Maria Hernandez the Company Did

Maria Hernandez

The company did not make a profit as Maria believed. The company had $47,000 in revenue, $33,000 in salaries and related operating expenses, plus rent. Even with that, the company also had non-cash items that should have been recorded, such as depreciation on the computer equipment and interest expense for the 6% she owed her father, even though it was not paid. The company's income statement would look more like this:

Revenues

COGS

Int exp

Supplies

Rent

Depr exp, equipment

Maria lost money during the first two months of business. That the cash in the bank account declined, however, does not have much to do with the question of whether or not Maria turned a profit. For example, much of the cash that was in the bank went towards the purchase of computer equipment. This shows on the income statement as a depreciation expense, the result is that the cash flow would more strongly negative than what shows on the income statement since the equipment is depreciated over three years. In addition, $5,500 of the new equipment has been paid for but has not had any amortization yet, and the other $5,500 of new equipment has not yet hit the books. The income statement also does not include September's rent, which has already been paid -- that will show on the balance sheet as an asset however. Additionally, $7,000 of the revenue remains as accounts receivable, and has yet to be converted to cash. The balance sheet will show that receivables, prepaid rent and inventories make up some of the current assets -- not all assets are in cash.

2) I would report the status of the business as above. The company lost $2,600 during the first two months of operations. The loss is not as great as the decline in cash, however, because much of the starting capital was converted into non-cash assets such as equipment, supplies, receivables and inventories. On balance, the company is probably doing fairly well, though it may wish to tighten its cash conversion cycle and ensure that revenue streams are steady before expanding further.

1) The purpose of an accounting journal is to track financial transactions, in particular cash outlays. This helps organizations in understanding their cash flows, in particular with respect to reconciling cash flow and the income statement. For many businesses, understanding their cash flow provides context for their operations. For example, Maria Hernandez did not understand why her cash decreased even though she thought she turned a profit. Cash spent is converted into a number of different assets, and it is important for a business to understand what it is spending and on what it is spending. Accounting journals allow for this information to be tabulated and compiled easily.

2) There are a number of factors for management to consider when deciding whether to switch from LIFO to FIFO. The change in accounting process will have an impact on the immediate year's profits, because it will adjust the cost of inventories. A LIFO reserve will need to be created to account for this change. So management must consider the impact of the transaction on the comparability of their income statements year-over-year. In addition, management must consider if FIFO is a better fit for their organization and the economic circumstances. LIFO, for example, will result in the highest estimate of COGS and the lowest net income during periods of inflation; FIFO will result in the lowest COGS and highest net income (Damodar, n.d.)

3) As an investor evaluating an investment in a company, there are a number of ratios with which I would be concerned, depending on the nature of the investments. As a debt investor, I would be most concerned with liquidity and solvency measures such as the current ratio, the debt-to-equity ratio and the interest coverage. I would also be concerned with these measures as an equity investor, along with several others. One is the return on equity and the return on investment. The price/earnings ratio is important for buying equity at the right price level. Also important is to analyze trends in the company's margins, and the company's efficiency ratios (asset turnover, inventory, turnover, receivables turnover).