeds the costs of offering products/services. Trend analysis provides a notion of the sequence of profits/loss, costs and sales for a number of years that in turn helps to make effective decisions. In addition, ratio analysis is used to evaluate the performance of the business like net profit margin and sales turnover, etc. For instance, net profit to sales ratio decreased from 0.4 to 0.24 indicates the inefficiency of business to turn the sales into profits. Conclusively, it is important to measure the performance of the business through trend and ratio analysis to run the operations in an effective manner. In addition, it helps the business to make effective decisions regarding business operations.
Work Cited
Mullis, Darrell, and Judith Orloff. The Accounting Game: Basic Accounting Fresh from the Lemonade Stand. USA: Sourcebooks, Inc., 2008.
